Silvergate Capital Stock: Depositors at the Gates (NYSE: SI)
silver gate (NYSE:IF) has serious red flags that need to be addressed. The company lost at least $1 billion (8.1%) in deposits between the end of Q3 2022 and its November 15 update. In addition, there is an extremely high percentage of deposits from digital banking customers and an absurd concentration of deposits from the top 10 customers. On the asset side, much attention is paid to the SEN$205 million leveraged loan to MicroStrategy (MSTR), but little attention is paid to the company’s other loans and the creditworthiness of its borrowers.
At the end of Q3 2022, SI had $13.2 billion in total deposits, of which $11.9 billion was held by digital asset customers. In a press release dated Nov. 11, SI revealed that FTX accounted for less than 10% of deposits in Q3 2022, implying that non-digital deposits were $1.4 billion in Q3 2022. SI said revealed that AVERAGE quarterly filings to date totaled $9.8 billion. Assuming non-FTX digital deposits amount to $9.8 billion on November 15, 2022 and non-digital and FTX deposits have not changed since Q3 2022, this would imply that total deposits have decreased of at least $1 billion, or 8.1%, which is a big outflow in a half-quarter.
(all figures are in thousands of dollars)
Additionally, it is suspected that SI released the numbers on AVERAGE instead of ending the filings. Market volatility has been particularly pronounced in crypto since early November and I think it is likely that deposits today are much lower than shown using an average.
Another major red flag is that the top 10 clients account for 47.9% of TOTAL DEPOSITS as of September 30, 2022. That’s $6.3 billion. Although it is not known who these 10 clients are – 8 clients are on the SEN Exchange – FTX (FTT-USD) network; Coinbase (COIN); Paxos; Crypto.com; Gemini; Kraken; timestamp; and cycle. In the week ending November 14, 2022 alone, users collected $3.7 billion worth of Bitcoin and $2.5 billion worth of Ether. If SI is the bank of choice, where will that money ultimately come from? One of the downsides of having a banking monopoly over crypto infrastructure built on assets that I believe are worthless (another discussion) is that this ecosystem becomes vulnerable to complete collapse.
When exchanges face withdrawals, they send money back to clients. Exchanges withdraw deposits from Silvergate to do this and Silvergate must sell assets to provide this liquidity. Looking at the balance sheet from the company’s recent appeal report and filings, the assets look pretty good at first glance – the company has $13.3 billion in cash and cash equivalents and securities.
(in thousands of dollars, unless otherwise indicated)
However, SI would likely take realized losses to sell securities to cover drawdowns. There have been numerous articles mentioning that SI holds AA+ designations. But I think, in practice, if SI is hit by, say, $6 billion in withdrawals, it should immediately sell at least $4 billion of on-demand securities, and many of the securities they trade n don’t have that kind of volume. Non-Agency CMBS has $1 billion ADV; ABS has $2.1 billion ADV. Moreover, rising yields had depressed the price of even the highest-rated bonds. In the following example, consolidated total assets are reduced by $3.12 billion, a 20% discount to average consolidated total assets. I assume that SI would have to bear $1 billion of loss realized on the sale of securities to cover the withdrawals. In this case, Tier 1 capital will be reduced to 5.1%, compared to 12.1% for the banking sector as a whole.
The loan portfolio also presents concerns: in particular the sensitivity to interest rates and the credit quality of the borrowers. A large portion of their loan portfolio is marked as held for sale. These loans have likely suffered significant losses since mortgage rates have almost doubled. According to the call report, 27.5% of residential loans are adjustable mortgages, which means that 72.5% of loans are fixed rate loans. Who are these mortgages granted to? If Silvergate is the digital currency bank, it would be safe to assume that most of these mortgages are granted to clients who derive income and wealth from digital currencies, which have plummeted in value. SI should disclose the credit ratings and delinquencies of its loan portfolio.
Finally, the SEN Leverage loan granted to MicroStrategy is attracting a lot of attention. This loan is $205 million and is secured against 30,051 Bitcoin, or a loan per Bitcoin of $6,822. In a scenario where Bitcoin drops to $1,000 per coin, the loan will have a salvage value of approximately $30 million. Under the terms of the loan agreement, MicroStrategy must maintain the LTV of this loan at 50% or must retain $410 million worth of Bitcoin as collateral. At the price of $1,000 Bitcoin, MicroStrategy would need to deposit an additional 380,000 Bitcoins on Silvergate. Unfortunately for Silvergate, MicroStrategy owns 130,000 Bitcoins, of which 115,110 are held by MicroStrategy, LLC, the borrower of the SEN loan. I think a drop in Bitcoin below $3,561 per coin would likely cause MicroStrategy to file for bankruptcy.
Below is the potential liquidation value of the loan portfolio. This analysis assumes that there is a bank run and that SI must sell assets at current prices.
(in thousands of dollars, unless otherwise indicated)
Note: I am not a banking analyst, just a curious crypto-skeptic. I could be completely wrong, and in theory, SI could support large withdrawals without writing Tier 1 capital. Most of the numbers are from the appeal report filed with the Federal Financial Institutions Examination Council. All figures are in thousands of dollars.