Why I Added To Silvergate After 45.33% Crash (SI)

recep-bgIt's a horrible feeling to be long Silvergate (NYSE.SI) and then see it fall 49% in one day. This is after a prolonged period of declining momentum. Today is not looking good. Data from YChartsThe collapse occurred because Silvergate published a business update revealing that it had lost 70% of its deposits. Although everyone knew that they were losing deposits and I doubt anyone thought they would lose as many, it was not what they expected.
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It seems that a downward correction is more than necessary. It's absurd to defend a company when it's releasing bad news such as this, and where there's more bad news (opinions may differ as to how bad it will get). These are times that you will remember for three years.
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Silvergate will be much higher than it is now, will it drop to zero or will it remain at this level? My view is that Silvergate will rise significantly in the next three years if I can distance myself from the outrage and chaos. Recognizing the challenges ahead, I understand that it might not work out if there are any wrongdoings or regulators trying to undermine the business' future. It is important to me that Silvergate encouraged customers, primarily digital asset companies, to make deposits elsewhere if they were not actively using the capital.
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Silvergate didn't pay any interest on digital asset customer deposits. Therefore, the capital had to be used in a more productive way than the short-term yield customers could get elsewhere. The deposit base had a volatile past, with its value fluctuating quite wildly. They prepared for this with an excellent balance sheet loaded with liquid government-guaranteed or backed securities
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Silvergate customers love the services it provides. They also see value in the SEN Network (which allows them to trade dollars). Customers may be a little scared of crypto companies popping up all around the world and all the rumors about Silvergate (go to Twitter and search $SI there) FDIC insurance does not cover large amounts of money that enterprise customers deposit.
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I was apprehensive that enterprise customers would not be easily scared away, and that trading firm deposits wouldn't be too sticky. The chaos in crypto means huge trading opportunities for market makers-type firms and arbs. I was wrong. 70% of my deposits were withdrawn
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Deposits are usually lost at a bank in a disaster. It is difficult to get them back once they are gone. They will not be attracted to you if they are offering high returns.
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Ideally, a bank wants low-cost, sticky deposits. Silvergate's situation is unique. Customers don't come to Silvergate because of the yield, or because they are familiar with the brand.
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Because of the SEN network, and their specialization in providing digital asset customers with bank services, they are available. It is difficult to find this information. If it is clear that Silvergate is sound, deposits may return quickly
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This latest PR should make it clear that Silvergate is sound. The bank has more cash than is required to cover the deposits of digital asset customers. The bank's latest deposit figure was slightly higher that the absolute bottom. This may indicate deposits are beginning to rebound.
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The remaining deposits are likely to be the most sticky. These customers are most likely to benefit from Silvergate's services the most. This company is not for you if you don't believe crypto will play any role in the future.
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Digital assets are, in my opinion, the future. That's why I see this site as valuable. Yesterday's press release had a lot more information. A long call was also held by the company, which is worth listening to. They provided lots of color and additional information.
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Without sounding delusional, I'll briefly review the "positive" takeaways of the business update. These quotes are taken directly from the PR and the call transcript. My discussion follows between. The Silvergate Exchange Network Platform continues its 24/7 operation with an average daily volume of $1.3B in Q4 as compared to $1.2B in the Q3 period.
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It seems that the volume has increased by a small amount. But, deposits fell by 70%. This suggests that trading volume, which was done by the remaining customers, has exploded.
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This is consistent with my expectation that remaining customers will continue to benefit from the SEN network and be more loyal customers. As of December 31, 2022, cash and cash equivalents were $4.6B. This is in addition to deposits from digital asset customers
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Customers should know that their funds are protected and they can withdraw their money at any time. Silvergate (SI), which sold $5.2B worth of debt securities to cash proceeds during Q4, 2022, suffered a $718M loss on the sale securities and derivatives. This loss appears to be primarily due to losses on the bond portfolio, which were present prior to this deposit run.
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Selling assets to pay redemptions forces the company recognize these losses in its financials and not just in the 10-K discussion. This is mostly due to the Fed raising rates and banks, including Silvergate, taking a hit at the long end their existing bond portfolios. Accounting rules permit you to classify these bonds/loans as HTM or held-to maturity. This means that you assume you will get your full amount back at the end.
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You must mark these to the market if you are unable to apply HTM in a realistic way, such as when 70% of your deposits are pulled. The economic loss existed in real life regardless of whether accounting reflects it. This is some color from this call:
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Late in the fourth quarter, we made the decision that we did not have the ability or the intention to continue holding securities previously classified as held-to maturity. This was quite obvious considering that we were selling a large portion of our securities portfolio. As I have already mentioned, we are likely to sell more securities here in 2023 in order to further reduce wholesale borrowings.
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To make sure that nobody is double-counting, you can look back at the mark on September 30's available sale portfolio and then look at the mark in the HTM portfolio. This was disclosed in our 10-Q. You could also assume that all that is now -- has either been realized by the $700-plus millions of loss or is included in the remaining approximately $300 million mark on the portfolio. Another observation from the call is: The company had $5.6 billion worth of total debt securities at fair values as of December 31, 2022. All of these are U.S.
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These securities are available for sale and are agency-backed. They also have unrealized losses of approximately $1.3 billion. To reduce wholesale borrowings, the company plans to sell a portion of these securities by early 2023. This will result in an impairment charge for fourth quarter due to unrealized losses on securities that are expected to be sold. We will continue to assess our liquidity management and balance sheet needs. This will be dependent on customer behavior and deposit flow.
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The company anticipates paying back wholesale deposits. They have been attracting nondigital assets customers with high rates to raise deposits (in order to reduce the need for selling securities). This is extremely high-cost funding and they would prefer to get rid of it under stable conditions.
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This suggests that they anticipate more stable conditions for the next quarter. However, they are not saying they expect to sell digital assets to cover their current financial obligations. Last but not least, I want to emphasize the following comment that Alan made during the call: There was a crisis in confidence and a lack trust in the industry in the fourth quarter. We had clients who were market makers and proprietary traders that had been doing business for 6-8 years. They stopped doing business together and took all of their deposits.
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Some clients moved -- these crypto-native companies moved almost entirely into U.S. Treasurys. That was the kind of dynamic that occurred in the fourth quarter
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We were speaking with clients and asked them "Hello, when can you move to a risk-on role?" They couldn't really tell us. Despite that, there weren't any clients who said they were leaving the space. We don't know if there will be any that do.
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Our clients supported Silvergate, despite having to withdraw their deposits. Given the circumstances, we decided to take this action. And -- but they seemed committed to the space, and ready to return when market conditions are right
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The company provided this feedback (hence, with a bullish bias) to confirm my suspicion that deposits are more likely than if they were left at a normal bank. Data from YChartsIf crypto is dangerous or uninvestable to you, then I don't see any reason why this bank makes sense. I don't like the idea of buying this bank at book value.
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The deposit news was horrible, but the business update is clear and has survived a great run. Today's Financial Times article stated that the company had decided to retrench. It may be able to find a way to survive, unlike other cryptocurrency-related companies.
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However, its reputation will not survive. Its reputation won't survive, but I don't agree with it. Given the bank run it went through, I think its reputation should be improved.
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A run that was not entirely necessary, but encouraged by social media is my opinion. The pain will likely last for some time in the short-term. In 2023, earnings power will not "normalize", and perhaps not in 2024.
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But I see ways where deposits will return and the bank can make $3+ per annum in EPS growth. In the short term, I see it reaching a level of $1-$1.20 per shares before 2020. This is enough to support the share price at its current level, with no growth.
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People are talking about survival and book values right now (as they did after 08 in every company). You too. The crypto world is moving fast and people need to start thinking about embedded optionality if they want to get past the fraud shakeout and deleveraging.
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Concerning the future earnings. Yesterday, I bought shares between $12.25 to $13.90. In the Special-Situations Report, I have included a speculative option that might be of interest to bullish investors.