Summary Silvergate's depositors are filing chapter 11s as the crypto winter bites. The growth of the crypto space will likely be handicapped for the foreseeable future with the risk of regulatory blowback likely to keep some institutions away. The company's depositary-preferred shares offer an alternative way to play a potential recovery. Silvergate Capital's ( SI ) push to offer banking services to the crypto space in 2014 retrospectively looked like a masterstroke. The company would IPO in 2019 just ahead of the pandemic-led surge of crypto and its inherent explosion into the mainstream on the back of an unprecedented level of institutional adoption. But the party is now over and the collapse of Silvergate's common shares this year has been built on the seemingly bleak future ahead for crypto. The near 40% short interest in the La Jolla, California-based company is reflective of just how much bears believe this new future will play out. To them, what lies ahead is a long dark crypto winter where the current list of 2022 bankruptcies grows even longer . Silvergate's depositors are already filing for chapter 11 bankruptcy. FTX on the 11th of November, Alameda Research on the 11th of November, and BlockFi on the 28th of November. Bulls would be right to state that Silvergate's total digital asset customer deposit exposure to some of these companies like BlockFi was small at $20 million but this would miss the bigger picture. Silvergate has so far in November become a financial layer for an industry realizing a structural decline. The chartered and FDIC-insured bank with an account at the Federal Reserve is now currently subject to a class action lawsuit over its alleged role in transferring FTX user deposits to Alameda bank accounts. Whilst the fundamental bearish point is that the FTX debacle will significantly hamper institutional adoption of crypto, the worst-case scenario for Silvergate could be realized if the company loses its charter over its FTX-Alameda dealings. The New Crypto Landscape Is Hostile It's important to note that there are a lot of allegations flying around and some of them might not be reflective of the truth. Hence, the lawsuit is important as it would allow the company to more transparently defend itself and more clearly separate fact from fiction. Silvergate currently faces the specter of regulatory blowback with US Senators Elizabeth Warren, Roger Marshall, and John Kennedy writing to the bank to seek answers on its role in the FTX collapse. With the SEC looking to more heavily Bitcoin as a security and more states looking to place more onerous regulations on crypto activity, the growth rates Silvergate has historically seen will likely be in the rearview mirror. For example, New York State-registered banks will now need to receive regulatory permission 90 days before they get involved in crypto even if it's via a third party. Whilst enhanced regulation could be good for the industry and increase its legitimacy, the current sentiment leans towards the regulations looking more reactionary. Indeed, the FTX debacle has been a total disaster with billions of lost customer funds likely pushing regulators to move to rein in the type of crypto activities that drove Silvergate's deposit growth. Prospective investors might be interested in the company's 5.375% Depositary Shares ( SI.PA ) which represent an alternative way to gain exposure. Quite confusingly, the company does not describe these as preferred shares but as depositary shares which represent a 1/40 interest in a share of the fixed rate non-cumulative perpetual preferred stock. QuantumOnline These currently trade at $10.90, which is around $14.10 or 56.4% below their $25 redemption value. They also currently pay out a $1.34 annual coupon which amounts to a 12.33% dividend yield with a call date quite a while away on the 15th of August 2026. As the commons don't pay a dividend and against the deep discount to redemption value, the 1/40 of a preferred depository shares offer an alternative way to gain exposure to Silvergate's potential recovery. However, it's important to note that the depositary shares are non-cumulative. This represents one of the least attractive structures as the company can choose to suspend the dividend at any time and the unpaid dividends will not accumulate to be paid fully at a later date. Cumulative preferred shares are designed to reduce the probability of dividends being suspended during times of economic discombobulation, hence, holders of these could find themselves out of income in the event the slowdown in the crypto space translates to a marked disruption of Silvergate's financials. Every Day Is For The Bull, One Day Is For The Bear Morgan Stanley recently slashed its 2023 EPS estimates for Silvergate by 51% to $4.48 compared with the broader analyst consensus of earnings of $5.95 per share. Silvergate's digital deposit balance is also expected to fall by 20% sequentially during its fiscal 2022 fourth quarter from $11.9 billion in its last reported third quarter. The company's revenue for its third quarter of $89.34 million grew by a staggering 72.8% over the year-ago period but was a miss by $11 million on consensus estimates. Digital asset customers reached 1,677, up from 1,305 in the year-ago comp and was a growth of 5.8% sequentially. A potentially lower deposit balance represents the greatest risk to EPS as Silvergate does not pay any interest to its depositors. Silvergate Capital The company's Silvergate Exchange Network, which allows crypto companies to transfer dollars any time of day, is already in decline and fell by 30% year-over-year to handle $112.6 billion of US dollar transfers. The FTX debacle and the ongoing retrenchment of the industry from the recent bankruptcy of one of North America's largest miners Core Scientific ( CORZ ) to the near-distressed valuation of most listed miners and the suspension of withdrawals by Gemini all point to a bleak near-term future. Hence, whilst the price-to-forward GAAP earnings ratio of 4x looks attractive, earnings might very well turn negative depending on the severity of the industry's pullback. The valuation is too low here to recommend this as a short, but it's equally not a buy until there is more clarity over the lawsuit and the regulatory response.
