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Bulls and bears alike knew it was coming, but last Thursday’s market update from Silvergate (NYSE:SI) that deposits had fallen by $8.1 billion, about 70% of total deposits, still came as a shock . This was a withdrawal rate higher than some banks experienced during the Great Depression and came on the back of a crisis of confidence. After the implosion of a number of crypto outfits over the past year, managing counterparty risk has become one of the dominant issues for crypto companies. 2023 kicked off with Gemini, a major cryptocurrency exchange and customer of the Silvergate Exchange Network, which released a open letter to its Earn product provider after having suspended payouts for over a month with no updates.
Silvergate is shedding 200 employees, roughly 40% of its total, and posting a $198 million impairment related to assets it bought from Diem, Metas Facebook’s former stablecoin project, and has attempted to through the forced sale of $5.2 billion to realize a loss of $718 million of debt. The company still held debt with a fair value of $5.6 billion. These are safer debt instruments backed by the US government and agencies.
Silvergate’s 5.375% Series A non-cumulative preferred stock is now trading at a discount of 55% to redemption value. I think this is the best way for those who are still bullish on the company to gamble on a possible recovery. Why? They are currently yielding 12% with the preferred stock trading at $11.15 versus their quarterly coupon of $1.344. The bearish case for these would have seen an announcement that all payouts would be suspended entirely, which was included in Thursday’s update.
Preferreds are trading at 45 cents on the dollar
Maintaining the coupon at what is arguably the best time to announce a cut has helped Silvergate stabilize broader confidence from depositors, shareholders and regulators. Additionally, Silvergate’s preferred stock cost just $2.7 million per quarter, a relatively tiny amount for a company that generated $100 million in cash flows from operations in the third quarter of its fiscal 2022, Thursday’s update said. This was more than deposits, which had declined to $3.8 billion from $11.9 billion. Therefore, preferred stockholders could be forever safe from a suspension of dividends.
Bears would be right to report Moody’s downgrade of the long-term deposit rating of Silvergate Bank, its main operating entity, from Baa2 to Ba1. This is essentially a drop from low-end investment grade to junk status. The short-term impact of this downgrade on the preferred stock would likely be to prevent some institutional participation, but it does not change the overall long-term value of the preferred stock.
Alpha wanted
The game of alpha here is Series A’s return to its $25 payback value within the next three years due to improving sentiment and the industry’s current crisis mode. This would represent upside potential of more than 100% of capital with an additional 12% per year from coupon payments. Just to be clear, I think the core business is set for a significant decline, but I’m inclined to open a position in the preferred stock. The Preferreds’ core risk remains their non-cumulative clause, although this has still not resulted in a suspension from Silvergate.
Sales and earnings are facing a significant decline
The dispute between Gemini and Genesis, backed by the Digital Currency Group, bodes ill for the industry. DCG has often been described as one of the most famous crypto institutions. While there have been some rumors of Genesis filing for bankruptcy, the current stalemate points to a continuation of a crisis that will affect sentiment and the overall dynamic of Silvergate’s operations.
The situation is not catastrophic. The Silvergate Exchange Network reported average daily volume of $1.3 billion in the fourth quarter versus $1.2 billion in the third quarter. Leverage commitments for the network decreased to $1.1 billion from $1.5 billion in the third quarter. Deposits are now expected to fall further as the entire industry continues to be impacted by the disruptions in the fourth quarter. Bank of America projects full-year 2023 earnings per share of $0.67, down about 90% from the 2022 comparable. This compares to the consensus that earnings per share should come in at $2.46 in the fourth quarter before the disruption.
Overall, revenue and EPS are set for decline, but the company is still expected to turn a profit. This bodes well for Preferred owners. The Commons could very well rebound if volatility settles and broader positive stock market sentiment takes hold, but for now it looks like things could take a turn for the worse in the meantime. The preferred players are doing a good game here and I’ll probably get a position towards the end of January.