Silvergate Bank Fights FTX Contagion Fears

Earlier this month, Silvergate Capital Corp. announced that it would be cutting 10.75% of its workforce. The move comes as the company looks to streamline its operations and reduce costs.

The staff of the bank gathered to celebrate its transformation into the go-to bank for the crypto market. However, the crypto market then blew up.

The recent collapse of crypto exchange FTX has raised questions about the relationship between the bank and the empire of Sam Bankman-Fried. Silvergate's stock price has been cut in half this month and is now down nearly 90% over the past year.

Silvergate has taken multiple measures to reassure investors of its stability, including issuing statements and pre-announcing some results. The bank has disclosed that its deposits are down, but that volume on its network for crypto investors has risen. It says it still has no losses on bitcoin-backed loans. However, the stock has continued to plunge.

"There is a fundamental misunderstanding as to the role that Silvergate plays," Chief Executive Alan Lane said on CNBC Friday.

What happens to a bank that has transformed itself from a small commercial lender into a middleman of the crypto world if the crypto world collapses? This is the question that the market is asking.

On Friday, crypto-trading platform FalconX announced that it would no longer be using Silvergate as its banking partner. FalconX cited the elevated risk in the current crypto market as the reason for this decision, saying that extra caution was needed. This move is consistent with other market players, according to FalconX.

"The recent sell-off in Silvergate shares implies that investors are pricing in a very dire scenario," said BTIG analyst Mark Palmer. "This is likely due to Silvergate's central role in the cryptocurrency ecosystem, which makes it appear more vulnerable."

The number of short bets against Silvergate has doubled this year. According to data from S3 Partners, it is the second-most heavily shorted regional bank, based on the percentage of shares outstanding. (The most shorted bank has a pending merger, and betting against it is part of an arbitrage strategy.)

Other banks that hold assets for crypto clients, including Signature Bank and Customers Bancorp Inc., have not been hit as hard. Signature is down 17% this month, while Customers has fallen 4.5%. Both have a more diverse mix of businesses that are less dependent on crypto companies.

Signature said its exposure to FTX was small, while Customers said it had no exposure. Both said their deposits are stable.

Silvergate is a bank that helps institutional investors move dollars into and out of cryptocurrency exchanges. It does this through its Silvergate Exchange Network, which links the bank accounts of investors and exchanges.

Ten years ago, it was a commercial real estate lender with a few branches in the San Diego area. Today, nearly all of its deposits are from cryptocurrency clients. It has closed branches and shrunk its lending book. However, it doesn't hold cryptocurrencies, only dollars.

As FTX imploded, investors sold down the bank's stock, worried about deposits fleeing. This caused a domino effect, with other banks' stocks also falling.

Silvergate said that it only held FTX deposits and that it had no other lending or investment exposures. It said it now has $9.8 billion in digital deposits, down by $2.2 billion, including removing all of the FTX deposits, since the end of the third quarter.

FTX held some deposits at Silvergate in what's known as an omnibus account. This means that the assets in the account belonged to FTX customers. FTX was responsible for keeping a ledger of the underlying customer assets. This is a common setup for firms that aren't banks themselves.

The Wall Street Journal has reported that FTX used customer assets to help fund its related trading operation, Alameda Research. Short sellers on Twitter and social media have asked questions about what Silvergate could have seen or should have flagged about movements between the two.

Silvergate would not have been able to see what was happening in the omnibus account, so it is unclear whether FTX or its customers were moving assets. FTX has halted withdrawals, and Silvergate has told customers that it cannot process requests to withdraw from FTX accounts. Bank monitoring usually looks for transactions that fall outside a client’s expected patterns, but this may be complicated by the fact that FTX and Alameda have a lot of overlap.

The bank says that even if all of the FTX deposits were to leave, it is structured in a way that would protect it from huge outflows. The vast majority of its assets are in highly liquid securities like Treasurys, which can be quickly sold or used as collateral for borrowing.

According to Michael Perito of KBW, Silvergate is the closest bank to being able to honor every deposit held on its balance sheet with cash.

This month, Silvergate had other plans. It gathered all its staff in California for the first time since the pandemic, people familiar with the bank said. On Nov. 7, it announced it had promoted Ben Reynolds, its crypto-industry point man, to president. It also named a new chief risk officer.

Instead of celebrating, executives found themselves answering calls and watching rumors swirl on Twitter about a potential run on the bank. They focused on making sure the network was working properly.

So far this quarter, average daily volume on the network has increased to $1.9 billion from $1.2 billion last quarter, according to the bank.

After reviewing third-quarter earnings, we posed the question: "Is the worst behind them?" However, we were wrong, according to Bank of America analysts who downgraded the stock.