Q4 2020 Silvergate Capital Corp Earnings Call
We never want to be dismissive of any potential competitors, but we really don't view of the more crypto need of firms as being competitive to the center.
As most of them tend to see each other as competitors and see Subrogate as independent.
If they were to participate in the network of competitor stands up.
That would be viewed as being detrimental to their own business objectives of increasing liquidity and customer adoption of their platforms.
Silver Gate is also mindful of not wanting to compete directly with its customers.
And it's given us of privileged role in the ecosystem, whereby everyone trusts silver gate and uses the same.
Also the network effects of the Sun as Alan mentioned would make it extremely difficult for a competitor really crypto based or otherwise to lure away.
Our existing customers.
No other network work would have the the depth of Counterparties, but the sand has achieved.
So of decision for our customers to move deposits from silver gate two of competing network would end up costing the user money.
As more kind of as they would need more capital in order to conduct the same activity.
As they're allocating capital between silver gate and the other network.
The the final comment I'll make on this one relates to kind of more traditional banking services.
You know all of the charters that have been.
Granted mm lately are more limited purpose as opposed to depository in nature the.
The key distinction being that the bank charter enables affirmed the whole deposits of the fed.
And make loans on the on a fractional reserve basis.
So.
Most of these newly chartered entity still need the relationship with silver gate. So that they can have access to the fed for deposits transactions and other services. So the charter that they've obtained is valuable because it allows them to forego getting state by state money transmitter licenses.
And that's a privilege the silver gate enjoys of the bank as well.
Essentially really good color, but can you talk to the left part of my question.
Thoughts on the margins for the start of leveraged products.
Yeah.
The line yet.
Yeah. So it's a really it's a really good good question so I.
I think you can think of it this way you Jim that you know during.
During the quarter, we saw the total market value of bitcoin.
By approximately $340 billion at.
At the same time, we're not aware of any significant new competitors that are willing to provide U S. Dollar funding that's collateralized by bitcoin, so while the asset values and the demand for leverage of increased significantly the supply of U S dollars for funding of the leverage has remained constant and as long as that's the case, we don't we don't expect it to be.
Compression of margins.
In in yield.
Obviously as the as the industry as a whole matures and as there's more leverage provided.
No, we would expect that to happen but.
As you mentioned most of these folks are just getting our are just starting with custody alone and and and Havent havent gotten anywhere close to taking the next step. So we think that that's.
<unk> a few years out as opposed to a few quarters out.
Thank you. Our next question comes from the line of David <unk> with.
Wedbush. Please proceed with your question.
Hi, Thanks, Good morning couple of questions for you so.
Starting on slide five with the deposits and you addressed this a little debt earlier.
Earlier, but.
You know the deposits were backend loaded you mentioned and I was curious as to you know this difference between the period end of $5 2 billion and looking at the average of $2 8 billion.
Can we expect that the average deposit as we look out to the first quarter could be in that neighborhood of $5 2 billion or was the nature of the quarter ending right before the weekend, leading to excess deposits that likely are to leave the bank.
Mike.
Yeah. Good morning, David Thank you for of the question.
So we you know we don't provide guidance on these calls, but what I can tell you is is that throughout the the second half of the year. If you go back and look at our end and you know on slide five you can see.
Yeah, we we had growth from the second quarter to third quarter, and then explosive growth between your you know in the fourth quarter as you mentioned, though and as can be seen in our press release. If you look at the average balance sheet and our average average deposit balances for for the quarter were a little.
Under 3 billion versus the period end of $5 billion. So there was definitely a run up in the second half of the quarter.
Which was consistent with the sand volume that we were seeing and consistent with the activity that we're seeing in the broader.
Digital currency ecosystem and there's there's no reason for us to believe that that debt that is going to slow down anytime soon this.
Just to provide a little bit of context, when we the last time, the digital currency markets, what we're experiencing.
Spirit thing this type of a run up in 2017.
There it was a little bit of a reset if if I can use that term where word of activity was growing rapidly. We we've got a lot of institutional adoption of bitcoin and other digital currencies more more broadly.
And so what we're seeing is the there's been this this theme for the last several years that the institutions are coming and and we're seeing a broader institutional adoption and as you know the silver gates entire strategy has been to serve the institutional community.
With with 76 digital currency exchanges and over 600 of institutional investors, who are all looking at bitcoin and other digital currencies as the new asset class to invest in and and so we certainly can't predict what will happen with deposits. They could continue to go up they could go back down and we've seen a lot of.
Volatility over the years, but but what we do see over time is as kind of these these new levels.
Where we kind of see a little bit of a reset and so that's that's that's kind of what we're seeing right now, but it's a little bit too early and in.
In the in the new year to tell how how sticky there.
Thanks for that and somewhat related question is on the securities portfolio.
You guys bought you know one bond for $5 million in the quarter, but yet you put up you know billions of balance sheet growth. So as we look out what is your strategy for securities purchases looking out and how you're managing the balance sheet.
Sure. That's another very very astute observation. So so the way we the way we manage our liquidity and I'll tie. This back to your first question, which is that first.
First and foremost we want to make sure that that we are providing uninterrupted service to our customer base and and our customers rely on the sand.
To have the right amount of liquidity on the right platforms at the right time and the the the sand with its 24 seven API enabled capabilities allow our customers to move U S dollars as you know on nights and weekends and so when we're seeing large inflows like we did in the in the.
Back half of the fourth quarter. Our primary focus is on our strategic advantage here and helping our customers with their with their liquidity and as we move through time to the extent of that that we believe those balances that we have in fact, you had kind of a new reset our you know our.
We set at a higher level I should say then we will absolutely look to deploy those funds in a prudent way one of the things that we've been able to benefit from in the second half of last year was the the mortgage refinance boom.
And as you'll see from some of our our disclosure in our press release, our mortgage warehouse. The activity was very strong in the fourth quarter and that is an asset class that is very well matched to the funding that that we receive from our digital currency customers because.
The mortgage warehouse.
Loan balances on average turnover about twice a month and so they are you know the that the scalable business, which which matches the the duration of the funding, but more importantly strategically as we look ahead of the Sen leverage product is also.
An area, where we expect to see growth and.
We did see some nice growth in the fourth quarter as we brought sen leverage out of the pilot and so that's another asset class that we would look to deploy these these deposits into as we move forward.
And on that last point of Sen leverage growth Hum.
How does the pipeline look there and do you have any kind of indication as to what sort of growth ramp we should expect in the sen leverage product.
Sure I'll turn that one over the ban.
Yeah good morning.
So the increases that we saw in Sen leverage during the quarter were really by expanding credit to some of the existing earlier borrowers in the pilot as well as adding new borrowers the consistent of traders market makers and other digital asset lenders. So as of the quarter, we had less than 5% of.
Our existing eligible customers utilizing the product and.
And we continue to see significant opportunity to expand.
You know San leverage in the in the coming quarters to our existing customer base.
Recall that as of the end of the quarter, we have about 600 institutional investment.
<unk> investors that are customers.
And we believe that almost all of them are looking for more efficient capital.
To invest in and trade the digital.
You know the digital currencies.
So.
We feel good about the pipeline.
That where we're actively working and we're going to expand it.
I think the term we use it judiciously to.
To make sure that we're you know that we don't have a huge ramp but as Alan was mentioning.
We see it as a as a significant significant opportunity and you know what.
The kind of just the hark back to one of my earlier comments.
The the market value of bitcoin.
Expanding by 340 billion.
In the quarter.
And he's being bitcoin collateralized loans.
We just think that it's there's a massive runway there.
Thanks for that and then last one for me you mentioned about introducing.
Introducing of Bitcoin custody solution can you talk about.
The liability associated with that I am thinking in terms of you know the risk for hacks, you now sort of.
Some exchanges have been hacked over the years, even in the U S. Government of of course had the huge hack recently is there insurance you guys couldn't can purchase to offset.
Offset some of that risk I'm curious as to how you guys are approaching this.
Yeah. Thanks for that question I'm going to ask Ben to go ahead and address that one as well.
Yeah. So.
For the custody product is something that we've been looking at and really studying for the.
The last couple of years, we really introduced it this quarter because some of our existing clients, who had asked us to provide.
In institutional grade solution.
Because they were looking to diversify some of there from some of their other custodial server service providers. So the idea there is by kind of the custody and your bitcoin at several different locations.
It minimizes the risk to a certain extent so.
We're doing this we're offering the service through a sub custodian.
Who is of regulated Trust company.
Whose technology already secures billions of dollars in digital assets you know obviously, the you know as a regulated bank the.
The vendor due diligence process that we have in places is very robust and.
It takes several quarters to two to achieve.
So.
As it relates to the custody on a on a standalone basis.
We chose to to go with the the regulated sub custodian.
Route because we didn't want to we didn't want to incur the the capital expenditures to stand up our own.
And they've already gone through the process of obtaining insurance and.
And in securing the the digital assets.
If I may.
Beyond our existing clients asking for it.
We believe the custody is a foundational piece of infrastructure.
It's required to scale, our lending and stable quaint initiatives.
So as we as we look to expand the services we think.
Having the custodial capabilities.
Will really help us to be critical to expand our product roadmap.
That makes sense, thanks very much.
Thank you, ladies and gentlemen that the reminder, if you'd like to join the question queue. Please press star one on your telephone keypad at this time.
Next question comes from the line of Michael Perito with VW. Please proceed with your question.
Hey, good morning, guys.
Good morning, Mike.
So I apologize that you guys are of popular bunch of just wondering I had a little bit of of wait time to get on the call. So if I missed this I apologize, but if I think about your.
Your product roadmap on the silver at the exchange network. Today, you know you have the some of the the digital currency related fees, which I think of fairly straightforward with the.
The deposit account services foreign exchange cash management stuff that you know I would presume should continue to grow at a nice rate as your customer base continues to grow and then you have the sudden leveraged product, which you discussed which seems like probably the biggest revenue opportunity over the next 12 months, but I was curious if you could maybe spend a little bit more time on the the stable core infrastructure and the asset management.
Capabilities that you guys have alluded to it in the past the wondering kind of how you. If you could walk through how revenues are general potentially generated in those two areas and what the growth opportunities look like for you that would be helpful. Thanks.
Sure Mike. Thank you for those questions I'll I'll touch briefly on the on the asset management revenue concept and then I'll turn it over the band to talk about stable coins.
And other growth initiatives. So the way we the way we think about asset management. It's it's it's tied to your observation around Sen leverage.
And if I can also I don't know at what point you were you were able to get on the line, but then spoke earlier about the massive opportunity in bitcoin collateralized lending. The fact that the asset classes has grown significantly and that there are very few lenders that are willing to to lend against bitcoin.
At least at this stage of the of the evolution of the digital currency markets and and so we believe that the demand could far exceed what we will be comfortable holding on our balance sheet in the near term and so that's really where the concept of asset management revenue comes it comes in it in that we will continue to to be proved.
And our rollout of sand leverage.
And as we get to a point, where we're where reaching our comfort level for on balance sheet exposure, we will seek to find others to participate those loans to so that we can continue to grow that product to serve our customers and in doing that we we believe that in a zero.
The rate world.
And you know of yield starved world that this is a very attractive asset class with an attractive yield and we will in fact be able we we certainly hope we'll be able to find participants who are interested in participating in this product with us that would allow us to continue to scale the business and and on the back end of this.
Turn turn the Sen leverage into both a and interest income opportunity as well as a a of noninterest income fee income opportunity. So multiple sources of revenue from the center Sen leverage as that product evolves and Ben you want to touch on stable coins.
Yeah, and and and more broadly on your on your product question. Mike. Thanks for the question. So we don't have any new products to announce today, but as you can tell by the launch of Sen leverage in our custody solution. During 2020 are launching new products is something that's a critical piece of our growth strategy.
At silver get we're really focused on adding value for our customers by creating products that solve problems for them and a symptom of sustainable competitive advantage for us today.
Today Silver gate provides each of the for regulated U S based stable coin issuers with 24, 7% and burn capabilities over the Sun, which is of critical piece of of infrastructure for the nature of stable coins used for commerce and payment systems. So.
We do see a massive opportunity in this area as you know the the landscape and the use case for stable coins shift from you know really of trading environment two of commerce environment.
And we're looking to expand our services and capabilities for.
For regulated stable coin issuers.
And then obviously being able to custody of the digital asset will be critical to two of our capabilities. There. So we're really excited about the space and we think that we're uniquely positioned because of the 24 seven real time API enabled the nature.
The nature of the Sen and the massive adoption that we've that we've seen there I mean, if you if you take our quarterly spend numbers of of 59 billion and you annualize on the it's 240 billion over the sand on it on an annualized basis. So.
We think we're in a good position and we're excited about the opportunity.
Helpful. Thank you and then I wanted to skin the cat attempts different way on the deposit question. That's been asked already but just Alan and I was just curious if you are willing or able to kind of maybe just tell US you know 'twenty 'twenty, one or 'twenty two days of the quarter here you know how have.
Those deposits deposit balances trended since 12 31.
Are you able to share of that should give us a little bit of a sense I mean at least it's a third of the quarter it might be able to paint the average balance picture a little bit more for us if we have a sense of where they've trended since the.
Ended the quarter in the last 20 days of yourself.
Sure, Mike I, I, I really I understand the desire to get that that kind of insight. Unfortunately, you know, we we really can't discuss you know kind of forward looking statements here.
You know what so all I'll say is is that if there was any material change we would've thought too to make a you know kind of of recent developments disclosure in that regard and so I would just encourage you to look at at the disclosures as they stand and look at our history.
And the.
Our product roadmap and everything that we're building and I think that's that's about as much insight as we can provide unfortunately.
Okay Fair enough just one last question for me you know when I look at the kind of whole crypto currency ecosystem right. I mean, you have your of 76 change customers. For example, I mean, it's hard to believe that over a longer period of time there'll be 76 exchanges.
So imagine there'll be some consolidation there, but but just a broader question I mean, you know.
Yeah, we're such a nascent stage here of the growth, it's pretty rapid of cross you and a lot of your peers are involved in this new asset class so to speak.
I was wondering how do you guys view consolidation as an opportunity is it kind of is it could it be of a headwind or is it kind of neither as far as you're concerned at this point or just any any general thoughts about how consolidation could impact the cryptocurrency space and your ability to monetize it over time would be great.
Sure.
So I'm going to ask Ben to to go into a little bit more detail on the exchange customers because you're you know what if you step back and you think gosh. There's 76 the exchanges that's a lot of quote unquote exchanges, but but they all.
There are there are there are nuances you know in that bucket in terms of what type of customer.
Gets categorized into the digital currency exchange bucket and I do by the way you think that consolidation will happen over time, but we're so early in this in this.
Lucian of digital currency is that.
I think of as consolidation happens theres still room for new entrants and so I'm not expecting to see some massive you know like consolidation of anytime soon because I think.
Initial consolidation will just make room for for potential new entrants, but I do want to give ban of chance to just touch briefly on the on on how we view that that bucket of customers.
Yeah. So you know.
Couple of bringing it back to the Sen we.
A lot about how the centers of two sided marketplace of exchanges on one side and institutional investors on the other side and so you know what's critical is the interaction between those two parties more so than the number of exchanges in total.
One of the reasons that we're not concerned about consolidation at all is because we bank all of the significant exchanges that are that are meaningful and that are out there.
Already and so.
And so where.
Where are we where we could be concerned as if if there was an exchange. If there were some massive exchange that was regulated and not using the Sen then sure. If they were to acquire one of our customers that is the same user then that could be problematic, but we're just there's not an exchange out there that has been through our compliance prop.
<unk> that the.
The word.
Not banking so so overall, we feel good about that in terms of just general expansion of that category.
One of the trends that the industry has seen overall is.
The other.
These digital first retail platforms.
You know folks like Paypal and square of Robin Hood offering these types of services or these types of assets to their to their customers and you know again, we just think that that's its exciting for the industry, it's exciting for silver gate.
And we're not really concerned about about consolidation at this point.
Thank you. Our next question comes from the line of Joseph <unk> with Canaccord Genuity. Please proceed with your question.
Hey, guys. Good morning, just a couple of quick ones here.
Just given the price of the coin in December and and the early January of the strength of the rise, but maybe a little bit early.
You know what does the the pipeline look like for new institutions wanting to come onto the Sun did you see any kind of change or.
Perhaps larger the surprise institutions are.
Anything that you may be able to provide in terms of color on that on that pipeline I mean, a lot of institutions have already joined just trying to get a feel for you know with with the price of bitcoin.
The increasing is.
<unk> in turn seeing you know a new set of institutions wanting to come on board. Thanks.
Yes, Joe Thanks for the question Ben do you want to touch on the pipeline.
Sure. So the pipeline of of customers is has remained robust at over 200.
When you have kind of of the rapid what we tend to see is that is the firms that are looking to make an allocation to the asset class or looking to launch of fund. It takes them three to six months to really get their funds setup.
Get their investment base of Investor base and whatnot. So we still we have seen.
High quality.
Institutional investors come into the pipeline and.
And without naming any customer names I mean, if there's you know there's a number of hedge funds out there that have been public about about coming into the space and just because of the salmon and the liquidity in all of the folks that are already participating in it.
For those folks really do need to open accounts at silver gate and so we feel good about the the pipeline, we're continuing to stick to our compliance and risk framework for evaluating those clients and we're not we're not loosening up there at all of them, but feel good overall about the the market expansion and the opportunity.
That creates for silver games.
Okay, Great and then just one other quick one I mean, it doesn't seem like demand is the gating factor at all on Sen leverage.
But is there any kind of correlation you can make to it.
Existing customers, perhaps increasing their overall deposits with you in Q4, I think Alan mentioned, there might've been a trend that way and what the implications maybe for some leverage.
For those kinds of customers who were increasing deposits.
You know as as more of a sudden leverages available. Thanks.
Yes, Ben you're on a roll you want to take that one.
Yeah. Thanks Alan.
Yeah. So.
We know we know the if you're in the institutional investor and we're talking about truly institutions here.
The primary objective is to.
Increased capital efficiency.
Maybe that's not the primary objective is is obviously returns, but but capital.
Achieving capital efficiency is something that leads to two of those returns and so we spend a lot of time thinking about how do we optimize.
You know how do we help our clients to optimize their balance sheet and you know there is of tension between deposits and credit there.
And the.
The.
I guess, taking a step back for a second prime broke the concept of prime brokerage is still nascent in this industry and so if you're going to if you're going to trade the asset class in the meaningful way you still have to have dollars and coin at the positive on deposit at all of these different venues and so we just think that.
There's really a massive opportunity on both sides and when you see the asset class grow the way that it has the.
Trading strategy that you were using with bitcoin 15000 might be the same strategy of use of bitcoin 30000, but youre going to need a lot more capital to do it and so we think that.
There's opportunity there for us to gross on leverage and also maintain the deposit balances.
Thank you, ladies and gentlemen, I'm sorry. This concludes the time allowed for questions I'll turn the floor back to management for any final comments.
Alright, Thank you Melissa and thank you everybody for your participation today and again my apologies for the technical difficulties, we had at the beginning of the call.
And I'm, just I just want to wrap up by by by saying how very excited we are not only by our fourth quarter results, but but by the the tremendous opportunities that that we see of had we believe that the fourth quarter results clearly demonstrate silver gate strong strong positioning.
And the continued adoption of the Sen. We believe will continue to fuel growth in the future and continue to allow us to provide an expanding array of products for our customers. I also wanted to take one last chance to thank our employees for for their ongoing hard work and dedication in serving.
Our customers and wish everybody a happy and prosperous 2021, thank you very much.
Thank you. This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation.