Analysts on Silvergate Bank’s Q1 earnings call pressed executives on how the crypto-friendly institution will make more money on excess cash in a low-interest rate environment, despite the company's gangbusters results.

The La Jolla, Calif.-based bank, which serves major crypto firms such as Coinbase, Gemini and Kraken, added a record 135 digital currency customers in Q1--more than it added in all of 2020. Crypto firms are often a rich source of low-cost deposits for the few banks that openly serve the sector. In Q1, Silvergate’s average cost of deposits was 0.00%. In contrast, average deposit costs for mid-cap commercial banks are normally around 0.75% to 1.25%.

However, analysts on Tuesday’s call were especially curious about what Silvergate was doing to increase interest income from customers like stablecoin issuers, the day after Circle announced that Silvergate banking rival Signature would become its primary banking partner to hold USD Coin deposits. 

Silvergate CEO Alan Lane said that while Silvergate allows stablecoin issuers to mint and burn stablecoins on the Silvergate Exchange Network (SEN), the bank's fiat on-ramp for bitcoin markets, it isn't interested in being the primary bank for stablecoin reserves which would double or triple the bank’s balance sheet size.

“We're in the lowest interest rate environment in my lifetime,” Lane said. “There's not a lot of places that you can go to earn yield on that excess cash.”

Bank analysts also pushed the bankers on what they would do with the excess cash Silvergate had raked in from the rest of its digital currency customers. Lane noted that while the bank could “juice short-term earnings” by putting the deposits into high-yield, longer-duration securities, it wouldn’t be sustainable long term because crypto firms want to use SEN as a highly liquid network to use as a fiat on ramp for trading on nights and weekends.

“It’s not that we don’t have comfort in putting the cash out,” Lane said in regards to lending out deposits for crypto customers. “All of that gets calibrated in how we manage our liquidity, and I’m very confident that over time we will be generating a nice net interest income in addition to growing fee income.”

By the numbers

The tough questioning from analysts came despite big gains in fee income and transaction revenue.

The SEN processed 166,772 transactions and transferred $166.5 billion over the network during Q1, up 83% and 181% respectively. Q1 net income was $12.7 million, up 40% over Q4.

Fee income driven by cash management accounts for crypto firms rose to $7.1 million from $3.8 million in the previous quarter.

The bank’s average total digital currency deposits during Q1 were $6.4 billion, the high and low daily total digital currency deposit levels were $8.4 billion and $4.6 billion, respectively. Overall, digital currency customer deposits grew by $1.8 billion in the quarter. 

The bank’s Tier 1 leverage ratio – which measures equity capital against risk-weighted assets – remained well above the regulatory threshold of 5% at 9.68%.

Lending

SEN Leverage, Silvergate’s bitcoin-backed lending business that is tied to the SEN, is another place for the bank to deploy new deposits in addition to its traditional commercial real estate (CRE) lending business. The bank processed $117.3 million in SEN Leverage loans in Q1, a 52% increase from the previous quarter and monumental increase from the $2 million in bitcoin-backed loans it did in the same quarter last year. Silvergate’s total loans--including traditional CRE--were $1.6 billion at the end of the last quarter.

Approved credit lines for SEN Leverage increased to $196.5 million in Q1, up from $82.5 million in the prior quarter. In March, the bank announced that it would be extending bitcoin-backed loans to Fidelity clients, and it already works with Coinbase Custody, Bitstamp and Anchorage. Partnering with custodians also gives Silvergate more exposure to new institutional customers who are looking for leverage, added Chief Strategy Officer Ben Reynolds. 

Noninterest expense has increased by 11% quarter-over-quarter, which included research and development expenses for new products coming in the future, Reynolds added. 

“Bitcoin grew by approximately $500 billion during the first quarter alone,” Reynolds saaid. “At the same time, we’re not aware of any significant new competitors that are willing to provide US dollar funding that’s collateralized by bitcoin. While the asset values of bitcoin and the demand for leverage increased significantly, the supply of US dollars for funding and leverage remain constant.”

While less than 10% of the 695 institutions banking with Silvergate are currently taking advantage of SEN, the bank does expect at least 80% of those customers to use the product over time, Reynolds said.

Lane described his intention to create a “network of custodians” so that customers don’t have to move their bitcoin when the bank is offering cash loans against it.