US Senators: Silvergate Failed Miserably

After finding responses to an earlier inquiry to be “evasive and incomplete,” a bipartisan group of US senators, including Democrat Elizabeth Warren and Republicans Roger Marshall and John Kennedy, grilled Silvergate Capital (NYSE: SI) about whether it knew of FTX’s alleged misuse of customer cash.

The lawmakers claimed in a letter to CEO Alan Lane that the firm declined to fully answer related queries in December, citing limits on revealing “confidential supervisory information.”

“We wrote to you seeking information on what appeared to be an egregious failure of your bank’s responsibilities to monitor and report suspicious financial activity. Your response confirms the extent of this failure – but then neglects to provide key information needed by Congress to understand why and how these failures occurred,” the letter wrote.

The senators also noted in the letter that as Silvergate fell deeper into trouble in 2022, it turned to the Federal Home Loan Bank (FHLB) of San Francisco for a liquidity injection large enough to “stave off a further run on deposits.”

“By using the FHLB as its functional “lender of last resort,” Silvergate has further introduced crypto market risk into the traditional banking system,” the lawmakers said, adding that if the crypto bank were to fail, FHLB could “assert statutory lien priority on other assets – essentially putting the Home Loan bank ahead of all other creditors,” including the Federal Deposit Insurance Company’s (FDIC) deposit insurance fund.

In early January, Silvergate revealed that it had $4.3 billion in short-term Federal Home Loan Bank advances and approximately $4.6 billion in cash and cash equivalents at the end of 2022. This cash assisted the company in avoiding a deposit run following the failure of FTX.

However, the senators highlighted that Lane’s response did provide some insights, including Silvergate asserting that it “conducted significant due diligence on FTX and its related entities, including Alameda Research” and the bank’s Chief Risk Officer, Tyler Pearson, “remains an important part of the risk management team at Silvergate.”

The crypto firm also admitted that “Alameda Research opened an account with Silvergate in 2018, prior to the founding of FTX.”

“These are important insights. They reveal that Silvergate had risk management and due diligence processes in place – but that they did, in fact, fail miserably,” the senators argued. Despite these processes, the senators noted that the Federal Reserve and Silvergate’s independent auditors were both unable to discover what we now know were exceptional flaws in Silvergate’s due diligence procedure.

On using “confidential supervisory information” as a defense mechanism to divulge information, the lawmakers said “this is simply not an acceptable rationale.”

“As members of Congress with enshrined oversight responsibilities, we are happy to work with you to address the confidential nature of any material in your possession,” said the senators. “But both Congress and the public need and deserve the information necessary to understand Silvergate’s role in FTX’s fraudulent collapse, particularly given the fact that Silvergate turned to the Federal Home Loan Bank as its lender of last resort in 2022.”

According to Sultan Meghji, former chief innovation officer for the Federal Deposit Insurance Corp., banks normally cannot divulge private supervisory information and may face criminal charges if they do – even to Congress.

“It is not surprising that Silvergate (or any other bank) would use those rules to avoid responding to a questionnaire from Congress,” Meghji said. “Congress should work with the banking regulators to get that information.”

The world’s largest asset manager BlackRock (NYSE: BLK) recently announced that it has a 7.2% stake in Silvergate Capital.

Silvergate creaking to a close?

At the height of the FTX debacle, Lane revealed that the firm has “‘less than 10%’ of its $11.9 billion total deposits from all digital asset customers tied to FTX.”

“Silvergate has no outstanding loans to nor investments in FTX, and FTX is not a custodian for Silvergate’s bitcoin-collateralized SEN Leverage loans. To be clear, our relationship with FTX is limited to deposits,” Lane clarified.

Following the news, Silvergate shares fell as much as 8.7% on Tuesday from its intraday peak. In the past year, the valuation fell by 87%, most of which transpired since FTX imploded in November.

With stock now trading in the two-year low range, investors are left examining how much insiders cashed out of the stock during the last two years. According to Form 4’s filed with the SEC, there were 167 instances where an insider sold, with only 1 instance where an insider bought shares.

Insiders sold shares between the prices of $88.53 and $221.36, or between 5x and 13x higher than the current price. In total, the sales over the last two years amounted to roughly $100.3 million in gross proceeds. Among those insiders is Lane, who personally sold 21 times throughout the last two years for proceeds of $16.1 million.

Silvergate is now in a responsive mode, trying to create more liquidity for its balance sheet including selling debt securities for cash proceeds at a loss. In Q4 2022, the crypto lender sold around $5.2 billion of debt securities–which are bought at a time when interest rates were much lower–and ended up losing $718 million in doing so. It also  took a $134.5 million impairment charge relating to an estimated $1.7 billion of securities that it expects to sell in the first quarter of 2023 to decrease borrowings.

Most recently, the firm said payment of dividends on outstanding 5.375% Fixed Rate Non-cumulative Perpetual Preferred Stock, Series A, has been suspended. The move was conducted as a means of preserving capital amid a volatile crypto market while the company attempts to remain “highly liquid.”

The cutting of the dividend on preferred shares suggests significant trouble for the firm, given its paltry impact to the firms balance sheet. The cancellation amounts to just $2.7 million in savings per quarter, or roughly $10.8 million on an annualized basis.

Silvergate Capital last traded at $14.15 on the NYSE.

Information for this briefing was found via Bloomberg and the sources mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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