SI (2020 - Q3)

Good morning and welcome to the Silvergate Capital Corporation Third Quarter 2020 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference line will be open for questions with instructions that follow at that time. As a reminder, this conference call is being recorded. I would like to turn the call over to Ms. Shannon Devine, Investor Relations for Silvergate. Please go ahead. Shannon

Thank you, operator and good morning everyone. We appreciate your participation in our third quarter 2020 earnings call. With me here today are Alan Lane, our President and Chief Executive Officer; Tony Martino, our Chief Financial Officer; and Ben Reynolds, EVP and Silvergate Bank’s Director of Corporate Development. As a reminder, a telephonic replay of this call will be available through 11:59 p.m. Eastern Time on November 9, 2020. Access to the replay is also available on the Investor Relations section of our website. Additionally, a slide deck to complement today’s discussion is available on the IR section of our website. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management’s future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks, uncertainties and other factors, including the COVID-19 pandemic that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our periodic and current reports filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today’s call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the most comparable GAAP measure can be found in our earnings release. At this point, I will turn the call over to Alan.

Thank you, Shannon and good morning everyone. Today, I will provide a high level overview of our operations before speaking to our results and the continued success we are achieving growing our global payments platform, the Silvergate Exchange Network, or SEN. I will then turn the call over to Tony who will provide a more detailed review of our third quarter financial results before opening the call for questions. On previous earnings calls, I have addressed the current environment and how we have optimized our workforce while continuing to deliver uninterrupted service to our banking clients. 95% of our employees continued to work remotely. And I would like to thank them once again for their continued hard work and efforts during such a challenging time. The record results we are achieving would not be possible without the dedicated commitment of our team. Several years ago, we made the decision to invest in our own infrastructure so that Silvergate could compete and succeed in a digital world. And when we saw digital currencies emerging as an investable asset class, we doubled down on that decision by investing in the technology and regulatory compliance necessary to develop the SEN. The acceptance of the SEN by the digital currency ecosystem is evident in our third quarter results, where our global payments platform achieved an incredible milestone, having surpassed $100 billion in transfer volumes, just 3 years from inception. Our customers completed over $36 billion in SEN transfers during the third quarter alone, exceeding the $32 billion that was completed during all of 2019. This milestone further validates the SEN’s competitive advantage and expanding network effect as we continue to add new customers to the platform. As can be seen on Slide 4, net digital currency customers increased 23% year-over-year to 928 in the third quarter of 2020 as compared to 756 in the year ago third quarter. Looking forward, we continue to maintain a strong pipeline of potential new digital currency customers, with more than 200 prospects either in the pipeline or on-boarding process. Digital currency activity was very strong in the third quarter and the SEN handled a record 68,361 transactions, representing a sequential increase of 70% as compared to the second quarter of 2020 and even more impressive year-over-year increase of 455% as compared to the year ago third quarter. This strong growth also contributed to the 36% sequential increase in digital currency fee income to $3.3 million in the third quarter as compared to $2.4 million in the second quarter of 2020 and a 106% increase as compared to $1.6 million in the third quarter of 2019. These results clearly demonstrate the SEN’s strong network effect and the need for digital currency investors to be on the SEN in order to efficiently transact in the digital currency ecosystem. During the third quarter, Bitcoin and other digital currencies saw strong price appreciation and an active trading environment, which we believe contributed to the increase in the number of transactions occurring on the SEN. Further, we saw digital currency deposits grow $586 million to $2.1 billion in the third quarter as customers maintained higher deposit balances in order to transact on the SEN. As we have seen in the past, our digital currency deposit growth is not linear. Factors such as digital currency price appreciation, trading volumes and volatility within the digital currency markets influence deposit levels, but we believe that as more FinTech firms and corporate treasuries announced their investments in Bitcoin, the ecosystem as a whole will continue to expand and Silvergate will continue to benefit. Turning to SEN Leverage, which as a reminder allows customers of Silvergate to obtain U.S. dollar loans collateralized by Bitcoin, we continue to make significant progress. We exited our pilot program at the end of the third quarter, with approved lines of credit totaling $35.5 million compared to $22.5 million in the second quarter. We anticipate a long growth trajectory for SEN Leverage and will judiciously expand credit availability to our customers over time. We believe that prudent underwriting, combined with the unique capabilities of the SEN to facilitate loan draws and repayment, 24 hours a day, 7 days a week will enable Silvergate to attain attractive risk-adjusted returns as we expand the offering. Before turning the call over to Tony, I thought I would touch briefly on the key banking risk metrics that provide the foundation for our success. We have always employed a disciplined and conservative credit culture, which is a key factor in our ability to navigate the recent economic duress with no loan losses and little in the way of loan loss provision expense. Turning to interest rate risk, while we don’t predict interest rates, we recognized sometime ago that our net interest margin and profitability could be negatively impacted in a falling interest rate environment. So in early 2019, we proactively addressed this risk with the interest rate hedging strategy we have discussed in the past. Finally, we remain well-capitalized with a total risk-based capital ratio of 24.68% at September 30, 2020 and a highly liquid balance sheet as reflected by our loan-to-deposit ratio of 61.45%. Our strong financial position provides our customers with confidence that we are managing our balance sheet to minimize risk and ensure that their deposits are highly liquid and available via the SEN 24 hours a day, 7 days a week, 365 days a year. To conclude, I am very pleased with our performance, especially given the ongoing uncertain economic environment. While the Fed’s zero interest rate policy will be a headwind for many, Silvergate has an exciting growth engine in the SEN, which provides us with numerous opportunities for profitable investment to enhance growth, while our scalable mortgage warehouse business should continue to be a strong contributor to earnings. We believe we are in a very enviable position and I couldn’t be more excited with what the future holds for Silvergate. With that, I would like to turn the call over to Tony for a more detailed review of our financial results.

Thank you, Alan and good morning everyone. As outlined on Slide 5, Silvergate reported third quarter net income of $7.1 million or $0.37 per diluted share, up from $5.5 million and $0.29 per diluted share reported in the second quarter of 2020. The increase in profitability this quarter versus last quarter was due to revenue growth, with increasing digital currency-related fee income, combined with interest income growth from our mortgage warehouse business as we handled a record level of financing transactions. In addition, we reduced our interest expense in the quarter by calling all outstanding brokered CDs by the end of last quarter. We also benefited from a reduction in our effective tax rate, which had an impact of approximately $500,000 or $0.03 a share due to a year-to-date adjustment upon filing our prior your tax returns, which also included a benefit from research and development tax credits. These items, in aggregate, more than offset the impact of decreasing yields and the absence of any securities gains versus last quarter as we did not sell any securities during the current quarter. Our tangible book value per share increased to $15.18 at the end of the quarter, up 17% compared to the year ago period. Net interest income was up 18% over last quarter, with net interest margin coming in at 3.19%, up 5 basis points as we reduced our funding costs, as discussed earlier. Non-interest income was $4 million during the quarter compared to $5.4 million in the second quarter of 2020 largely due to the $2.6 million gain-on-sale of securities in the second quarter. Our allowance for loan losses remained at $6.8 million, representing 91 basis points of loans held for investment. Turning to Slide 6, in the third quarter, deposits were $2.3 billion as compared to $1.7 billion at the end of the second quarter of 2020. Non-interest bearing deposits totaled $2.2 billion, representing 95% of our total deposits at September 30, 2020. The increase in total deposits from the prior quarter was driven by an increase in deposit levels from digital currency customers, resulting from increased volume of SEN transactions during the quarter as Alan has discussed earlier. On an overall basis, our weighted average cost of deposits for the quarter was 1 basis point compared to 37 basis points in the linked quarter due to the absence of brokered CDs in the third quarter. Turning to Slide 7, our net interest margin was 3.19% for the third quarter compared to 3.14% in the second quarter and 3.39% for the third quarter of 2019. The third quarter increase was driven by the reduction in callable brokered CDs, which drove down the cost of funds partially offset by low yield on loans and securities, along with the impact of maintaining a higher level of cash and cash equivalents during the quarter related to the increase in digital currency deposits. Now on to non-interest income on Slide 8, non-interest income for the third quarter of 2020 was $4 million, a decrease of 27% compared to the $5.4 million in the second quarter of 2020 and a $1.4 million increase compared to $2.6 million in the third quarter of 2019. The primary driver of this decline compared to the second quarter of 2020 was a decrease of $2.6 million in gains on sale of securities offset by an $855,000 or 35.1% increase in deposit-related fees. Compared to the year ago period, the increase was primarily due to $1.7 million, or 98.7% increase in deposit-related fees partially offset by $344,000 decrease in gain-on-sale of loans and a $282,000 decrease in service fees related to off balance sheet deposits. Turning to Slide 9, non-interest expense for the third quarter of 2020 was $14.1 million, up slightly from $14.0 million when compared to the second quarter and up versus $12.6 million in the third quarter of 2019 due to increases in salaries and employee benefits to professional services and other general administrative expense. On to Slide 10, our securities portfolio totaled $944 million, with a yield of 2.49% for the third quarter, down $7 million from a balance of $951 million at the end of the second quarter of 2020, with its corresponding yield of 2.67%. Our securities portfolio, when combined with our balance of cash and cash equivalents, represented 43.6% of total assets as of the end of the third quarter in keeping with our strong liquidity position, with a combined balance of $1.1 billion. Our total loans at September 30, 2020 were $1.4 billion, up $286 million compared to the linked quarter and up 40% compared to the third quarter of 2019. The increase from prior year was driven by mortgage warehouse loans, which were up 106% in aggregate and some leveraged loans, which are new into 2020. Overall, the credit quality of our loan portfolio is strong, as our non-performing assets totaled $4.1 million or 16 basis points of total assets at September 30, 2020, that is a decrease of $445,000 from the $4.6 million in non-performing assets or 20 basis points of total assets that we had at June 30, 2020. On Slide 11, we provide a detailed breakdown of our loan portfolio and an update on our COVID-19 related loan modifications. We continue to work very closely with our borrowers to provide necessary support under the current circumstances. As of September 30, 2020, we have an aggregate loan value of $33 million or 4.4% of our total loan balance held for investment, remaining on full payment deferrals or modified interest-only payments. On Slide 12, you can see a breakdown of the loan-to-value ratios for our commercial and multifamily real estate loans, along with our 1-to-4 residential loans. As Alan touched upon earlier, we managed the loan-to-value ratios on our real estate loans to relatively low to moderate levels, providing significant collateral protection from losses in the event of default. At the end of the third quarter, our weighted average LTV was 53% in our commercial and multi-family portfolio and 55% in our 1-to-4 family residential real estate portfolio. The levels at which we maintain our portfolios is key to supporting our levels for allowance for loan losses. During the third quarter, we did not record a provision for loan losses, which compares to $222,000 recorded in the 2020 second quarter. The level of our allowance remained flat from the prior quarter due to historically strong credit quality and minimal loan charge-offs and was largely influenced by the low-to-moderate – loan-to-value margin in the company’s commercial and multifamily real estate and single-family real estate loans held for investment. Turning to Slide 13, our Tier 1 leverage ratio was 10.36% at the company level and 9.84% at the bank level, with the bank ratio well in excess of the 5% minimum ratio to be considered well-capitalized under federal banking regulations. Our total risk-based capital ratio of 24.68% reflects the fact that a large proportion of our deposits are held in cash in high grade and highly liquid securities. Our loan-to-deposit ratio was 61.45% at the end of the quarter, a decrease compared to 66.75% at the end of the second quarter as our deposit growth more than offset our loan growth compared to the prior quarter. Now that we have concluded the formal part of the presentation, I would like to ask the operator to open up the lines for any questions. Operator?

[Operator Instructions] Our first question comes from the line of Joseph Vafi with Canaccord. You may proceed with your question.

Our next question comes from the line of Eugene Koysman with Barclays. You may proceed with your question.

[Operator Instructions] Our next question comes from the line of Michael Perito with KBW. You may proceed with your question.

Our next question comes from the line of Michael Grosso with Compass Point. You may proceed with your question.

Our next question comes from one of Ryan Todd with Block Research. You may proceed with your question.

Ladies and gentlemen, we have reached the end of today’s question and answer session. I would like to turn this call back over to Alan for closing remarks.

Alright. Thank you, Laura. We are very pleased with our third quarter results as they clearly demonstrate Silvergate’s strong positioning given the solid credit quality of our loan portfolio, ample liquidity and capital, combined with the numerous opportunities that we have to further grow the SEN. We believe that the runway for the SEN is boundless as we continue to develop and grow products such as SEN Leverage. We are truly in a position of strength and are excited with what the future holds for Silvergate. Given the continuing pandemic, I do hope everyone with us here today is safe. And I want to thank our employees once again for their ongoing hard work and commitment. Thank you again everybody for your time and hope you have a great day. Thank you.

Thank you for joining us today. This concludes today’s conference. You may disconnect your lines at this time.