Here’s what could happen next to crypto-friendly bank Silvergate Capital

Once a crucial banking partner for the crypto firms, Silvergate Capital (SI) is now on the verge of failure.

The La Jolla, California-based company said Friday night that it is suspending the Silvergate Exchange Network (SEN), but “other deposit-related services remain operational.”

The announcement came about an hour after Moody’s downgraded Silvergate’s bank deposit rating from Ba3 to Caa1, a blow that condemns the bank’s liabilities to being exposed to very high credit risk.

In November, Silvergate faced both financial losses and regulatory investigations, largely due to the collapse of significant clients such as FTX and related hedge fund Alameda Research.

Silvergate̵[ads1]7;s stock, which plunged on Thursday and Friday, is down 95% in the past year.

On Thursday, Silvergate said it had to further delay its annual report, and that the bank expected further losses beyond a nearly one billion drop in net loss it reported in preliminary results for the fourth quarter.

The bank also cited ongoing regulatory investigations, legislative inquiries and its “ability to continue as a going concern for the twelve months following the release of these financial statements.”

Silvergate faced a run on deposits from the crypto firms it bankrolled, including Coinbase, Paxos, Galaxy Digital and others, which made efforts to distance itself from the troubled bank.

What happens afterwards?

In the worst case scenario, Silvergate may file for bankruptcy.

More likely, the FDIC-insured bank may go into receivership.

Not unlike bankruptcy, bankruptcy acts as a “protective umbrella” where a “receiver” or trustee is appointed to take over the business with the ultimate goal of protecting creditors – especially those with secured loans.

Unlike bankruptcy, bankruptcy is not a legal action and is aimed at protecting a company’s lenders rather than borrowers (as is the case in bankruptcy).

Jesse Austin, a former partner in King & Spaulding’s bankruptcy practice, explained that probate decisions and enforcement are made by two federal bank regulators, the US Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC).

“If the comptroller finds Silvergate undercapitalized, they will refer them to the FDIC, the FDIC will then come in and close the bank,” Austin told Yahoo Finance.

Here’s what could happen next to crypto-friendly bank Silvergate Capital

Although bankruptcy code specifically prevents a bank from filing for Chapter 11 or Chapter 7 bankruptcy, Austin said Silvergate’s holding company could still file for bankruptcy — especially if it has other valuable assets besides customer deposits.

Along with Silvergate’s SEN network, the company also owns stablecoin assets purchased from Meta’s closed stablecoin project, Diem, last January for 1.2 million shares and $50 million in cash.

The crypto-friendly bank’s troubles follow joint statements in January and February issued by the Federal Reserve with the FDIC and the OCC that warned of the volatility risks of banks that approached crypto customers.

In light of Silvergate’s position, the statements raise further questions about whether US banks will become “much more shadowy” to the digital asset industry, limiting access for crypto firms, according to a banking industry source familiar with Silvergate’s capitalization.

“On the one hand, if crypto is going to be out there and Americans are putting dollars into it, do you really not want those dollars to be held in American versus foreign banks?” this person, who requested anonymity to speak freely about Silvergate, told Yahoo Finance. “Maybe it’s not that if you’re a bank, you can’t take such deposits, but you have to limit them according to conditions on your balance sheet.”

How Silvergate reached the brink

Silvergate became a regional bank in 1996, but it wasn’t until 2014 that CEO Alan Lane opted for the company to start serving crypto clients like the now-bankrupt Genesis.

The company carved a niche for itself by providing banking access to a growing number of crypto startups, and the bank’s offerings evolved into a formalized payment platform known as the Silvergate Exchange Network, where 24/7 operating crypto depositors could make transfers in US dollars and loans outside traditional banking hours.

Silvergate had $1.8 billion in total deposits and $2 billion in assets at the end of Q4 2018. By the crypto’s peak in 2021, its total deposits and assets had risen to $14.3 billion and $16 billion, respectively.

Silvergate's logo displayed on a phone screen and representation of cryptocurrencies are seen in this illustration photo taken in Krakow, Poland on January 29, 2023. (Photo by Jakub Porzycki/NurPhoto via Getty Images)

Silvergate’s logo displayed on a phone screen and representation of cryptocurrencies are seen in this illustration photo taken in Krakow, Poland on January 29, 2023. (Photo by Jakub Porzycki/NurPhoto via Getty Images)

Following the bankruptcy of crypto exchange FTX, Silvergate’s total deposits and assets fell to $6.2 billion and $11.3 billion at the end of last year’s fourth quarter.

With this drop in deposits, Silvergate’s capital relative to assets shrank by half. That gearing ratio fell from 10.7% in the third quarter to 5.3%, a level of particular concern for banks with regulators having reason to advocate for any US bank below 5%.

“The difficulty here is that Silvergate was not a big bank,” the banking industry source told Yahoo Finance. “They strategically increased their deposits by working with crypto companies, but their crypto deposits became much larger than the rest of the business.”

David is a reporter for Yahoo Finance. Follow him on Twitter @DSHollers

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