Interest rates

How Rising Interest Rates Propelled This Crypto Stock Higher

It was a year that many investors would like to forget, with the S&P500 index at its worst start to a semester in 50 years. Cryptocurrency markets have been hit even harder, and Bitcoin is down more than 50% since the beginning of the year.

Volatility in crypto markets has hurt many stocks, including crypto banking Silvergate Capital (IF -7.53%). However, the bank surprised some investors by announcing strong results this week. Despite volatility in the crypto markets, the bank crushed estimates, thanks to rising interest rates. Here’s how.

Interest rates are rising at the fastest pace in years

In June, the consumer price index (CPI), which measures the evolution of the cost of consumer goods, increased by 9.1% on an annual basis. That’s the highest reading we’ve seen since November 1981.

In response, the Federal Reserve is raising rates to slow the economy and curb consumer spending. He hopes this will bring inflation down. Since March, the Fed has raised interest rates from near zero to a target range of between 1.5% and 1.75%.

Effective federal funds rate given by Y charts.

Rising interest rates have a ripple effect throughout the economy. Banking is one of the industries benefiting from rising rates.

Specifically, banks earn interest on loans and pay interest on deposits, and the difference between the two is called net interest income. This tends to increase when interest rates rise because banks can collect more interest income than they pay on deposits. This is where Silvergate has a major advantage.

Silvergate’s deposit advantage over its peers

Silvergate provides banking services with a focus on cryptocurrency customers. One of its main products is the Silvergate Exchange Network (SEN), which allows cryptocurrency exchanges to transfer US dollars between each other. The SEN has helped Silvergate significantly increase its non-interest bearing deposits, giving it an edge over traditional banks. More than 99.5% of Silvergate’s $13.5 billion in deposits are non-interest bearing.

The bank invests this money in a conservative portfolio of cash and other short-term securities with attractive risk-adjusted returns. Silvergate’s advantage is that as interest rates rise, its interest income on loans increases, while interest paid on deposits remains minimal.

A person looks at a bitcoin wallet on their phone.

Image source: Getty Images.

Skyrocketing growth in net interest income

Silvergate Capital generated net income of more than $38 million in the second quarter, representing growth of 41% over the first quarter and 84% over the same quarter last year. The increase was primarily driven by net interest income, which was $70 million in the quarter, up 33% from the first quarter and 132% from the same quarter last year. .

Silvergate benefited from rising interest rates, which boosted returns on its interest-earning assets. The bank aims to keep high quality loans on its books and 97% of its securities are rated AA- or better. In addition, 55% of its securities have variable rate interest rates, so when interest rates rise, its interest income increases simultaneously.

A graph shows the growth of Silvergate's net interest income.

Image source: Silvergate Capital.

What to expect

Silvergate Capital is a well-run bank that got into the cryptocurrency game early, giving it a big first-mover advantage. The move to crypto has given the bank a significant head start over its peers in the form of interest-free deposits, which became evident this year when the Fed aggressively hiked interest rates. interest.

According to the company, a 25 basis point increase in interest rates would increase net interest income by $16 million year-over-year. Experts expect the Fed to raise interest rates an additional 75 basis points at its July meeting later this month, which would translate into additional interest income of $48 million. dollars for Silvergate next year.

Silvergate could also benefit if the Fed were to pivot and start cutting interest rates again. Indeed, cryptocurrency prices – which correlate with tech stocks – could rise, as could crypto trading volume, benefiting Silvergate’s network products and putting it in an excellent position to profit, regardless. what the Fed is doing.

Courtney Carlsen has positions in Bitcoin. The Motley Fool has positions and recommends Bitcoin. The Motley Fool recommends Silvergate Capital Corporation. The Motley Fool has a disclosure policy.