Morgan Stanley Is Bullish on 'Crypto Bank' Silvergate

While many financial institutions have looked askance at cryptocurrency, Morgan Stanley—the fourth-largest investment bank in the world by revenue—has actively flirted with it.

In a research note today, Morgan Stanley recommended stock in Silvergate, which provides commercial banking and lending services to crypto firms. Morgan Stanley analyst Ken Zerbe thinks SI stock is severely undervalued at its current $109 trading price. By his reckoning, $158 would be more accurate—with the potential for $300, though he recognized there's a risk it could fall as low as $40.

In the past 24 hours, the price of SI stock has increased by 6.5%.

"We believe Silvergate should be valued based on its earnings growth (similar to other faster-growing financials), rather than being compared against more traditional and slower-growing banks, particularly given its minimal credit risk as its [held-for-investment] loan portfolio is just 6% of earning assets," Zerbe wrote.

He makes several cases in Silvergate's favor. First, the company's Silvergate Exchange Network allows customers to deposit funds with the bank and then transfer in and out of digital currencies. While it doesn't pay depositors interest, Morgan Stanley sees this as a positive. It's plain easier for customers to move funds but can avoid the scrutiny from securities regulators that has greeted high-interest lenders such as BlockFi and Celsius—not to mention Coinbase, which scuttled its own Lend project to avoid a standoff with the SEC.

Silvergate does, however, issue loans backed by Bitcoin—and it's done so over the past year without posting losses or needing to liquidate customers' positions. Morgan Stanley thinks loan demand will grow but that only a small fraction of loans will be held for investment. That's a good thing. "Unlike most other banks, loan growth is not a meaningful driver of earnings growth (but deposit growth is), implying far less credit risk at Silvergate than most other banks," wrote Morgan Stanley.

Though Zerbe noted the risks to cryptocurrency markets, such as regulation and price volatility, that's outweighed by a boom in demand for crypto services: "Silvergate gives bank investors a nearly pure-play way to participate in the rapid growth of the nascent cryptocurrency industry."

Silvergate also stands to benefit from its relationship with Facebook's Diem project. In May, the Diem Association announced that Silvergate would be the sole issuer of its stablecoins.

Morgan Stanley has been inclined toward SI since before then. In March, it introduced its cryptocurrency exposure basket, which featured Silvergate stock along with MicroStrategy, Square, Riot Blockchain, and Nvidia (but no Tesla).

That all adds up to Morgan Stanley giving the stock an "overweight" rating, meaning it thinks the stock price will do better than industry competitors. As Morgan Stanley puts it, "Silvergate is unlike any other bank we cover, and that could be a very good thing."