Top of the charts: The housing-loans behemoth is the largest value creator among banks and financial services companies

If you go by the swelling market values of some key bfs companies, investors are clearly expecting plenty in future from this sector. Topping the list of wealth creators is HDFC, which has produced Rs 6,470 crore, followed by HDFC Bank (Rs 4,501 crore), and icici Bank with an MVA of Rs 2,306 crore. The State Bank of India (SBI) has come a long way, moving from negative MVA to a positive Rs 1,421 crore, thereby climbing to fourth position from 44th last year. Others to increase market value include Andhra Bank, Dena Bank, and Vysya Bank. Kotak Mahindra has moved from number 21 to five in the MVA list mainly on market expectation from the finance company converting itself into a bank by end-March.

Investor expectations are led by the fact that bank managements are becoming more focused on return on equity. What's more, the setting up of Asset Reconstruction Companies (arcs) will help banks realise value and recover non-performing loans. Says Ritesh Maheshwari, Head of Financial Sector Ratings, CRISIL: ''As bulk of the NPAs are with the public sector banks, the passing of the Securitisation and Reconstruction of Financial Assets Act has had a positive impact on the market value of these stocks.'' The banking sector is also reaping the benefits of rationalising employee costs.

The trend prevailing for some years now is that banks and financial institutions with the largest assets or market value of equity are amongst the biggest destroyers of wealth. Consider IDBI, which has a total capital employed totting up to Rs 8,237 crore. With a negative MVA of Rs 6,836 crore, IDBI brings up the rear as the largest wealth destroyer. The economic value added (EVA) too has declined by about Rs 1,304 crore over the past five years, and stands at a negative Rs 1,586 crore as of 2002. The deterioration in all the EVA drivers has led to a decline in MVA (See Banking And Financial Services: The Top Three).

HDFC's Deepak Parekh: Wealth creator #1

Leader Of The Pack

As you might have learnt in school, a company is supposed to increase the capital shareholders entrust it with. And-what do you know-there are some companies that have actually performed that role. Not too many, but fact is such companies do mercifully exist. Like HDFC, which tops the MVA charts, and which has been consistently creating tons of wealth. HDFC's EVA stands at Rs 180 crore, and it's tough to believe that the housing finance behemoth actually had a negative EVA of Rs 138 crore five years ago. Over its entire life, HDFC has employed just Rs 2,546 crore capital from shareholders. By utilising those funds in the home loans market, HDFC has given the opportunity for investors wishing to cash in to more than double their returns. For the record, that Rs 2,546 crore is worth Rs 6,470 crore as of 2002.

Wealth creation stems from sustained performance on key EVA drivers, including revenue growth, better operating margins and higher capital returns. The topline of HDFC has grown by 83 per cent during the last five years from Rs 1,410 crore to Rs 2,588 crore. Pre-tax profits of the company grew by 25 per cent last year, the highest growth in percentage terms in the last 10 years. Operating profit margins have improved from 17 per cent to 21.8 per cent and the capital returns from 0.8 to one times. What is HDFC doing right that others are not? First, the average weighted cost of capital has been shrinking, as the gearing has increased with the debt to equity ratio at 6.9:1 in 2002 as against 4.5:1 in 1998.

Explains Keki Mistry, Managing Director, HDFC: ''We have been doing continuous realignment of assets and liabilities in keeping with the changing interest rate environment and broad-based the sources for raising debt.'' For instance, HDFC is at present doing a yen borrowing at an all-in cost of 5.5 per cent. In January this year, HDFC did a 10-year bond issue at an all-in annualised cost of 6.29 per cent, perhaps the lowest at which any corporate has raised money abroad in recent times. HDFC has also done a few securitisation deals. The strategy behind developing the securitisation market is HDFC expects this to form a significant source of funding in three years time.

Says Mistry: ''The challenges for a finance company in a low interest rate regime is to keep recycling liabilities, and keep on adjusting interest rates to the current environment.'' Going ahead, with the consolidation of group accounts, the company expects the return on investments made in subsidiaries to further add to the EVA for HDFC. Over the long run, the key to a large MVA is a strong and growing EVA. Given that outstanding housing loans contribute to less than 2 per cent of GDP, as against 15 per cent in Asian countries and nearly 51 per cent in the US, business can only grow for HDFC. That gets ultimately reflected in profit numbers and, therefore, financial performance.

Turnaround Story

While flexibility is the key to HDFC's wealth creation, in case of India's largest state-owned bank State Bank of India (SBI), it's the tech-aided retail surge that's helping create value. SBI has made the highest addition to the MVA of Rs 2,804 crore, moving from a negative Rs 1,383 crore to a positive Rs 1,421 crore. The improvement in MVA has been driven by a strong positive EVA of Rs 308 crore as against a negative figure of Rs 774 crore in 2001. A.K. Purwar, Chairman, SBI, attributes the performance to ''the retail and technology push, which has helped us tremendously to manage our risk better and to create wealth for shareholders''. The retail business is expected to touch Rs 7,000 crore, of which Rs 3,500 crore is home loans. Add to it several new branded products catering to specific sections of society like Doctor Plus, Teacher Plus or Justice Plus. This, coupled with aggressive marketing, should help SBI grow in this segment. Add to this fat budgets on technology, with a focus on interconnectivity. The bank expects to spend another Rs 500 crore in the coming year on computerisation of up to 6,000 branches by next year. SBI is also expanding its horizon by entering life insurance distribution. It's a small business now but has growth potential.

Although the bank is a leader in terms of EVA, the stockmarket is yet to react fully to this performance. That explains the negative delta MVA for three years. The biggest challenge for the bank is to change the mindset of the workforce, get more customer-oriented and also craft strategies that would lead to further improvement in EVA.

In Anticipation Of Growth

The pressure is on: ICICI Bank has to deliver on the enormous expectations that are built into the stock price. As against an MVA increase from Rs 795 crore to Rs 2,306 crore, the bank's EVA is a negative Rs 901 crore. The market for its part is expecting things to improve. Or perhaps they already have. ICICI Bank's EVA in our study is actually understated due to the fact that the annual report for 2002 takes into account just two days of the earnings of ICICI (the financial institution that was merged into ICICI Bank.) If one were to annualise the nine-month audited results for ICICI Bank and ICICI, the EVA figure would be in positive territory. Points out Kalpana Morparia, Executive Director, ICICI Bank: ''Even in the current financial year, with all the burden of a negative carry over of SLR and CRR on ICICI borrowings, ICICI Bank has returned an roe of over 17 per cent for the nine months ended December 2002.'' ICICI Bank has been focusing on maximising returns to shareholders by optimally deploying capital. It has been using the concept of economic capital in pricing its loans for a long time now and is maximising the return on its capital by employing the same in the highest returning assets. Translated, that means retail. Retail assets have increased from about Rs 7,700 crore to about Rs 16,500 crore during the nine months ended December 2002. Also, it is focusing on non-fund based business where the capital requirement is lower than in other businesses. This will ensure continued delivery of handsome returns on capital.

Clearly, the challenge for the BFS sector is to meet expectations of investors. That's evident in the growth of MVA vis-a-vis EVA for the top 20 companies in this sector: MVA growth is a whopping 65 per cent as against EVA growth of 19.6 per cent. So, not just do the bank top brass have to improve earnings, they have to do so without adding on loads of capital. A tough task, but then nobody said it's going to be easy.