>BANKING: Cherry-picking key to outsized returns (CENTRUM)

We believe a combination of defensive bets within the sector and a strategy that would call for reduction in betas would be stocks to bet heavily on within the Indian financial sector. Banking stocks with lower C/D ratios, adequate capitalization (not exceeding 11% in Tier I) and better resource franchise will likely be better positioned to deliver superior returns. With this, our preferred picks within our universe are Bank of Baroda (BoB), HDFC Bank, Indian Bank, Federal Bank and South Indian Bank. Axis Bank, Indian Overseas Bank (IOB) and Bank of India (BoI) continue to be high conviction Sells.

■ Cherry-picking on margin strength…: A bank’s margin strength can be determined from a
combination of its liability franchise and composition of its asset franchise. With credit offtake showing signs of growth in spurts, franchise quality holds the key.

■ …and lower C/D ratios: We believe banks with higher C/D ratios may either need to cut back or witness a capping of opportunity for margin augmentation. Further, in an environment of lower pricing power, banks with better liquidity would be better equipped to tap the resurgence.

■ Asset quality to be watched closely: While certain banks would surprise positively in terms of NPL recoveries, this space needs to be watched closely. Within our banking universe, Indian Bank and IOB currently have the highest restructuring ratios and we reckon, with the improving macro-economic picture, the former should surprise positively, given its fundamental strength. Indian Bank’s current estimates do not factor in this upside.

■ Change of guard … now at PSU banks: We would see change of guard at several PSU banks in 2010. Management quality will likely become a key focus theme across the financial services space and a likely driver for valuations.

To read the full report: BANKING UPDATE