Bank of America Merill Lynch (BofAML), in a recent report, has upgraded IndusInd Bank to 'buy' with a target price of Rs 2,000 per share, indicating a 37 percent upside from its current market price of Rs 1,458.

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"As we move into 2020, we believe IndusInd Bank offers the best risk-reward in the sector. We expect most of the investor concerns (especially asset quality) to be addressed positively in the next couple of quarters driving a re-rating towards at least historic averages (base case) and our bull case playing out if macro recovery is stronger. If the macro normalisation is stronger, we see further upside to our target," the brokerage said in the report.

BofAML believes the bank has the most diversified exposure across the business and retail segments. The Bharat Financial acquisition could provide medium-term optionality with both cross-sell and organic growth expectations, it added.

"The recent underperformance may have been driven by concerns around IL&FS exposure -- we expect this issue to be behind us. At current valuations, the risk-reward looks attractive given the near-to-medium-term growth outlook and the lender's superior ROE profile," it stated.

BofAML's core investment thesis on IndusInd Bank is driven by one of the best operational stories in the sector, best in class ROEs, comfortable capital cushion, and attractive risk-reward at current valuations.

As current multiples are already pricing in a stress scenario, we believe downside risks are limited, the report stated. BofAML increased FY20-22 earnings estimates by 1-13 percent driven by higher growth and NIMs assumptions offset by more conservative credit cost assumptions.

Bull Vs Bear Scenario

The brokerage analysed potential ROE scenarios for the bank based key-income drivers - NIM, non-interest income, opex and provisioning costs. These were looked at under different stress scenarios to determine the risk-reward.

It's bull case scenario for FY21E estimates an ROE of 22.2 percent based on the following assumptions:

• Strong NIMs, with an improvement over the historical range, due to the liability and asset mix of the bank, with a higher proportion of fixed-rate book and wholesale funding.

• Normalisation of credit costs, going into FY21, on the back of both improved

asset quality and write-back of provisions based on recoveries. Its credit cost

estimates for FY21E in the bull case are in the range of 90-100 bps.

• It assumes a lower leverage ratio in our bull case, given the expected boost to the capital from increased profitability.

On the other end, our bear case/ high stress case, with an implied ROE of 12.7 percent, rests upon these key assumptions:

• Margin squeeze and higher opex- unequal transmission of any further rate cuts and external benchmarking of loans may impact margins unfavourably.

• Higher credit costs (based on severe stress case scenarios for CV and Corporate loan book segment).

It further noted that the key investor concerns are likely to be resolved in the first half of FY21.

1) Auto/CV exposure- The cycle now close to bottoming with IIB’s specialised approach limiting losses.

2) Quality of liability franchise - Re-utilization accelerating, wholesale

funding now a tailwind

3) Quality of fee growth

4) Low NPA coverage - NPA is likely to improve close to 60 percent as early as Q3FY20.

BofAML expects Q3FY20 results to offer more clarity on asset quality-related concerns. Better clarity on the macro (especially auto related) in 3-6 months as macro numbers are likely to show improvement by June.

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