NBFCs enter durable recovery phase; MOFSL backs L&T Finance, PNB Housing

MOFSL said that NBFC asset quality has emerged as the biggest positive surprise, with improved collections and moderated fresh slippages after nearly two years of stress.

Disclaimer: This article is written by Motilal Oswal Wealth Management Research Desk. Views expressed are his own. Readers' discretion is advised.

 

India’s NBFC sector appears to be entering a more durable phase of recovery, with 1QFY27 performance reinforcing the improvement across loan growth, asset quality and profitability. Importantly, unlike earlier cycles where earnings were supported largely by provision reversals, the current recovery is being driven by multiple operating levers moving in tandem—healthy credit demand, moderating credit costs, resilient margins and improving operating leverage. The recovery is also broadening across vehicle finance, diversified lending, housing finance and microfinance, strengthening the outlook for sector-wide earnings momentum.

 

 

Loan growth remains healthy across secured and select unsecured segments, supported by rising formalisation of credit, improving consumer balance sheets and sustained demand from housing, vehicles and MSMEs. Vehicle financiers continue to benefit from healthy underlying auto volumes and replacement demand, while HFCs are seeing steady disbursements across affordable and mid-income housing. Diversified lenders are witnessing improving traction across personal, business and secured loans, although growth is increasingly being calibrated towards profitability and risk-adjusted returns rather than market-share maximisation. This greater emphasis on underwriting discipline should support the sustainability of growth as competitive intensity remains elevated.

 

Asset quality has emerged as the most significant positive surprise. After nearly two years of stress across microfinance, unsecured lending and certain retail portfolios, collection efficiencies have improved, and fresh slippages have moderated. Tighter underwriting standards, stronger collection infrastructure, greater use of analytics and a greater focus on secured lending have contributed to faster-than-anticipated normalisation in credit costs. Microfinance and micro-LAP, which endured some of the sharpest stress, are now showing early signs of cyclical stabilisation. A gradual recovery in disbursements, alongside lower credit costs, could provide meaningful operating leverage for lenders with exposure to these segments.

 

Margins have remained relatively resilient despite some moderation in lending yields. The recent easing in bond yields has provided incremental relief on borrowing costs, although funding conditions remain sensitive to inflation, liquidity and geopolitical developments. HFCs continue to face near-term NIM pressure amid intense competition and elevated incremental borrowing costs, but stable asset quality provides an important cushion to profitability. Meanwhile, investments in technology, digital sourcing, analytics and centralised operations are increasingly translating into greater cost efficiency. As loan growth recovers, better absorption of operating expenses should allow incremental growth to flow through more efficiently to earnings, making operating leverage an increasingly important driver of return ratios.

 

Competitive dynamics are also reshaping the sector. Larger, diversified franchises with strong liability access and multi-product platforms are gaining greater flexibility to allocate capital across lending segments based on relative risk-adjusted returns, while monoline lenders remain more exposed to segment-specific cycles. Gold finance illustrates this contrast: healthy collateral values continue to support industry growth, but the entry of well-capitalised lenders is likely to intensify pricing competition and structurally compress yields over time. Regulatory developments around revolving credit products and insurance commissions also remain important near-term monitorable, with potential implications for product economics and fee income.

 

Looking ahead, the trajectory of interest rates, inflation, monsoon conditions and regulatory changes will determine the pace of the recovery. A sustained moderation in funding costs, alongside continued credit demand, could extend the earnings upgrade cycle further. Overall, the NBFC sector appears well placed for a constructive phase of growth, with healthier balance sheets, stronger operating discipline and expanding digital capabilities providing a firmer foundation for sustained profitability.

 

L&T Finance

 

Target price: ₹380

 

L&T Finance remains well positioned for sustained growth, supported by strong retail disbursements, a granular loan mix and multiple growth engines across rural business finance, gold loans and personal loans. Its disciplined approach to growth, with selective moderation in disbursements to protect asset quality, underscores its focus on sustainable profitability. Stable NIMs plus fees, improving operating efficiency, moderating credit costs and a technology- and AI-led strategy should drive a structural improvement in return ratios. We estimate ~25 per cent loan book and ~30 per cent PAT CAGR over FY26-28E, with RoA/RoE improving to 2.6 per cent/~15 per cent by FY28E.

 

PNB Housing Finance 

 

Target price: ₹1,390

 

PNB Housing Finance remains well positioned for stronger growth, supported by increasing traction in the affordable and emerging housing segments, deeper customer penetration and the upcoming micro-housing finance rollout. While NIMs moderated in 1QFY27, management expects margin recovery from 2HFY27, aided by an improving business mix, higher incremental yields and lower funding costs. Healthy asset quality, declining repayments and continued recoveries provide further support to profitability. We estimate a 21 per cent/13 per cent CAGR in loans/PAT over FY26-28E, with RoA/RoE of ~2.3 per cent/13 per cent in FY28E.