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In 1QFY24, our NBFC coverage universe reported 45% YoY growth in PAT led by 19% YoY AUM growth, 25% YoY PPOP growth. NII was up 24% YoY for the coverage universe. NIMs though exhibited mixed trends – NBFC-MFIs saw an expansion in NIMs (with 47bps QoQ improvement led by benefit of lending rate hikes) while vehicle financiers (VFs) witnessed 37bps QoQ compression. Diversified financiers (incl BAF) and AHFCs saw largely stable NIMs on a sequential basis. Large HFCs benefitted with better asset yields in the quarter driving NIM uptick. Cost of funds on an avg was up 10bps QoQ on a sequential basis with highest increase seen in diversified segment while yields were up 25bps QoQ. Asset quality continued its improving trajectory with credit costs slightly moderating sequentially across most players.

We had previously highlighted that NBFC stock performance was driven by narrative of uptrend in interest rates even as fundamental performance was on a continuous upward trend over the last year. With a potential peak of interest rates in sight, NBFCs have delivered strong performance over the last 3M/6M period which has led to a meaningful re-rating of NBFCs as a sector.

In our view, easy gains from the sector are behind and we expect growth leaders to sustain the outperformance. We forecast 29% earnings CAGR for our NBFC coverage universe over FY23-FY25E. Our preferred segments are diversified NBFCs, NBFC-MFIs and AHFCs. Our top picks – Bajaj Finance, Poonawalla Fincorp, Creditaccess Grameen, Fusion Microfinance, Home First Finance Co and Mahindra & Mahindra Financial Services.

* Diversified NBFCs – strong all round show: Diversified NBFCs exhibited a strong performance across all the parameters with a) healthy sequential AUM growth (barring LTFH which de-grew 2.9% QoQ due to wholesale book run-down) b) strong operating performance with steady NIMs and c) sequential improvement in asset quality. AUM growth (our coverage universe grew by 20% YoY) exceeded our expectations with BAF and Poonawalla both registering 9% and 10% sequential growth driven mainly by retail consumer and SME loans. Diversified NBFCs have been able to evade any sharp margins contraction from rate hikes due to its diversified product mix spread across fixed and floating rate products. Diversified NBFCs also carry a healthy provision cover (avg PCR for our coverage universe at 61%) to prevent from any major asset quality headwinds going forward. Thus we remain positive on the segment as a whole with BAF and Poonawalla as our preferred picks.

* Vehicle Financiers – NIM compression sharper than expected: Vehicle Financiers saw a soft quarter driven by: a) margins compressed on account of higher quantum of fixed rate loans b) growth was healthy despite seasonally weak Q1 and c) steady asset quality. Growth in VFs during Q1FY24 (our coverage universe grew 12% YoY) was aided by uptick in used vehicles as well as improvement in passenger vehicles demand while SME segment also registered a robust growth which contributed to non-vehicles segment. Margin compression was higher than anticipated mainly due to higher CoFs and majority fixed rate loans. Frontline asset quality for VFs remained largely steady while credit costs were relatively higher during the quarter. Even as headline asset quality was steady and on expected lines, credit costs were higher than expectations given ECL methodology (high run-rate over last couple of years) and we expect the same to moderate going ahead given lower fresh stress creation. MMFS is our preferred play in the space.

* HFCs and AHFCs – steady quarter: AHFCs demonstrated a steady quarter with a) healthy demand in low ticket affordable housing loans b) margins contraction on account of transmission lag (except HFFC) and c) marginal increase in GS3 across the sector due to seasonality (on account of higher exposure to rural). AHFCs continued its healthy growth performance (our coverage universe grew 30% YoY) with HFFC and Five-Star reporting 8% and 10% sequential growth respectively. On the margins front, HFFC was able to protect its margins as it raised NHB funds during the quarter. Prime/large HFCs on the other hand reported muted loan growth on account of developer book run-down and seasonality while they were able to pass on the rate hikes to end customers which contributed to margins expansion. We believe that, since CoFs for most of the HFCs have largely stabilized and NIMs for HFCs should remain steady. We prefer HFFC as our top pick due to its easy access to funding, niche target customers, strong underwriting techniques, tech-led loan processing and lower stress.

* NBFC-MFIs – strong quarter more to follow: NBFC MFIs continued their solid performance in 1QFY24 on the back of tailwinds in the form of a) sector growth revival b) robust asset quality parameters resulting in lower credit costs and c) healthy operating profitability as NIMs see an inch up. After tepid growth seen during Covid-19 period, MFIs are seeing a strong revival in growth (our coverage universe grew by 19% YoY) – aided by resilient demand in the rural segment, further accelerated by restart of strong customer additions by MFIs along with increase in ATS. Margins have been on an upward trend aided by removal of spread caps and controlled cost of funding for the major players. Asset quality pain seems to be behind with most of the MFIs in our coverage universe reporting low to moderate credit costs – on the back of proactive stress recognition in previous quarters resulting in limited residual stress for the sector. We expect the rerating to continue for MFI players as they stay on a strong growth path along with materially lower credit costs which in turn should drive strong return ratios. Despite outperformance over the past 6 months (c.30% avg outperformance vs NIFTY), we see the sector delivering meaningful outperformance given earnings momentum is expected to continue and valuations still remain favourable. CreditAccess Grameen and Fusion are our preferred play in the space.

* Out preferred picks: -Diversified Financiers – Bajaj Finance, Poonawalla Fincorp -AHFCs – Home First Finance Company -Vehicle Financiers – Mahindra Finance -MFIs – Creditaccess Grameen and Fusion Microfinanc

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