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We expect the NBFC sector to witness a strong start to FY27, characterized by sustained growth momentum and broadly stable asset quality in Q1FY27. Margins, however, are expected to moderate during the quarter due to elevated CoFs driven by higher benchmark yields in Q1. On the credit cost front, Q1 performance is likely to see some sequential deterioration, reflecting typical Q4-to-Q1 seasonality. Nevertheless, overall asset quality is expected to remain resilient, with only marginal seasonal deterioration, supported by strong collection efficiencies across players. Despite short-term margin pressures, the industry is likely to report a relatively good quarter. However, indications of below-average rainfall would impact rural segments, which could compress rural cash flows in Q2. This anticipated rural stress is likely to partially offset the strong operational performance witnessed in Q1. Nevertheless, factoring in a likely resolution of the West Asia conflict and fading concerns over an RBI rate hike, the overall FY27 outlook appears stable. While the material re-rating of NBFC stocks over the past two months limits any further significant upside, steady core performance should continue to support share prices. We continue to prefer ABCAP and MMFS.

A good start to FY27

Healthy credit demand continues to drive sector-wide growth, with vehicle financers seeing Q1 volumes largely intact despite typical seasonal softness. Recent business updates from BAF, LTF, and MMFS have affirmed this trend, highlighting strong disbursements and robust AUM growth. However, we expect overall margins to witness some compression this quarter (excluding SHFL), driven by an elevated cost of funds. Meanwhile, operating expenses are expected to be broadly stable, reflecting continued investments in technology and infrastructure across the board.

Asset quality and credit cost to display some seasonality

The seasonal slight worsening of asset quality and inching up of Q4-to-Q1 credit cost would be seen in Q1FY27 as expected, while many of the NBFCs have indicated that overall collection efficiency has been strong, which should keep asset quality resilient. Though we can see some pressure on asset quality and credit cost for rural-focused lenders, especially in the vehicle and farm segments in Q2, on account of rural cash flows getting impacted if the monsoon remains weak

Softer growth weighs on power financiers

Although near-term AUM growth for power financiers like REC and PFC will remain soft, weighed down by higher loan repayments from state utilities (such as RBPF schemes) and muted disbursements due to slower power capex. Overall margins are expected to remain healthy. On the asset quality front, the broader book remains exceptionally strong; even as the tailwind of recoveries from stressed assets begins to fade, credit costs are anticipated to remain firmly low. While the merger process between the two entities is ongoing, we do not expect this to have any material impact on their overall business fundamentals or operational trajectory in the near term. The recent correction in share prices appears to have fully priced in this near-term growth moderation, making valuations quite compelling. With the recent correction in share prices fully pricing in this growth moderation, both stocks are now attractively valued and offer a strong RoE.

Steady core performance to support valuations

Notwithstanding near-term margin pressures and seasonal credit cost blips in Q1, the overall FY27 outlook for the NBFC sector appears stable. Factoring in fading concerns over an RBI rate hike and the likely resolution of the West Asia conflict, we anticipate sustained credit demand and resilient asset quality driving steady core performance. While a potentially weak monsoon poses a risk to rural cash flows and asset quality in Q2, robust collection efficiencies provide a strong buffer. The financial health of our coverage universe remains solid, underpinned by healthy AUM growth and disciplined operational investments. Although the recent material re-rating of the sector limits significant further upside, steady profitability should continue to support valuations. We retain our positive view on the sector and continue to prefer ABCAP and MMFS.

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