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Balancing growth and asset quality amid macro headwinds

Benefits of Cyclops will be more visible from 2HFY26

* LTF began FY26 on a stable footing, despite ongoing asset quality challenges in the MFI industry (more residual in nature), unsecured business loans and micro-LAP. The company continues to pursue a measured growth strategy, with a sharper focus on secured and prime segments, while effectively leveraging its proprietary underwriting platform, Project Cyclops, to reinforce credit discipline.

* In Mar’25, we highlighted in our note that although the company was also facing challenges in its MFI business, it will likely emerge out of the MFI credit cycle much less affected than its peers. Since Mar’25, the stock has delivered ~60% returns.

* LTF remains focused on acquiring high-quality customers through technology-driven underwriting and stringent credit controls while maintaining strong collection efficiency (CE) across all segments. Although credit costs were slightly elevated due to a slower-than-expected recovery in Karnataka, steady improvements have been observed, with CE strengthening in 1Q and further in Jul-Aug’25. CE is expected to stabilize during 2Q and return to normal levels by mid-3Q.

* LTF is harnessing technology as a structural advantage, making rapid progress with Project Cyclops, its AI-ML-powered underwriting engine. With 100% of 2W disbursements now processed through Cyclops, asset quality has seen a sharp improvement, with net non-starters dropping to 0.34% in Jun’25 from 2.36% in Dec’24 (~2pp improvement in just five months). The company is now rolling out Cyclops to its Farm Equipment and SME Finance businesses, with full deployment targeted by end-2QFY26, strengthening its position to deliver scalable and high-quality growth.

* LTF has swiftly completed the integration of Paul Merchants Finance’s gold loan business in just two months, adding 130 branches, 700+ employees. It now has a gold loan book of ~INR13b. Gold loans, being a high-yield secured product, are expected to materially strengthen the retail franchise and offer significant cross-selling potential across its 26m+ customer base (driven by its 20,000+ field force). The company targets scaling up to 300+ gold loan branches by FY26, largely through its new ‘Sampoorna’ multiproduct branches.

* LTF has been assigned a debut investment grade credit rating of ‘BBB-/ Positive’ by S&P Global Ratings and ‘BBB-/Stable’ by Fitch Ratings, unlocking access to a wider pool of global capital at competitive costs.

* We estimate a CAGR of ~22% in loans and ~25% in PAT over FY25-FY27, with consolidated RoA/RoE of 2.7%/~14% by FY27E. LTF will soon emerge out of the MFI credit cycle and will continue to deliver better profitability and RoA expansion. Reiterate BUY with a TP of INR260 (based on 2x Mar’27E BVPS).

Well positioned for stronger growth in 2H

* LTF remains focused on expanding its customer base by deepening penetration in existing segments and broadening its geographic presence. In Rural Business Finance, the approach has been calibrated to prevailing macro conditions, with disbursements now gradually regaining momentum. The 2W finance business is witnessing renewed traction, aided by policy changes and the reactivation of dealers to strengthen engagement with prime customers. Farmer Finance is set to pick up pace in the ongoing kharif season, while the Personal Loan portfolio continues to follow a risk-calibrated strategy, ensuring prudent growth.

* Digital partnerships with Amazon, CRED, and PhonePe continue to gain traction, delivering INR6.5b of personal loan disbursements in 1QFY26 (INR12.4b till date), with a strong focus on risk-calibrated growth.

* We expect LTF to sustain its growth momentum with healthy traction in 2Q, followed by a strong acceleration in 2H, supported by festive season demand. We model a CAGR of ~22% in the loan book over FY25-FY27E.

Margin pressure from change in loan mix partly offset by decline in CoF

* NIMs are likely to remain under pressure through FY26, primarily due to a reduced share of high-yielding MFI loans in the portfolio mix and yield compression from a growing focus on prime and secured customer segments. However, this pressure is expected to be partially offset by a decline in borrowing costs, supported by the declining interest rate cycle.

* While the reported yields may moderate, we believe that the portfolio shift toward better-quality assets is expected to enhance risk-adjusted returns and support profitability over time.

* The planned expansion of the gold loan business, a high-yielding segment, will also provide support to overall yield levels and act as a key growth driver in the near-to-medium term, supported by favorable industry tailwinds. We model NIMs of ~9.5%/9.6% in FY26/FY27 (vs. ~9.9% in FY25).

Asset quality better than MFI peers’; expect gradual moderation in credit costs

* LTF has demonstrated resilience in asset quality, maintaining stability despite industry-wide pressures in select segments. This has been driven by its disciplined underwriting standards and strategic focus on secured assets and prime customer profiles.

* While credit costs remained slightly elevated due to a slower-than-expected recovery in Karnataka, the company is now seeing steady improvement, with CE strengthening in 1Q and further in Jul’25. We expect the situation to stabilize in 2Q and normalize by mid-3Q.

* LTF has cumulatively utilized INR7b of macro-provisions, with INR4b utilized in FY25 and INR3b in 1QFY26. It now has an unutilized buffer of INR2.75b as of Jun’25. Looking ahead, the company expects further utilization of macroprovisions to address forward flows from Karnataka; however, such usage will remain measured and prudent. Over FY27-FY28, the company will re-build provision buffers, primarily utilizing the inflows/gains from SR resolutions.

* We expect asset quality to strengthen over FY26-FY27, with GNPA improving to 2.5%/2.4% from 3.3% in FY25. Correspondingly, credit costs are expected to moderate gradually to 2.7%/2.6% in FY26/FY27 from 2.8% in FY25.

Smarter underwriting, stronger outcomes: Engineering the future with AIML

* With a strong emphasis on artificial intelligence (AI), machine learning (ML), and data-driven insights, LTF is transforming its financial services ecosystem. Flagship initiatives like Project Cyclops, the AI-powered credit underwriting engine, and Project Nostradamus, the predictive risk management platform, are set to revolutionize the company’s credit assessment and portfolio monitoring capabilities.

* The company has fully deployed Project Cyclops in the 2W segment, delivering significant improvements in asset quality. A phased rollout in the farm business is in progress and is expected to be completed by end-2QFY26. Implementation in the SME and personal loan segments is also on track, with full deployment targeted by 2QFY26 and 3QFY26, respectively.

* The impact of Project Cyclops is expected to become more pronounced from 4QFY26 onward, as the portfolio originated under this framework matures and expands to account for a meaningful share of the overall book.

Valuation and view

* LTF has invested in process automation and customer journeys. This, along with large partnerships with digital behemoths, should lead to stronger and more sustainable retail loan growth. While there is industry-wide stress in non-MFI retail segments like unsecured business loans and micro-LAP, we expect the stress to subside within the next few quarters. Going forward, we expect LTF’s growth in MFI loans to be more opportunistic in nature, given that it targets to bring down the MFI loans in the loan mix to 20-22% over the long term.

* LTF's relatively better navigation of the MFI credit cycle and diversification into non-leveraged MFI markets demonstrate its resilience and adaptability. Supported by digital partnerships with major players such as Amazon and PhonePe, LTF is poised for sustainable earnings growth once the near-term headwinds in the MFI business subside.

* LTF can deliver a PAT CAGR of ~25% over FY25-FY27E, which will result in a RoA/RoE of 2.7%/14% in FY27E. Reiterate our BUY rating on the stock with a TP of INR260 (based on 2x Mar’27 P/BV). Key risks: 1) stress in microfinance lingering beyond the next 3-4 months, 2) asset quality deterioration in relatively vulnerable retail segments such as 2W, unsecured business loans and micro-LAP and 3) any near-term pressure on NIM and fee income.

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