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* Overall volumes remain mixed amid festive cheer and risk aversion. We will monitor the commentary on changes in demand trends.

* NIM to improve qoq for most NBFCs. Credit costs to remain largely flat sequentially, with a positive bias for vehicle financiers & some pain for SMEs.

* We reiterate Bajaj Finance (ADD, TP: Rs1,250) as our high-conviction pick & believe that affordable housing finance companies are lucrative bets.

Selective disbursements amid festive cheer and risk aversion

Overall demand remained healthy sequentially, though disbursements were selective. We saw strong growth in vehicle finance segment, driven by favorable policy actions (repo rate cuts and Goods and Services Tax or GST rationalisation) and festive-season demand resulting in a reduction in vehicle prices. In contrast, disbursements in unsecured products, particularly personal loans, remain robust. However, we expect subdued disbursements in affordable housing, loan against property (LAP) and SME segments as lenders adopt tighter underwriting standards to focus on high-quality customers. We expect AUM growth of 13-19% yoy for vehicle financiers, 16-25% yoy for affordable housing lenders, and 20- 44% yoy for other financiers (ex-microfinance) in our coverage universe. We await management commentary on sustainability of the recent growth trajectory.

Margins supported by gradual rate transmission

We expect NIM to expand by 5-10bp qoq, as the transmission of recent rate cuts gradually flows through. This is aided by predominantly fixed-rate nature of NBFC loan portfolios, including secured finance, unsecured personal loans, SME/MSME loans, & credit cards, which helps to protect asset yields in the near term. Accordingly, we expect Bajaj Finance (BAF), Shriram Finance (SFL), and Mahindra & Mahindra Financial Services (MMFS) to report sequential NIM expansion.

Asset quality improving amid selective stress

We expect asset quality to be sequentially in line with the previous quarter, though with a selective positive bias for vehicle financiers due to strong recovery in vehicle demand and affordable housing finance on the back of tight underwriting practices and a shift towards higher-ticket loans. We expect continued SME stress to inch up credit costs for Bajaj Finance (BAF) and await management commentary on the same. SBI Cards is expected to show some easing in credit costs, given tighter underwriting norms and a higher churn.

MFI: Gradual recovery with easing backlog of stressed assets

We expect most microfinance lenders to report a qoq revival in disbursements. Collections are likely to improve, aided by better macroeconomic conditions. In our coverage universe, we expect Spandana Sphoorty Financial (SSFL) to report yet another loss on account of the sale of stressed assets worth Rs 4.9bn, though we expect disbursements to gradually pick up pace in coming quarters.

Outlook and valuation

We remain positive on affordable housing finance companies as we believe that growth will take off again on the back of strong demand, as highlighted in our recent report - Affordable Housing Finance: A sweet spot - once credit costs normalise. We believe that valuations remain compelling in the case of both Aavas Financiers (ADD, Rs2,100) and Home First Finance Company (ADD, Rs 1,400). BAF (ADD, Rs1,250) continues to be resilient in new customer onboarding, adding dry powder to its cross-sell franchise, and believe that the slowdown in AUM growth is transitory although we await management commentary on the same. We remain positive on Shriram Finance (ADD, Rs1,200) amid the strategic investment. We also like MMFS (ADD, Rs450) & UGRO Capital (ADD, Rs260) due to favourable risk-reward ratio. We retain HOLD rating on Cholamandalam Investment Finance Co. (Rs1,850) amid a selective slowdown in its new products, and SSFL (Rs280) for the looming uncertainty. We retain REDUCE rating on SBI Cards (Rs700) as we believe that most positives have been priced in.

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