Motilal Oswal Financial Services expects the NBFC sector to enter a stronger earnings cycle, with improving loan growth, better asset quality and stable margins creating room for further gains. The brokerage highlighted that the 1QFY27 earnings season has strongly validated their thesis that NBFCs are entering a new cyclical recovery. Operating performance has improved meaningfully across the sector, with healthy loan growth, broad-based asset-quality normalisation, resilient margins, and improving operating leverage driving earnings beyond expectations. The strength and breadth of this recovery have already translated into meaningful upward revisions to FY27/FY28 earnings estimates across MOFSL's NBFC coverage universe. This represents a fundamentally different recovery phase from previous cycles where earnings upgrades were primarily driven by lower-than-expected credit costs.
Motilal Oswal projects profit after tax (PAT) for its NBFC coverage universe to grow 24% in FY27 and 18% in FY28, as the first-quarter earnings season validated a recovery that is increasingly being supported by multiple factors rather than only lower credit costs. The current recovery differs from earlier cycles because earnings improvements are being supported simultaneously by healthy loan growth across secured and unsecured segments, faster-than-expected normalisation in credit costs, moderation in funding costs, resilient margins and improving operating leverage. Diversified NBFCs' PAT is expected to rise 40% in FY27 and 28% in FY28, while vehicle financiers' PAT is projected to grow 39% and 18% respectively. Housing finance companies are expected to see more moderate PAT growth of 8% in FY27 and 13% in FY28. The sector's focus is shifting from recovery to the durability of the earnings and return-ratio cycle, with the question being how far the earnings and return-ratio cycle can extend.
Asset quality has been one of the strongest positives in the NBFC sector's recovery, with collection efficiencies improving and fresh slippages moderating after nearly two years of stress across microfinance, unsecured personal and business loans. According to The Economic Times, tighter underwriting, stronger collection infrastructure, lower borrower leverage and a greater focus on secured lending have contributed to the improvement. The faster-than-expected decline in credit costs suggests that the sector may have moved beyond the peak of the asset-quality cycle. Growth is also recovering without a visible deterioration in risk discipline, with vehicle financing benefiting from strong demand following GST cuts, steady commercial vehicle replacement and improving used-vehicle financing. Housing finance continues to see healthy disbursements in affordable and mid-income segments, while gold financing remains supported by demand for secured credit. Operating leverage is beginning to emerge as an additional support to profitability, with investments in technology, digital sourcing, centralised operations and analytics made over recent years beginning to support efficiency and improve return ratios over the medium term.
Despite strong Q1FY27 performance, NBFCs face mounting margin pressure as the regulator's hawkish undertone creates negative implications for the sector. According to Business Standard, net interest margins (NIMs) may be under pressure in H2FY27, with the pressure increasing in FY28. Q1FY27 saw a sequential increase in borrowing costs, with many lenders guiding for a flat to 10-15 basis point increase in the cost of funds over the next nine months. If there is a 50 basis point increase in repo rates over the next 12 months, this will lead to around a 10-15 basis point rise in the cost of funds for most NBFCs. Corporate bond yields have inched up, indicating an expansion in credit spreads, while G-Sec yields moved up in March and April and have since eased. The replacement of non-convertible debentures (NCDs) maturing in FY27, representing 2-6% of total borrowings (maybe 20% of NCDs) with costs of 7.5-9%, will provide some relief for large, highly rated NBFCs.
Motilal Oswal's top four NBFC picks are Bajaj Finance, L&T Finance, PNB Housing Finance and Five-Star Business Finance. As per the latest report, Bajaj Finance is among the preferred diversified lenders and stands to benefit from improving credit demand and recovery in consumer lending. Bajaj Finance expects a 10-15 basis point rise in borrowing costs for the rest of the year, but gold and new loan segments are generating higher yields, with the consumer durables business growing 40% year-on-year in Q1FY27. L&T Finance saw growth in the microloans business in Q1, which will push up margins, though management indicates this segment will see slower growth in future. PNB Housing Finance is one of the brokerage's picks, with Motilal Oslal believing relatively under-owned housing finance companies could attract more investor attention as the recovery broadens. Five-Star Business Finance provides investors exposure to lending to small businesses and self-employed borrowers. The brokerage believes the recovery seen in the Q1FY27 could be more than a short-term improvement, with the possibility of higher earnings estimates and another round of valuation rerating. Bajaj Finance target price is ₹1300 and L&T Finance target price is ₹380 according to The Economic Times.
