Fiscal 2024-25 has been a year to forget for the microfinance (MFI) lenders, with many slipping into quarterly losses. Apart from over-leveraged borrowers, lenders pushing aggressively for growth also played its part. We had pointed this out in our earlier Big Story article in bl.portfolio edition dated January 12, 2025.
During FY25, delinquencies rose, loan losses ballooned and earnings dipped. The said Big Story was published before most firms were to report financial results for Q3 FY25 – which along with Q4 turned out to be a nightmare for the industry. For some lenders, gross NPA ratio shot up to early teens, quarterly return on assets plummeted to below -25 per cent, sending stock prices tumbling to 52-week lows. There have also been reports that suggest banks, which are the primary source of funding for most microfinance NBFCs turning cautious in extending credit, owing to concerns over risk to capital.
Broadly though, companies appear to be pulling their act together after reaching crisis levels. Q1FY26 results indicate improvement in the bottom line and credit cost on a sequential basis, on the back of stringent underwriting adopted. Prices of most stocks have run up from their respective 52-week lows, recovering about 20-40 per cent of the drop from 52-week highs. The market seems to believe the worst is over and is pricing in a sustained recovery back to the situation as it was before the second half of FY25. That said, should you throw your hat in the ring and bet on the industry’s turnaround? Read on to find out.
Industry overview
As over-leveraging wreaked havoc, MFIN (Microfinance Industry Network), a self-regulatory industry organisation (SRO), had brought out a set of guidelines known as ‘Guardrails 2.0’ in late-November 2024. This was a more stringent version than the one brought in July 2024.
Guardrails 2.0 advocated three actions:
* Number of lender associations per client to be reduced to three from four. In other words, a borrower should not be indebted to more than three lenders
* Total indebtedness of a client should not exceed ₹2 lakh. This should be checked across MFI and other unsecured loans
* Lending rates should be closely overseen by the board of the lenders, such that efficiency gains are passed on
While the second and third actions were implemented by the members from January 1, 2025, the first one was deferred to April 1.
These actions and the overall stricter underwriting of loans meant that the industry’s gross loan portfolio declined 17 per cent on a year-on-year basis, from ₹4.3 lakh crore in Q1 FY25 to ₹3.6 lakh crore as of Q1 FY26 (data as published in CRIF High Mark’s quarterly ‘MicroLend’ report). Even on a sequential basis, this is a decline of 5.8 per cent. Disbursements, too, are down 20 per cent on a quarter-on-quarter basis in Q1 FY26, versus a 12 per cent rise seen in Q4 FY25. Hence, the industry doesn’t appear to be growing, as it consolidates its underwriting practices.
Consequently, the share of over-leveraged borrowers is on the decline. As prescribed under the Guardrails 2.0, the share of loans borrowed by clients who are indebted to more than three lenders (by value) has come down significantly from 19.2 per cent as of Q1 FY25 to 10 per cent as of Q1 FY26. Further, the share of loans borrowed by clients who are indebted to more than ₹2 lakh has fallen from 7 per cent as of Q1 FY25 to 2.3 per cent as of Q1 FY26.
Delinquencies for the industry are easing too. Overdue accounts are put in various buckets of days overdue — PAR 1-30, 31-90, 91-180 and over 180. PAR stands for portfolio at risk. Simply put, PAR 1-30 represents the loans (by value, as a percentage of loan base) that are overdue by more than a day, but not exceeding 30 days.
It can be seen from the graphic that across buckets, the stress, which peaked in Q3 and Q4 of FY25, has eased in the recent quarter. However, stress in the later-stage bucket of PAR 180+ remains elevated. Though this indicates challenging collections, there could also be the effect of diminishing base. That is, the pace of late-stage delinquencies might continue without meaningful recoveries, while AUM is declining. Also, stress in the earlier PAR 1-30 bucket seems to have rebounded slightly. All in all, there is a broad improvement in asset quality, though not thorough enough.
At the time of our said Big Story, the news of the Karnataka government coming up with a law to curb coercive practices by unorganised micro lenders was making the waves. Even Tamil Nadu followed with a similar legislation later. The thought of the State having one’s back encourages borrowers to default, even if they were regular, even if indebted to an organised lender.
This, in fact, was one of the incremental reasons among others why delinquencies could’ve shot up during Q3 and Q4 of FY25. Thankfully, now it appears that the issue is isolated to Karnataka alone, as all other States have shown improved asset quality as seen pan-India (see graphic). The State also has the worst PAR 31-180 ratio at 12.5 per cent, while it is 5.5 per cent pan-India. Some listed lenders do have meaningful exposure to the State, though not to a large extent. West Bengal showed a mild uptick in the said ratio; however, its PAR 31-180 ratio is one of the best at 3.3 per cent.
Overall, there appears to be signs of broad-based recovery in asset quality, though it might take longer to get back to levels seen in Q1 FY25, when pan-India PAR 31-180 ratio was 2.7 per cent.
Analysis of listed players
The listed players operating in the MFI segment — both NBFC-MFIs and NBFCs with significant exposure to MFI, bore the brunt as the industry deepened into a crisis. For our analysis here, besides those in the above two categories we have also considered top four SFBs (small finance banks), ranked by share of the MFI book (see chart). In total, 12 such stocks were taken up (referred to as universe).
Data from these companies reveal Q3 and Q4 of FY25 (also Q2 in few cases) were the worst in terms of asset quality, profitability and even growth. Analysis of performance in Q1 FY26 versus these two quarters gives away mixed signals — improvement in some metrics and deterioration in the other.
Here we analyse three parameters — growth, profitability and asset quality through various metrics.
Growth
Q2 FY25 was the first quarter where there was a secular decline in sequential growth in MFI AUM (barring L&T and Muthoot), which continued in Q3 and Q4. Hence to get a better understanding of the impact the current slowdown has resulted in, it is apt to analyse AUM growth in Q1 FY26 over Q1 FY25. On an average, the year-on-year decline in MFI AUM for the universe was 16.9 per cent. This was arrived at as the year-on-year change in sum of MFI AUMs of stocks in the universe. Only three stocks posted growth, while also not being healthy figures (see chart). This can be compared with credit growth in the banking system in Q1 FY26 over Q1 FY25 at 9.5 per cent.
In a similar way, MFI disbursements were also analysed. Disbursements growth represents fresh loans and indicates managements’ confidence in underwriting. While the average of the universe came at -18.7 per cent, only four stocks reported growth. Apart from the three stocks shown in the chart, Ujjivan also posted growth.
The stocks in the universe have adhered to the said Guardrails and there is reduction in the share of over-leveraged borrowers. However, it is still work in progress and it can be expected that broadly disbursements will remain measured, such as extending loans only to clients with good vintage with the company and being cautious with new-to-credit borrowers.
Profitability
Besides slowing AUM growth and the resultant decline in interest income, the primary reason lenders slipped into losses or faced falling earnings was provisions or impairment of loan assets.
Provisions are best analysed as credit cost ratio, which is roughly calculated as provisions divided by the loan portfolio. The chart above collates entity level credit cost ratios. It can be seen that credit cost has largely eased in Q1 FY26 from peaks seen in Q3 or Q4 of FY25. While this sure is a positive sign, it remains to be seen in the quarters ahead, if this can be sustained. For example, IIFL, Utkarsh and Satin Creditcare have an uptick in credit cost in Q1 FY26, even though it eased in Q4 FY25.
The gains from reduced credit cost can be seen in the RoA (return on assets) metric, as shown in the valuation chart. Except for IIFL, Utkarsh and Spandana Sphoorty, all others in the universe have improved their RoAs (quarterly annualised net profit divided by average assets) in Q1 FY26 over Q4 FY25.
Asset quality
Asset quality metrics are a mixed bag too. First, going by the headline GNPA ratio (consolidated), while some stocks have seen the ratio improve in Q1 FY26 after the weak quarters, most others have seen a rebound in the ratio or have seen it rise continuously (see chart).
This could also be due to the diminishing base of loans, as mentioned in the industry part earlier. Microfinance-specific GNPA ratios also were analysed. While most saw an improvement, L&T Finance, Muthoot, Spandana Sphoorty and the four SFBs saw MFI NPAs peak in the recent quarter.
GNPA ratio apart, metrics such as the ratio of stage-2 accounts (31-90 days past due) which give early signals of rising gross NPAs and collection efficiencies show broad-based improvement. Further, newly originated loan accounts are behaving well, as they have been underwritten stringently.
Other key factors
Here we remind readers of a few qualitative points. Since banks have turned cautious lending to MFI firms, there could be liquidity concerns in the near term, which might have a bearing on cost of funds. Recently MFI SROs have appealed to the government to set up a credit guarantee fund. SFBs might face sticky cost of deposits. Utkarsh saw a rating downgrade on its subordinate debt from A+ (Negative) to A (Negative) by ICRA.
Further, there have been resignations of key managerial personnel in Fusion Finance and Spandana Sphoorty. These two firms have also raised capital via rights issue to strengthen the balance sheet.
Valuation, outlook
While underlying fundamentals paint a mixed picture, the markets seem optimistic of the early signs in recovery, taking cues from declining credit cost, improving collection efficiencies and an expected rural economic recovery thanks to a good monsoon and the upcoming festive season. The repo rate cuts could also aid cost of funds for some players. While all stocks (barring Satin and Utkarsh) have run up from their 52-week lows, some are even trading close to P/B multiples they had at their 52-week highs.
At this juncture, the quarterly RoA provides a good guide to take a valuation call, as it adequately factors in any improvement in loan growth, cost of funds and credit cost. Hence RoA in Q1 FY25 can be used as a benchmark and compared with the recovery in RoA in Q1 FY26 – to see whether enough progress has been made to justify the current P/B ratio.
Of the lot, we view L&T Finance as trading at a fair valuation, given its progress in RoA and a diversified exposure apart from MFI. As for the rest, there isn’t enough recovery in RoA yet and their current valuations appear to be running ahead of fundamentals, baking in overoptimistic assumptions. Given that most of them are down 20 to 60 per cent from their 52-week highs, investors need not treat them as value buys because it seems to be a steep climb from here, back to the heydays of these stocks.
We had pointed out the underperformance of private bank IPOs against Nifty Bank index since listing, in our earlier article in the edition dated March 23, 2025. Similarly, the stocks in the universe too, have underperformed since listing versus Nifty Bank. Only three – IIFL Finance, CreditAccess Grameen and Satin Creditcare have managed to beat the index, while the rest have failed. Until there is better conviction on the recovery in the industry, investors will be better served banking on the index, rather than bottom fishing.
Published on August 16, 2025
