HDFC - Demystifying forex equation; visit note; Hold :: Edelweiss

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HDFC (HDFC IN, INR 683, Hold)

We recently met the HDFC management for better understanding of the company’s foreign currency exposure, hedging policies and related accounting adjustments in Q3FY12. We also gained clarity on utilization of excess reserves/networth due to adjustments pertaining to interest on zero coupon bonds and standard asset provisioning. We maintain our PAT estimate of 18% CAGR and RoEs of 23-24% over FY11-13. However, due to utilization of reserves, as discussed above, book value accretion will be 18-19% (refer table 6). Our SOTP fair value is INR664/ share (FY13E) (valuing the core book at 4.2x and investments at INR 224) and we maintain ‘HOLD’.

Forex exposure: Adequately hedged

·       HDFC had USD1.1bn of foreign currency denominated liabilities (refer table 1), which were completely hedged as of FY11. Over and above forex denominated liabilities, the company had entered into USD697mn cross currency swaps and interest rate swap converting its fixed rate INR liability into floating rate forex liability to trim the overall cost of borrowing (refer table 2). Besides using principal only swaps, currency option, forward contracts and cross currency swaps for hedging (refer table 3), it has build USD denominated assets of USD500-600mn to create a natural hedge against currency movement risk.

·       The net open position on forex exposure in FY11 was USD304mn (on cross currency swaps). However, due to sharp INR depreciation in 9mFY12, limit on ~USD300mn currency options (European) got triggered and if the INR /USD rate continues to remain above the trigger limit, it will also be classified as an open position.

·       HDFC accounted for cross currency swaps at fair value, i.e., incorporating MTM on both currency movement and interest rate differentials. As per management, historically the moves often offset each other, leading to minimal MTM hit. Q3FY12 onwards, an accounting policy change has been effected whereby outstanding liability will be marked to spot rates, but the benefit on interest rate differentials will be excluded.