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Leading Indian Lender HDFC Completes Unusual Transaction to Hedge Interest Rate Risk

Industry: Financial Services
Current: Company Performance

Housing Development Finance Corp., India’s largest rupee-bond issuer in 2022, used a ‘total return swap’ to hedge rate risks on a debt issuance
The switch in hedging tools comes as markets are buffeted by surging policy rates, with the Reserve Bank of India hiking interest rates by 140 basis points since May to tackle inflation
The total return swap will allow HDFC to get returns on its sovereign bonds without having to fund the assets on its balance sheet

Housing Development Finance Corp. (HDFC), the largest mortgage financier in India, began to diversify its risk management strategies by hedging some of its borrowings against interest rate volatility through an unusual exchange. The largest rupee-bond issuer in the country in 2022, HDFC executed a ‘total return swap’ to protect against rate risks while issuing debt.

What is Total Return Swap? Why is it Rare?

In a total return swap, one party makes payments based on a variable interest rate such as Libor plus a specified spread, and the counterparty receives payments depending on the performance of an underlying asset such as a bond, stock, or equity index. The returns reflect any price changes for the reference asset over the period and any applicable coupons or dividends. In exchange for assuming the price and default risk, the swap enables the buyer to obtain exposure to an asset without really owning it. Total return swap is not used by all Indian businesses to manage interest rate risk because some of them are not in the lending industry, in which case risk hedging is not necessary, and that no other shadow financier in the country has a balance sheet as sizable as that of HDFC.

Total Return Swap to Hedge Rate Risks on Debt Issuance

It is crucial for HDFC to manage potential yield mismatch between the variable-rate loans it gives and the fixed rates at which it borrows, as debt instruments account for more than 40% of the $66 billion in borrowings made by HDFC. The swap arrangement allows HDFC to have a fluctuating liability and borrowing, preserving its lending margins. Should policy rates decline during the bond’s maturity period, this would be beneficial. The Reserve Bank of India (RBI) increased policy rates by 140 basis points since May to combat inflation, and this change in hedging instruments comes as markets are being buffeted by these rising rates.

RBI Hikes Repo Rate by 50 bps

The RBI increased its repo rate by 50 basis points, from 4.9% to 5%, increasing the cost of borrowing for individuals and businesses, including home and vehicle loans. Even though the rate hike exceeded market expectations, the RBI’s decision to maintain its projections for GDP growth (7.2%) and inflation (6.7%) for 2022–2023 helped calm the market. The rate increase by the RBI comes at a time when crude oil prices and other commodities began to decline amid concerns about a possible recession in the West.

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