If part of the hedged item is sold, prepaid, or otherwise extinguished, consistent with the treatment of a full extinguishment discussed in DH 10.3.6
, a portion of the basis adjustment is derecognized.
In the case of partial sale or extinguishment, we believe the portion of the amount in AOCI related to excluded components recognized through an amortization approach on the partially sold or prepaid derivative should be reclassified to earnings currently.
The hedging relationship may no longer be effective if a portion of the hedged item no longer exists. If so, the reporting entity will have to dedesignate the entire relationship (because it will no longer qualify for hedge accounting). Alternatively, it may partially dedesignate the hedging instrument if done concurrent with the change to the hedged item.
Example DH 10-1 illustrates a partial dedesignation of a hedging instrument when the hedged item is partially extinguished.
EXAMPLE DH 10-1
Partial dedesignation of hedging instrument upon partial extinguishment of hedged item
DH Corp issues $100 million of fixed-rate non-callable debt and enters into a receive-fixed/pay-floating interest rate swap with a notional amount of $70 million. DH Corp designates the interest rate swap as a fair value hedge of benchmark interest rate risk of 70% of the debt.
One year after issuing the debt, DH Corp repurchases $20 million of the debt in the market so that the new debt balance is $80 million.
What is the impact of the debt extinguishment on the hedging relationship?
After the debt extinguishment, the amount of debt hedged would be $56 million (70% of the $80 million new debt balance). To maintain a highly effective hedge, DH Corp could partially dedesignate (concurrent with the extinguishment) the portion of the hedging instrument no longer needed once the debt balance decreases to $80 million. Once the unnecessary portion of the swap is dedesignated, $56 million of the notional amount would be designated as a hedge of the debt and $14 million would not.
DH Corp may redesignate the $14 million of swap notional in a new hedging relationship, including as a hedge of the originally unhedged portion of the debt.