16. Risk management and concentrations of risk

Derivative instruments can be used in accordance with the overall risk management policy.

Foreign exchange risk

All financing, interest expenses from financing and most of the Partnership’s revenue and expenditures for vessel improvements are denominated in U.S. dollars. Certain operating expenses can be denominated in currencies other than U.S. dollars. For the three and nine months ended September 30, 2017, and 2016, no derivative financial instruments have been used to manage foreign exchange risk. The Höegh Gallant time charter provides that revenues are denominated 90% in U.S. dollars and 10% in Egyptian pounds, or as otherwise agreed between the parties from time to time. For the three and nine months ended September 30, 2017, the revenues from the Höegh Gallant were denominated 97% in U.S. dollars and 3% in Egyptian pounds. The revenues from the Höegh Gallant were denominated 98% and 93% in U.S. dollars and 2% and 7% in Egyptian pounds for the three and nine months ended September 30, 2016, respectively. A limited amount of operating expenses was also denominated in Egyptian pounds. Due to restrictions in Egypt, exchangeability between Egyptian pounds and other currencies was more than temporarily lacking during 2016 and 2017. There are two official published rates for the Egyptian pound. The lower rate is applied in the Partnership’s consolidated financial statements for revenues, expenses, assets and liabilities. For most of 2016 and all of 2017, the Partnership has agreed to the payment of monthly revenues denominated in Egyptian pounds that align with its working capital needs for the next month which reduces its foreign exchange rate exposure to a minimal amount and the risk of loss should the Egyptian pound be devalued.

Interest rate risk

Interest rate swaps are utilized to exchange a receipt of floating interest for a payment of fixed interest to reduce the exposure to interest rate variability on its outstanding floating-rate debt. As of September 30, 2017, there are interest rate swap agreements on the Lampung, Gallant and Grace facilities’ floating rate debt that are designated as cash flow hedges for accounting purposes. As of September 30, 2017, the following interest rate swap agreements were outstanding:

Fair

value

Fixed

Interest

carrying

interest

rate

Notional

amount

rate

(in thousands of U.S. dollars)

index

amount

liability

Term

(1)

LIBOR-based debt

Lampung interest rate swaps (2)

LIBOR

159,912

(4,979)

Sept 2026

2.8%

Gallant interest rate swaps (2)

LIBOR

126,750

(509)

Sept 2019

1.9%

Grace interest rate swaps (2)

LIBOR

138,375

(1,735)

March 2020

2.3%

	1)	Excludes the margins paid on the floating-rate debt.
	2)	All interest rate swaps are U.S. dollar denominated and principal amount reduces quarterly.

The following table presents the location and fair value amounts of derivative instruments, segregated by type of contract, on the consolidated and balance sheets.

	Current		Long-term
	liabilities:		liabilities:
	derivative		derivative
(in thousands of U.S. dollars)	instruments		instruments
As of September 30, 2017
Interest rate swaps	$	(3,287)	$	(3,936)
As of December 31, 2016
Interest rate swaps	$	(3,534)	$	(3,511)

The following effects of cash flow hedges relating to interest rate swaps are included in gain on derivative financial instruments in the consolidated statements of income for the three and nine months ended September 30, 2017 and 2016.

	Three months ended September 30,				Nine months ended September 30,
(in thousands of U.S. dollars)	2017		2016		2017		2016
Interest rate swaps:
Ineffective portion of cash flow hedge	$	(28)		30		(380)	$	12
Amortization of amount excluded from hedge effectiveness		813		701		2,502		1,807
Reclassification from accumulated other comprehensive income		(214)		(214)		(641)		(641)
Unrealized gains (losses)		571		517		1,481		1,178
Realized gains (losses)		—		—		—		—
Total gains (losses) on derivative instruments	$	571		517		1,481	$	1,178

The effect of cash flow hedges relating to interest rate swaps and the related tax effects on other comprehensive income and changes in accumulated other comprehensive income (“OCI”) in the consolidated statements of changes in partners’ capital is as follows for the periods ended and as of September 30, 2017 and 2016 included in the consolidated statements of other comprehensive income.

	Cash Flow Hedge
(in thousands of U.S. dollars)	Before tax gains (losses)		Tax benefit (expense)		Net of tax		Accumulated OCI
Balance as of December 31, 2016	$	(6,947)		1,211		(5,736)	$	(5,736)
Effective portion of unrealized loss on cash flow hedge		342		—		342		342
Reclassification of amortization of cash flow hedge to earnings		641		(259)		382		382
Other comprehensive income for period		983		(259)		724		724
Balance as of September 30, 2017	$	(5,964)		952		(5,012)	$	(5,012)

	Cash Flow Hedge
(in thousands of U.S. dollars)	Before tax gains (losses)		Tax benefit (expense)		Net of tax		Accumulated OCI
Balance as of December 31, 2015	$	(8,830)		1,589		(7,241)	$	(7,241)
Effective portion of unrealized loss on cash flow hedge		(6,283)		—		(6,283)		(6,283)
Reclassification of amortization of cash flow hedge to earnings		641		(250)		391		391
Other comprehensive income for period		(5,642)		(250)		(5,892)		(5,892)
Balance as of September 30, 2016	$	(14,472)		1,339		(13,133)	$	(13,133)

Credit risk

Credit risk is the exposure to credit loss in the event of non-performance by the counterparties related to cash and cash equivalents, restricted cash, trade receivables and interest rate swap agreements. In order to minimize counterparty risk, bank relationships are established with counterparties with acceptable credit ratings at the time of the transactions. Credit risk related to receivables is limited by performing ongoing credit evaluations of the customers’ financial condition. In addition, Höegh LNG guarantees the payment of the Höegh Gallant time charter hire by EgyptCo under certain circumstances. PGN also guarantees PGN LNG’s obligation under the PGN FSRU Lampung time charter.

Concentrations of risk

Financial instruments, which potentially subject the Partnership to significant concentrations of credit risk, consist principally of cash and cash equivalents, restricted cash, trade receivables, amounts due from owners and affiliates and derivative contracts (interest rate swaps). The maximum exposure to loss due to credit risk is the book value at the balance sheet date. The Partnership does not have a policy of requiring collateral or security. Cash and cash equivalents and restricted cash are placed with qualified financial institutions. Periodic evaluations are performed of the relative credit standing of those financial institutions. In addition, exposure is limited by diversifying among counterparties. There are three charterers so there is a concentration of risk related to trade receivables. Credit risk related to trade receivables is limited by performing ongoing credit evaluations of the customer’s financial condition. In addition, Höegh LNG guarantees the payment of the Höegh Gallant time charter hire by EgyptCo under certain circumstances. PGN also guarantees PGN LNG’s obligation under the PGN FSRU Lampung time charter. No allowance for doubtful accounts was recorded for the three and nine month periods ended September 30, 2017 and 2016 and the year ended December 31, 2016. While the maximum exposure to loss due to credit risk is the book value of trade receivables at the balance sheet date, should any of the time charters terminate prematurely, there could be delays in obtaining a new time charter and the rates could be lower depending upon the prevailing market conditions.