Debt

Credit Agreement

At December 31, 2011, the Credit Agreement consisted of a $275 million senior secured revolving credit facility expiring in February 2016. During the year ended December 31, 2011, we received advances totaling $118 million and repaid $77 million, resulting in net borrowings of $41 million under the Credit Agreement and an outstanding balance of $200 million at December 31, 2011.

On February 3, 2012, we amended the Credit Agreement, increasing the size of the credit facility from $275 million to $375 million (the “Amended Credit Agreement”) and is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. It is also available to fund letters of credit up to a $50 million sub-limit and to fund distributions to unitholders up to a $30 million sub-limit. The Amended Credit Agreement expires in February 2016; however, in the event that our 6.25% senior notes are not repurchased, defeased, financed, extended or repaid prior to September 1, 2014, the Amended Credit Agreement shall expire on that date.

Our obligations under the Amended Credit Agreement are collateralized by substantially all of our assets. Indebtedness under the Amended Credit Agreement is recourse to HEP Logistics Holdings, L.P. (“HEP Logistics”), our general partner, and guaranteed by our material, wholly-owned subsidiaries. Any recourse to HEP Logistics would be limited to the extent of its assets, which other than its investment in us, are not significant.

We may prepay all loans at any time without penalty, except for payment of certain breakage and related costs.

Indebtedness under the Amended Credit Agreement bears interest, at our option, at either (a) the reference rate as announced by the administrative agent plus an applicable margin (ranging from 1.00% to 2.00%) or (b) at a rate equal to LIBOR plus an applicable margin (ranging from 2.00% to 3.00%). In each case, the applicable margin is based upon the ratio of our funded debt (as defined in the Amended Credit Agreement) to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined in the Amended Credit Agreement). We incur a commitment fee on the unused portion of the Amended Credit Agreement at an annual rate ranging from 0.375% to 0.50% based upon the ratio of our funded debt to EBITDA for the four most recently completed fiscal quarters.

The Amended Credit Agreement imposes certain requirements on us which we are subject to and currently in compliance with, including: a prohibition against distribution to unitholders if, before or after the distribution, a potential default or an event of default as defined in the agreement would occur; limitations on our ability to incur debt, make loans, acquire other companies, change the nature of our business, enter a merger or consolidation, or sell assets; and covenants that require maintenance of a specified EBITDA to interest expense ratio, total debt to EBITDA ratio and senior debt to EBITDA ratio. If an event of default exists under the Amended Credit Agreement, the lenders will be able to accelerate the maturity of the debt and exercise other rights and remedies.

Senior Notes

In March 2010, we issued $150 million in aggregate principal amount outstanding of 8.25% senior notes maturing March 15, 2018. A portion of the $147.5 million in net proceeds received was used to fund our $93 million purchase of the Tulsa and Lovington storage assets from HFC on March 31, 2010. Additionally, we used a portion to repay $42 million in outstanding Credit Agreement borrowings, with the remaining proceeds available for general partnership purposes, including working capital and capital expenditures.

Our 6.25% senior notes having an aggregate principal amount outstanding of $185 million mature March 1, 2015 and are registered with the SEC. The 6.25% and 8.25% senior notes (collectively, the “Senior Notes”) are unsecured and impose certain restrictive covenants, which we are subject to and currently in compliance with, including limitations on our ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates, and enter into mergers. At any time when the Senior Notes are rated investment grade by both Moody’s and Standard & Poor’s and no default or event of default exists, we will not be subject to many of the foregoing covenants. Additionally, we have certain redemption rights under the Senior Notes.

Indebtedness under the Senior Notes is recourse to HEP Logistics, our general partner, and guaranteed by our wholly-owned subsidiaries. However, any recourse to HEP Logistics would be limited to the extent of its assets, which other than its investment in us, are not significant.

Our purchase and contribution agreements with HFC with respect to the intermediate pipelines acquired in 2005 and the crude pipelines and tankage assets acquired in 2008, restrict us from selling these pipelines and terminals acquired from HFC. Under these agreements, we are restricted from prepaying borrowings and long-term debt to outstanding balances below $206 million prior to 2015 and $171 million prior to 2018, subject to certain limited exceptions.

Promissory Notes

In November 2011, we issued senior unsecured promissory notes to HFC (the “Promissory Notes”) having an aggregate principal amount of $150 million to finance a portion of our November 9, 2011 acquisition of certain tankage, loading rack and crude receiving assets located at HFC’s El Dorado and Cheyenne refineries (see Note 3). The Promissory Notes are due in full including all accrued and unpaid interest on November 1, 2016.

Indebtedness under the Promissory Notes bears interest at a rate equal to one-month LIBOR plus an applicable rate, currently 3.50%. To the extent any principal amount of the Promissory Notes is due and outstanding, the applicable rate shall increase by 0.25% on November 1, 2013 and on each February 1, May 1, August 1 and November 1 thereafter until the Promissory Notes have been paid in full. Interest is due and payable semi-annually on May 1 and November 1 of each year. However in the event that such payment is not permitted pursuant to the terms of the Amended Credit Agreement, such payment shall be deferred, and interest accrued shall be added to the principal balance outstanding of the Promissory Notes.

Subject to the terms of the Amended Credit Agreement, we may prepay the Promissory Notes in whole or in part at any time prior to the maturity date without penalty or premium. In December 2011, we repaid $77.1 million of outstanding principal using proceeds received in our December 2011 common unit offering and existing cash. At December 31, 2011, the Promissory Notes had an outstanding principal balance of $72.9 million.

Long-term Debt

The carrying amounts of our long-term debt are as follows:



	December 31,
	2011			2010
	(In thousands)
Credit Agreement	$	200,000		$	159,000
6.25% Senior Notes
Principal	185,000			185,000
Unamortized discount	(1,203		)	(1,584		)
Unamortized premium – dedesignated fair value hedge	1,098			1,444
	184,895			184,860
8.25% Senior Notes
Principal	150,000			150,000
Unamortized discount	(1,907		)	(2,212		)
	148,093			147,788
Promissory Notes	72,900			—
Total long-term debt	$	605,888		$	491,648

Maturities of our long-term debt are as follows:



	(In thousands)
Years Ending December 31,
2012	$	—
2013	—
2014	200,000
2015	185,000
2016	72,900
Thereafter	150,000
Total	$	607,900

Interest Rate Risk Management

We use interest rate swaps (derivative instruments) to manage our exposure to interest rate risk.

As of December 31, 2011, we have an interest rate swap contract that hedges our exposure to the cash flow risk caused by the effects of LIBOR changes on a $155 million Credit Agreement advance. This interest rate swap effectively converts $155 million of our LIBOR based debt to fixed-rate debt having an interest rate of 0.99% plus an applicable margin, currently 2.50%, which equaled an effective interest rate of 3.49% as of December 31, 2011. This swap contract matures in February 2016.

We have designated this interest rate swap as a cash flow hedge. Based on our assessment of effectiveness using the change in variable cash flows method, we have determined that this interest rate swap is effective in offsetting the variability in interest payments on $155 million of our variable-rate debt resulting from changes in LIBOR. Under hedge accounting, we adjust our cash flow hedge on a quarterly basis to its fair value with the offsetting fair value adjustment to accumulated other comprehensive loss. Also on a quarterly basis, we measure hedge effectiveness by comparing the present value of the cumulative change in the expected future interest to be paid or received on the variable leg of our swap against the expected future interest payments on $155 million of our variable-rate debt. Any ineffectiveness is reclassified from accumulated other comprehensive loss to interest expense. As of December 31, 2011, we had no ineffectiveness on this cash flow hedge.

Prior to entering into our swap contract in December 2011 (discussed above), we terminated our previous interest rate swap that prior to settlement also served to hedge our exposure to the effects of LIBOR changes on the same $155 million Credit Agreement advance. We terminated this swap at a cost of $6 million, to lock in a lower effective interest rate on this $155 million advance, which by means of the previous swap contract was effectively fixed at 6.24% at the time of termination.

At December 31, 2011, we had an accumulated other comprehensive loss of $6.5 million that relates to our current and previous cash flow hedging instruments. Of this amount, $6 million relates to our cash flow hedge terminated in December 2011 and represents the application of hedge accounting prior to termination. This amount will be amortized as a charge to interest expense through February 2013, the remaining term of the terminated swap contract. Of the remaining $0.5 million amount, approximately $0.1 million will be effectively transferred from accumulated other comprehensive loss to interest expense as interest is paid on the underlying swap agreement over the next twelve-month period, assuming interest rates remain unchanged.

Additional information on our interest rate swaps is as follows:

Derivative Instrument

Balance Sheet

Location

Fair

Value

Location of Offsetting

Balance

Offsetting

Amount

(In thousands)

December 31, 2011

Interest rate swap designated as cash flow hedging instrument:

Variable-to-fixed interest rate swap contract ($155 million of LIBOR based debt interest)

Other long-term liabilities

520

Accumulated other comprehensive loss

520

December 31, 2010

Interest rate swap designated as cash flow hedging instrument:

Variable-to-fixed interest rate swap contract ($155 million of LIBOR based debt interest)

Other long-term liabilities

10,026

Accumulated other comprehensive loss

10,026

We previously had interest rate swap contracts that served as economic hedges on interest attributable to outstanding debt. For the years ended December 31, 2010 and 2009, we recognized $1.5 million and $0.2 million, respectively, in non-cash charges to interest expense as a result of fair value adjustments to these swap contracts.

We have a deferred hedge premium that relates to the application of hedge accounting to a variable-rate swap associated with our 6.25% senior notes prior to its hedge dedesignation in 2008. This deferred hedge premium having a balance of $1.1 million at December 31, 2011, is being amortized as a reduction to interest expense over the remaining term of our 6.25% senior notes.

Interest Expense and Other Debt Information

Interest expense consists of the following components:



	Years Ended December 31,
	2011		2010		2009
	(In thousands)
Interest on outstanding debt:
Credit Agreement, net of interest on interest rate swap	$	10,477	$	9,109	$	10,657
6.25% senior notes	11,565		11,404		10,703
8.25% senior notes	12,380		10,298		—
Promissory Notes	745		—		—
Partial settlement of interest rate swap – cash flow hedge	—		1,076		—
Net fair value adjustments to interest rate swaps ⁽¹⁾	41		1,464		175
Net amortization of discount and deferred debt issuance costs	1,212		713		706
Commitment fees	430		392		268
Total interest incurred	36,850		34,456		22,509
Less capitalized interest	891		455		1,008
Net interest expense	$	35,959	$	34,001	$	21,501
Cash paid for interest ⁽²⁾	$	34,825	$	31,305	$	21,721


(1)	Includes fair value adjustments to previous interest rate swap contracts settled during the first quarter of 2010.


(2)	Presented net of cash received under previous interest rate swap contracts of $1.9 million and $3.8 million for the years ended December 31, 2010 and 2009, respectively.