Credit Agreement

In June 2012, we amended our credit agreement increasing the size of the credit facility from $375 million to $550 million. Our $550 million senior secured revolving credit facility expires in June 2017 (the “Credit Agreement”) and is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. It is available also to fund letters of credit up to a $50 million sub-limit and to fund distributions to unitholders up to a $60 million sub-limit. In February 2012, we amended our credit agreement increasing the size of the credit facility from $275 million to $375 million. During the year ended December 31, 2012, we received advances totaling $587 million and repaid $366 million, resulting in net borrowings of $221 million under the Credit Agreement and an outstanding balance of $421 million at December 31, 2012.

Our obligations under the Credit Agreement are collateralized by substantially all of our assets. Indebtedness under the 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 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 0.75% to 1.75%) or (b) at a rate equal to LIBOR plus an applicable margin (ranging from 1.75% to 2.75%). In each case, the applicable margin is based upon the ratio of our funded debt (as defined in the Credit Agreement) to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined in the Credit Agreement). We incur a commitment fee on the unused portion of the Credit Agreement at an annual rate ranging from 0.30% to 0.50% based upon the ratio of our funded debt to EBITDA for the four most recently completed fiscal quarters.

The Credit Agreement imposes certain requirements on us which we are 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 Credit Agreement, the lenders will be able to accelerate the maturity of the debt and exercise other rights and remedies.

Senior Notes

In March 2012, we issued $300 million in aggregate principal amount outstanding of 6.5% senior notes maturing March 1, 2020 (the “6.5% Senior Notes”). Net proceeds of $294.8 million were used to redeem $157.8 million aggregate principal amount of our 6.25% senior notes maturing March 1, 2015 (the “6.25% Senior Notes”) tendered pursuant to a cash tender offer and consent solicitation, to repay $72.9 million in promissory notes due to HFC as discussed below, to pay related fees, expenses and accrued interest in connection with these transactions and to repay borrowings under the Credit Agreement.

In April 2012, we redeemed $27.2 million aggregate principal amount of 6.25% Senior Notes that remained outstanding following the cash tender offer and consent solicitation.

We also have $150 million in aggregate principal amount outstanding of 8.25% senior notes maturing March 15, 2018 (the “8.25% Senior Notes”).

The 6.5% Senior Notes and 8.25% Senior Notes (collectively, the “Senior Notes”) are unsecured and impose certain restrictive covenants, which we are 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 assets located at HFC's El Dorado and Cheyenne refineries (see Note 3). In December 2011, we repaid $77.1 million of outstanding principal using proceeds received in our December 2011 common unit offering and existing cash. We repaid the remaining $72.9 million balance in March 2012.

Long-term Debt

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



	December 31, 2012			December 31, 2011
	(In thousands)
Credit Agreement	$	421,000		$	200,000
6.5% Senior Notes
Principal	300,000			—
Unamortized discount	(4,725		)	—
	295,275			—
6.25% Senior Notes
Principal	—			185,000
Unamortized net discount	—			(105		)
	—			184,895
8.25% Senior Notes
Principal	150,000			150,000
Unamortized discount	(1,601		)	(1,907		)
	148,399			148,093

Promissory Notes	—			72,900

Total long-term debt	$	864,674		$	605,888

Maturities of our long-term debt are as follows:



Years Ending December 31,	(In thousands)
2013	$	—
2014	—
2015	—
2016	—
2017	421,000
Thereafter	450,000
Total	$	871,000

Interest Rate Risk Management

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

As of December 31, 2012, we have three interest rate swaps that hedge our exposure to the cash flow risk caused by the effects of LIBOR changes on $305 million of Credit Agreement advances. Our first interest rate swap entered into in December 2011, effectively converts $155 million of our LIBOR based debt to fixed rate debt having an interest rate of 0.99% plus an applicable margin of 2.25% as of December 31, 2012, which equaled an effective interest rate of 3.24%. This swap contract matures in February 2016. In August 2012, we entered into two similar interest rate swaps with identical terms which effectively convert $150 million of our LIBOR based debt to fixed rate debt having an interest rate of 0.74% plus an applicable margin of 2.25% as of December 31, 2012, which equaled an effective interest rate of 2.99%. Both of these swap contracts mature in July 2017.

We have designated these interest rate swaps as cash flow hedges. Based on our assessment of effectiveness using the change in variable cash flows method, we have determined that these interest rate swaps are effective in offsetting the variability in interest payments on $305 million of our variable rate debt resulting from changes in LIBOR. Under hedge accounting, we adjust our cash flow hedges on a quarterly basis to their fair values with the offsetting fair value adjustments 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 swaps against the expected future interest payments on $305 million of our variable rate debt. Any ineffectiveness is recorded directly to interest expense. As of December 31, 2012, we had no ineffectiveness on our cash flow hedges.

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, 2012, we have an accumulated other comprehensive loss of $4.3 million that relates to our current and previous cash flow hedging instruments. Of this amount, $0.8 million represents an unrecognized loss attributable to a cash flow hedge terminated in December 2011 and relates to the application of hedge accounting prior to termination. This amount is being amortized as a charge to interest expense through February 2013, the remaining term of the terminated swap contract. Of the remaining $3.4 million, approximately $1.0 million will be transferred from accumulated other comprehensive loss into 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, 2012

Interest rate swap designated as cash flow hedging instrument:

Variable-to-fixed interest rate swap contract ($305.0 million of LIBOR based debt interest)

Other long-term

liabilities

3,430

Accumulated other

comprehensive loss

3,430

December 31, 2011

Interest rate swap designated as cash flow hedging instrument:

Variable-to-fixed interest rate swap contract ($155.0 million of LIBOR based debt interest)

Other long-term

liabilities

520

Accumulated other

comprehensive loss

520

We previously had interest rate swap contracts that served as economic hedges on interest attributable to outstanding debt. For the year ended December 31, 2010, we recognized $1.5 million 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 was amortized in 2012 and the unamortized balance was taken as a reduction to interest expense during the cash tender offer and consent solicitation of our 6.25% Senior Notes.

Interest Expense and Other Debt Information

Interest expense consists of the following components:



	Years Ended December 31,
	2012		2011		2010
	(In thousands)
Interest on outstanding debt:
Credit Agreement, net of interest on interest rate swaps	$	8,736	$	10,477	$	9,109
6.5% Senior Notes	15,716		—		—
6.25% Senior Notes	2,422		11,565		11,404
8.25% Senior Notes	12,380		12,380		10,298
Promissory Notes	543		745		—
Partial settlement of interest rate swap - cash flow hedge	—		—		1,076
Net fair value adjustments to interest rate swaps ⁽¹⁾	—		—		1,464
Amortization of unrealized loss attributable to discounted cash flow hedge	5,095		41		—
Amortization of discount and deferred debt issuance costs	1,946		1,212		713
Commitment fees	621		430		392
Total interest incurred	47,459		36,850		34,456
Less capitalized interest	277		891		462
Net interest expense	$	47,182	$	35,959	$	33,994
Cash paid for interest ⁽²⁾	$	38,476	$	34,825	$	31,305


(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 contract of $1.9 million for the year ended December 31, 2010.

We recognized a charge of $3.0 million upon the early extinguishment of debt for the year ended December 31, 2012. This charge represents the premium paid to our 6.25% Senior Note holders upon their tender of an aggregate principal amount of $185.0 million and related net discount.