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Rating Action:

Moody's rates Milagro's notes Caa2; outlook negative

Global Credit Research - 28 Apr 2011

Approximately $250 million of debt affected

New York, April 28, 2011 -- Moody's Investor's Service assigned a Caa2 rating to Milagro Oil and Gas, Inc.'s (Milagro) senior secured second lien notes due 2016, and assigned a Corporate Family Rating (CFR) of Caa1. The rating outlook is negative. This is the first time that Moody's has rated Milagro.

Net proceeds from the notes will be used to repay the existing second lien term loan and to reduce the amount currently outstanding under the revolving credit facility. Concurrent with the transaction the credit facility will be amended and restated, extending the maturity date to 2014.

RATINGS RATIONALE

"The Caa1 CFR reflects Milagro's very high leverage on production and reserves, small scale, and the potential for tight liquidity if leverage continues to increase," commented Jonathan Kalmanoff, Moody's Analyst. "The ratings are supported by a relatively high and increasing proportion of liquids production, shallow decline rates, good geological diversification, and supportive financial sponsors." The negative outlook considers the potential for increasing leverage on production and reserves as the company outspends cash flow, as well as the potential for decreasing covenant headroom, depending on the mix of debt versus equity financing and the levels of production and cash flow achieved.

Moody's calculates Milagro's December 31, 2010 pro forma leverage on average daily production at $50,796/boe/d. In calculating leverage, we view the company's preferred stock as 50% debt.

At December 31, 2010 pro forma for the notes issuance Milagro had $18 million of cash and $70 million of availability under its new $300 million senior secured first lien credit facility. Availability under the revolver is restricted by its $170 million borrowing base. Covenants under the facility include a Debt / EBITDA limit of 4.5x (stepping down to 4.25x in 2012), a Senior Secured Debt / EBITDA limit of 2.0x, minimum EBITDA / Interest of 2.25x (stepping up to 2.5x in 2012), and a current ratio of 1.0x. At December 31, 2010 pro forma, covenant calculations were Debt / EBITDA of 3.2x, EBITDA / Interest of 5.0x, and a current ratio of 1.3x. While there is currently adequate headroom under the covenants, if leverage rises over the next few quarters as Milagro outspends cash flow and funds part of the negative free cash flow with debt, covenants could become stressed. With the credit facility maturing in 2014 and the notes maturing in 2016 there are no near term debt maturities. Substantially all of Milagro's oil and gas reserves are pledged as collateral which limits the extent to which asset sales could provide a source of additional liquidity if needed.

The Caa2 senior unsecured note rating reflects both the overall probability of default of Milagro, to which Moody's assigns a PDR of Caa1, and a loss given default of LGD5-70%. The size of the senior secured first lien revolver's potential priority claim relative to the senior secured second lien notes results in the notes being rated one notch beneath the Caa1 CFR under Moody's Loss Given Default Methodology.

The outlook could be changed to stable if leverage on production and reserves does not continue to increase from current levels, covenant headroom does not deteriorate, and a positive production trend is established in response to increasing levels of capital spending. The rating could be lowered if liquidity or covenant headroom becomes stressed, leverage on average daily production appears likely to increase to $60,000/boe/d or higher, or Debt / Proven Developed Reserves appears likely to increase to $21.00/boe or higher.

The principal methodology used in rating Milagro Mezz was the Independent Exploration and Production (E&P) Industry Methodology, published December 2008. Other methodologies used include Loss Given Default for Speculative Grade Issuers in the US, Canada, and EMEA, published June 2009

Milagro Oil and Gas, Inc. is an independent exploration and production company headquartered in Houston, Texas.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

New York
Jonathan Kalmanoff
Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Steven Wood
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
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JOURNALISTS: 212-553-0376
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Moody's rates Milagro's notes Caa2; outlook negative
No Related Data.
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