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Rating Action:

Moody's rates United Refining's secured notes B3

22 Feb 2011

Approximately $350 million of debt securities affected

New York, February 22, 2011 -- Moody's Investors Service assigned a B3 (LGD 3, 44%) rating to United Refining Company's (United) proposed $350 million senior secured notes offering. Simultaneously, Moody's affirmed United's B3 Corporate Family Rating and B3 Probability of Default rating. Proceeds from the notes offering will be used to fund a tender offer for United's existing $325 million senior unsecured notes due 2012. The rating outlook is stable.

RATINGS RATIONALE

United's B3 Corporate Family Rating reflects the company's single refinery status, which exposes its cashflows to unplanned downtime, its exposure to inherently volatile and cyclical refining margins, its high financial leverage profile (as measured on a debt to complexity and debt to capitalization basis), and the potential for high working capital needs driven by highly volatile crude prices.

The B3 Corporate Family Rating is supported by the company's long operating history and niche market position within the northwest Pennsylvania, southwest New York and eastern Ohio markets, the refinery's ability to run at least 70% heavy sour crudes, enabling the company to take advantage of light/heavy crude differentials when they are sufficiently wide, and its retail network of convenience stores, which offers a modest degree of earnings diversification and a steady source of its gasoline product sales.

United has historically generated volatile and cyclical earnings and cash flows due to inherent volatility, seasonality and cyclicality in refining margins, and margin pressure on asphalt when high crude costs cannot be passed on in product prices or when light heavy crude differentials are narrow. United's earnings and cash flow in fiscal 2010 were very weak, being negatively impacted by the recent shutdown of Line 6B on Enbridge's Lakehead system, non-cash LIFO inventory charges, the weak refining market in the beginning of the fiscal year and planned maintenance work. Moody's notes that the company's first quarter results in fiscal 2011 have improved from fourth quarter fiscal 2010 levels and we expect the company will continue to generate improved results in fiscal 2011, driven by higher utilization levels and more supportive light heavy differentials and crack spreads.

United's financial leverage ranks among the highest for all independent refiners rated by Moody's. As of November 30, 2010, United's pro forma debt/complexity barrels (as adjusted for pensions and operating leases) was approximately $785/barrel, as compared the B-rated peer average of approximately $540/barrel, and its debt/capitalization ratio was about 91%, as compared to the B-rated average of 53%.

United projects free cash flow generation over the near to medium term as it has only modest capital expenditure needs, which with the benefit of the excess cash flow offer in the proposed notes could result in lower debt balances. However, if light heavy spreads were to narrow or refining margins weaken, debt balances could further rise. In addition, the excess cash flow offer is based on a certain leverage ratio, and the proposed notes permit significant dividends to United's controlling shareholder once this leverage ratio is achieved. While Moody's notes that the parent company has not taken any material dividends out of United since fiscal 2008, historically, dividends have been significant. Dividends drain capital that could be used for additional debt reduction, reinvestment or building a credit cushion for weaker margin or operating environments.

Under Moody's Loss Given Default Methodology (LGD), the proposed $350 million senior secured notes are rated on par with United's B3 Corporate Family Rating. The notes will be secured by a first-lien on United's refinery assets and a pledge of the stock of its pipeline subsidiary and will have unsecured subsidiary guarantees. The company's $130 million revolving credit facility is secured by a first-lien claim on United's current assets. The B3 rating on the notes is restrained by lack of a full asset collateral package, weak coverage of debt by book assets and low recent refinery valuations, which have reflected secular weakness in the refining sector, particularly in PADD I.

The stable rating outlook assumes Untied will maintain adequate liquidity and generate improved earnings and cash flows during fiscal 2011.

Materially reduced leverage (debt/complexity barrels below $700/barrel) and strong operating performance could result in a positive rating action. On the other hand, diminished liquidity, debt financed dividends or a period of prolonged refinery downtime could pressure the rating.

The principal methodologies used in this rating were Global Refining and Marketing Rating Methodology published in December 2009, and Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009.

United Refining Company is headquartered in Warren, Pennsylvania.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics 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.

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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.

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New York
Gretchen French
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Thomas S. Coleman
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's rates United Refining's secured notes B3
No Related Data.
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