Fitch Affirms PNW and APS' IDR at 'BBB-'; Outlook Negative for PNW; Stable for APS.

NEW YORK -- Fitch Ratings has affirmed the Issuer Default Ratings (IDR) of Pinnacle West Capital and its core operating utility subsidiary, Arizona Public Service Company (APS) at 'BBB-'. The Rating Outlooks for PNW and APS are Negative and Stable, respectively. Approximately $4.1 billion of debt is affected by the rating action.

Fitch's short and long-term Issuer Default and instrument ratings are summarized below:

Pinnacle West Capital:

--Long-term IDR 'BBB-';

--Short-term IDR 'F3';

--Commercial paper 'F3'.

Arizona Public Service Co.:

--Long-term IDR 'BBB-';

--Short-term IDR 'F3';

--Senior unsecured 'BBB';

--Commercial paper 'F3'.

PVNGS II Funding Corp.

--Secured lease obligation bonds 'BBB'.

Fitch revised PNW's Rating Outlook to Negative in December 2007 reflecting concerns about the performance of SunCor Development Company, PNW's real estate development subsidiary. The sharp ongoing decline in the real estate segment resulted in management's recently announced plan to exit from the real estate business, requiring a pre-tax charge of approximately $200 million to be booked in the first quarter of 2009. The Negative Outlook at PNW reflects ordinary execution risk associated with its plan to divest its real estate assets. Completion of PNW's plan to exit its real estate business and reduce debt at SunCor and PNW could result in favorable resolution of the Rating Outlook.

PNW's ratings also consider the relatively stable earnings and cash flows provided by APS. Importantly, the ratings assume that a final order in APS' pending general rate case (GRC) will provide future revenues sufficient for the utility to earn a return in-line with its authorized return on equity. Continued under-earnings in 2010 and beyond would lead to further erosion of APS' credit metrics and negative rating actions.

SunCor's plan to exit the real estate business contemplates the sale of virtually all of SunCor's assets in 2009. Proceeds from the anticipated sale of assets and resulting tax benefits will be used to repay SunCor and PNW parent company debt. As of Dec. 31, 2008, SunCor debt approximated $180 million - $190 million and PNW parent debt totaled $326 million. SunCor is working with its banking group to facilitate amendments to its credit agreements required to provide flexibility for the company to proceed with the asset sale.

On April 7, 2009, the administrative law judge in APS' GRC indicated that she would delay a procedural hearing until April 21, 2009 to allow more time for APS and the relevant parties to the proceeding to negotiate a mutually acceptable agreement.

In December 2008, the Arizona Corporation Commission (ACC) approved a $65 million annual emergency surcharge to be effective for bills collected after the end of 2008. The surcharge is subject to refund with interest. That same month, the ACC staff, along with other intervening parties, filed testimony in APS' GRC. In its testimony, the staff supports a $155 million non-fuel base rate increase, based on an 11.0% authorized return on equity (ROE). This compares with the company's requested $278 million rate increase based on an 11.5% ROE.

The staff recommendation approximates 56% of APS' request and, on its face, is supportive of the present ratings. However, without specifics to address regulatory lag, APS' earnings power is expected to remain well below its authorized return. Fitch notes that APS is currently collecting rates based on a 2005 test year and will be collecting rates based on a 2007 test year at the conclusion of this rate case in the fourth quarter of this year or early 2010.

The ratings also consider APS' above-industry-average service territory growth. On the operating front, the recent return to routine inspection and oversight by the Nuclear Regulatory Commission following the Palo Verde Nuclear Generating Station Unit 3's removal from the 'multiple degraded cornerstone' column is considered favorable, as well as continued top-quartile coal plant performance.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 'www.fitchratings.com'. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.