Fitch Lowers PNW & APS' Sr. Unsecured Ratings to 'BBB-' & 'BBB', Respectively; Outlook Stable.

NEW YORK -- Fitch Ratings has lowered Pinnacle West Capital's (PNW) long- and short-term ratings. At the same time, Fitch has lowered Arizona Public Service Company's (APS) long-term ratings, while affirming its commercial paper rating. The securities of PNW and APS have been removed from Rating Watch Negative, where they were placed Jan. 6, 2006. The Rating Outlook is Stable. The following actions are effective immediately:

Pinnacle West Capital:

-- Issuer default rating (IDR) downgraded to 'BBB-' from 'BBB';

-- Senior unsecured debt downgraded to 'BBB-' from 'BBB';

-- Commercial Paper downgraded to 'F3' from 'F2'.

The Rating Outlook is Stable.

Arizona Public Service Co.

-- IDR downgraded to 'BBB-' from 'BBB';

-- Senior unsecured debt downgraded to 'BBB' from 'BBB+';

-- Commercial Paper affirmed at 'F2'.

The Rating Outlook is Stable.

Approximately $3.8 billion of debt is affected by the rating actions.

The rating actions and Stable Rating Outlook reflect the resolution of APS' power supply adjustor (PSA) proceedings by the Arizona Corporation Commission (ACC) and the utility's significant exposure to high and rising natural gas commodity costs. The commodity exposure is a function of a generating capacity mix, about half of which is natural gas fired, and rapid service territory load growth, which is likely to be met predominantly by natural gas-fired resources. The revised ratings also consider the operational risk and asset concentration of the Palo Verde nuclear plant. The facility has experienced intermittent operating problems over the past year and a sustained, unscheduled outage at the plant could lead to further negative rating actions.

The ACC decision in the PSA proceedings, issued on Jan. 25, 2006, has positive and negative implications for PNW and APS' creditworthiness. The commission's decision to accelerate the effective date of the PSA rate to Feb. 1 from April 1, along with the removal of the $776 million annual power supply cost limit, were constructive developments in Fitch's view. However, the ACC bench order rejecting APS's $80 million surcharge request on procedural grounds and restriction of PSA adjustments to an annual reset is less favorable than Fitch had anticipated in its previous ratings and is a significant source of concern for PNW and APS fixed-income investors. The fact that there is no vehicle within the PSA protocol to recover supply costs more frequently than annually during periods of sustained high and rising energy costs subjects APS to significant cash flow volatility and working capital requirements. Such costs would be exacerbated in a meaningful way by an extended outage of a base load nuclear- or coal-fired generating facility during periods of peak demand. The only option to recover fuel and purchase power costs above amounts determined annually in the PSA would be an emergency rate filing, in which the timing and amount of rate relief would be uncertain.

It is Fitch's understanding that energy cost deferrals in a particular year of up to four mills per kilowatt hour (approximately $110 million-$115 million on an annual run rate) will be recovered through an annual PSA rate adjustment that will recover those costs over the following 12 months. The surcharge is expected to facilitate recovery of costs in excess of the four mills per kilowatt hour limit over a time horizon to be determined by the commission.

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.