Fitch Rates Tucson, AZ $84.1MM Water Rev Ref Bonds 'AA'.

AUSTIN, Texas -- Fitch Ratings assigns an 'AA' rating to the City of Tucson, Arizona's $84.1 million water system revenue refunding bonds, series 2004. In addition, Fitch affirms its 'AA' rating for the city's $249.9 million of outstanding water system revenue bonds. The Rating Outlook is Stable.

The bonds tentatively are scheduled to sell via a negotiated sale led by Citigroup the week of Nov. 8. The bonds are payable solely from net revenues from the city's water system, after payment of operations and maintenance expenses. Bond proceeds will be used to refund a portion of the system's outstanding parity revenue bonds for debt service savings and pay costs of issuance.

The 'AA' rating reflects the strong financial management of the system, sufficient long-term supplies to meet customer demands, and a manageable capital improvement plan (CIP). Extensive water planning has helped produce a diverse mix of water supplies, and these planning efforts and customer outreach have led to strong community support for the city's bond program. The existing debt load per customer is moderate. However, roughly one-half of the five-year CIP is expected to be derived from pay-as-you-go sources; as a result, forecasted debt levels are expected to remain manageable. Service area wealth levels are below average, but the effect is largely offset by the diversity and stability of the economy.

The system provides potable water to around 690,000 residents (85% of the population) within the Tucson metropolitan area. Potable water supplies are derived almost evenly between groundwater and renewable Colorado River water that is delivered via the Central Arizona Project (CAP). The city's Clearwater Renewable Resource Facility (Clearwater) diverts all of the city's purchased CAP water to recharge basins and then recovers a blend of CAP and native groundwater for treatment and distribution. Clearwater, which began operations in 2001 and is expected to supply 60,000 acre-feet of potable water annually, is a critical component of Tucson's future water supplies, allowing the city to reduce its groundwater pumping.

Reclaimed water is a key water resource for the city, meeting over 9% of demands in fiscal 2003. Through an intergovernmental agreement with Pima County, the city receives a portion of treated wastewater produced in the metropolitan area. Wastewater received is treated to reclaimed water standards and distributed to various customers, primarily governmental entities irrigating large tracts of land, thereby reducing potable demands.

The city's right to withdraw groundwater is regulated by the Arizona Department of Water Resources (ADWR), which is responsible for adopting water conservation regulations that ensure adequate water supplies in intensively urbanized areas of the state known as active management areas (AMAs). To subdivide real estate in AMAs (Tucson is part of the Tucson AMA), the water supplier serving the area must have an ADWR designation of an assured water supply (AWS) for 100 years. Based upon the city's construction of recharge projects (including Clearwater) and its membership in the Central Arizona Groundwater Replenishment District, the city received an AWS designation from ADWR in 1998.

Financial performance has been sound, reflective of the city's conservative management and prudent fiscal policies. From fiscal years 1999-2003 annual debt service (ADS) coverage on water system revenue bonds has been 2.0 times (x) or higher and projections indicate similar performance through fiscal 2009; the city maintains a formal policy of at least 1.75x ADS on all debt, including subordinate lien debt placed through the Arizona state revolving fund program. Liquidity levels, which declined from fiscal years 1999-2001 due to pay-as-you-go capital funding, have improved to a healthy 127 days of operating expenditures in cash on hand for fiscal 2003 and should remain strong through fiscal 2009.

Capital demands for the fiscal years 2005-2009 period are moderate at $254 million. The CIP focuses on increased production and storage and improved operational efficiencies with over 80% of the CIP dedicated for potable system improvements. Funding is expected to be derived almost evenly between debt sources and cash on hand.

Outstanding debt per customer of almost $1,600 is above-average for the 'AA' category. However, relatively low monthly charges to customers, as well as modest anticipated future rate increases and limited future borrowing somewhat mitigate debt burden concerns.

Tucson, located in southern-central Arizona, is the second largest city in the state. The economy is anchored by military, government, higher education, medical, and tourism enterprises. Primarily as a result of most of these sectors, income levels within the city are on balance, 20%-25% lower than those of the state and nation. Partially offsetting this weakness is a stable labor market that has consistently produced unemployment rates around 1% less than those of the state and nation.