Fitch Rates Tucson, Arizona's $18.7MM Water Revs 'AA'.

Business Editors

AUSTIN, Texas--(BUSINESS WIRE)--May 14, 2004

Fitch Ratings assigns an 'AA' rating to the City of Tucson, Arizona's (the city) $18.7 million water system revenue bonds, series 2000-D (2004). In addition, Fitch assigns an initial rating of 'AA' to the city's $318.7 million of outstanding water system revenue bonds. The Rating Outlook is Stable.

The bonds are scheduled to sell competitively on May 24. Dated May 1, the bonds mature July 1, 2011-2023, and are subject to optional redemption as specified in the official statement. Bond proceeds will be used to acquire and construct improvements to the city's water system (the system) and pay costs of issuance.

The city's initial '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 and customer outreach has lead to strong community support for the city's bond program and a diverse mix of water supplies. Existing debt levels per customer are moderate; however, roughly one-half of the CIP is expected to be derived from pay-as-you-go sources and expected rate increases are modest, limiting the debt burden to ratepayers. Service area wealth levels are below average, but this 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). In order 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 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 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 2004-2009 period are moderate at $299 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 (including the current offering) and cash on hand.

Outstanding debt per customer of almost $1,600 is above average for the 'AA' category. But relatively low monthly charges to customers as well as the modest amount of future rate increases (1.5% for fiscals 2005, 2007, and 2009) and limited future borrowing somewhat mitigate debt burden concerns.

Tucson, located in south-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 the state and nation. Partially offsetting this weakness is a stable labor market that has consistently produced unemployment rates around 1% less than the state and nation.