OREANDA-NEWS. Fitch Ratings has assigned an 'AA' rating to the following bonds issued by the city of Tucson, AZ (the city):

--Approximately $14.6 million water system revenue obligations, series 2016.

Proceeds will be used to fund capital improvements to the city's water system (the system) and to pay for the costs of issuance. The obligations are scheduled to sell via negotiation the week of May 31.

The Rating Outlook is Stable.

SECURITY

The bonds and obligations are payable from a first-lien pledge on the net revenues of the system on parity with the outstanding water revenue bonds and obligations.

KEY RATING DRIVERS

ADEQUATE FINANCIAL PROFILE: The system's financial profile has improved over the past few years, although its metrics remain somewhat below average for the rating level.

PLANNED RATES INCREASES: Since 2011, management has worked with city council to prudently raise rates in order to meet the rapidly rising costs of operations. Future rate increases have been planned by management and will likely be necessary to keep debt service coverage (DSC) steady.

IMPROVING DEBT PROFILE: The system's 2016 capital improvement plan (CIP) is about $90 million less than the previous year's. This is expected to lead to an improved debt profile as outstanding bonds are expected to amortize rapidly without the added pressure of new debt.

SUFFICIENT WATER SUPPLIES: Extensive planning by system management has ensured sufficient water supplies to meet the city's long-term needs.

RATING SENSTIVITIES
FINANCIAL MARGIN IMPROVEMNTS: Delays in or failure to achieve projected improvements with respect to the system's all-in DSC by the end of the forecast period would likely result in a rating downgrade. Additionally, significant and sustained decreases in days cash without an off-setting improvement to all-in DSC could also result in rating pressure.

CREDIT PROFILE
Tucson, located in south-central Arizona, is the second largest city in the state. Tucson's water system provides potable water to about 715,000 area residents via 230,000 metered connections, or 72% of the population within the metropolitan area. Potable water supplies are derived from both groundwater and Colorado River water delivered via the Central Arizona Project (CAP).

SATISFACTORY FINANCIAL PROFILE
The system's financial profile has remained stable-to-improved over the last few years, as rate increases continue to offset the rising cost of operations. Fiscal 2015 finished with senior and all-in DSC at satisfactory levels of 1.8x and 1.7x, respectively, although both measures were down slightly from levels posted in 2013 and 2014. In accordance with its bond ordinance, the city calculates DSC differently than Fitch by excluding capitalized costs from its operation and maintenance expenses. As a result, the city's calculation of senior and all-in DSC was slightly higher in fiscal 2015, finishing at 2.0x and 1.8x respectively. The system's liquidity, measured by the number of days unrestricted cash can cover operations, finished at about 170 days in 2015. Both DSC and liquidity are below-average in comparison to similar 'AA' water system revenue bonds rated by Fitch.

Management's latest five-year forecast is mostly consistent with the forecast provided at Fitch's recent review in March. The forecast demonstrates all-in DSC, as calculated per the ordinance, finishing at about 1.6x in fiscal 2016 before slowly rebounding to 2.0x by fiscal 2021. The city is also projecting a decrease in liquidity to just 95 days cash in 2017 before rebounding to 110 days by 2021. If realization of projected decreases in all-in DSC (as calculated by Fitch) and liquidity were to occur, negative rating action could result.

RATES APPROACH THRESHOLD LEVEL
The system will need to implement the planned rate increases to maintain adequate DSC and liquidity. Current customer bills have recently reached Fitch's affordability threshold of 1%. Nevertheless, rates are competitive within the region and therefore Fitch believes rating flexibility remains available.

IMPROVING DEBT BURDEN
The system's CIP for fiscal years 2016-2020 totals $249 million, down quite significantly from approximately $85 million the prior year. The reductions are attributable to management's prudent decision to push out some of the supply-related projects beyond the five-year CIP window as conservation efforts and moderate customer growth have changed the need for such projects.

The primary focus of the CIP is repair and rehabilitation of existing facilities and improvement projects that relate to CAP water. Funding for the CIP is expected to be split between surplus cash (61%) and debt (39%). At $2,393, debt per customer is somewhat elevated, but amortization is quick at 67% in 10 years and 100% in 20. This bond refunding combined with the reduced CIP and the expected partial cash funding of capital should result in the system's debt profile slightly improving over the next five years. Projected debt per capita in 2020 is approximately $2,060, which would align the city more with its 'AA'-rated peers.

EXTENSIVE PLANNING INITIATIVES LEAD TO FAVORABLE SUPPLY
A large majority of the city's potable water supply is derived from Tucson's Clearwater Renewable Resource Facility, which 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. The city also maintains sizable recycled water distribution capabilities.

The city is currently purchasing its maximum annual allotment (144,191 acre-feet) of CAP water and using surplus amounts, which amounted to about 57,000 acre feet in 2015, to replenish groundwater that has been depleted over many decades. Additionally, nationally-recognized conservation efforts have resulted in a net decrease in per capita water utilization over the last decade. Proactive water supply management practices such as these should keep water supply sufficient over the long term. Notably, 2015 marked the first year in decades that no groundwater was pumped.

MIXED ECONOMIC PROFILE
At 4.9% in March 2016, the city's unemployment rate was better than the state average and the national average (both 5.1%). City wealth levels are below state and national averages and poverty rates are elevated. However, the economy is fairly diverse, anchored by government (including military), higher education, medical, and tourism enterprises.