OREANDA-NEWS. August 18, 2015. Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of Tucson Electric Power Co. (TEP) at 'BBB' and revised the Rating Outlook to Positive from Stable. Fitch has also affirmed TEP's short-term IDR at 'F2'. A complete list of ratings appears at the end of this release. Approximately \\$1.5 billion of debt is affected by today's rating action.

TEP's ratings and Positive Outlook reflects a constructive regulatory environment in Arizona, improving economic conditions in TEP's service territory, strengthening credit metrics. The ratings also consider the utility's improved access to capital due to Fortis' financial strength and the expectation that Fortis will continue to support TEP's growth objectives and provide appropriate financing support as needed.

KEY RATING DRIVERS
New GRC Filing Expected: Fitch expects the regulatory environment in Arizona to remain constructive and assumes a reasonable outcome in TEP's forthcoming GRC. Fitch expects TEP to file its 2015 GRC in the fourth quarter of this year and assumes a 9% ROE for rates effective Jan. 1, 2017. Fitch expects a decision by the ACC in the fourth quarter of 2016.

Improving Credit Metrics: For the LTM period ending June 30, 2015, TEP's EBITDAR coverage ratio increased slightly to 5.4x as compared with 5.2x for 2014 and reflects strong wholesale sales partially offset by mild winter weather. Debt/EBITDAR leverage approximated 4.3x for the same period. Going forward, EBITDAR coverage is expected to approximate over 6x through 2019, and leverage, as measured by debt/EBITDAR is expected to improve to less than 3.8x over the same period due to a combination of new rates, amortizing capital lease obligations, and improving economic conditions in TEP's service territory.

Financial Support From Fortis: Since the acquisition last year, Fortis has injected over \\$400 million of equity into TEP to help strengthen its balance sheet, and Fitch's ratings assumes Fortis will continue to support TEP's growth objectives and provide financial support as needed. In June, Fortis injected \\$180 million of equity into TEP and continues a trend of recent financial support.

Constructive Regulatory Environment in AZ: The more timely adjudication of rate filings by the ACC in recent years is a constructive development that has enabled TEP to reduce regulatory lag and improve its earned returns. The ACC has adopted several regulatory mechanisms to facilitate cost recovery outside of and in between GRCs. Such cost recovery mechanisms include lost fixed cost recovery, an environmental compliance adjustor, demand side management and a renewable energy surcharge. Additionally, Fitch views the ACC's recognition of an extended post-test-year period for new plant additions and the allowance of a premium rate of return on fair value of rate base as further constructive developments. The cost recovery mechanisms allow for timely earnings growth in between GRC proceedings.

NM and DG Update: TEP withdrew its request with the ACC to revise its net metering tariff in June and indicated it will instead propose a new net metering tariff as part of its planned GRC filing in late 2015. TEP had proposed to purchase excess solar generation from new customer rooftop systems at a utility scale solar rate rather than the current full retail rate which would largely address future cost-shifting issues between TEP's solar and non-solar customers under current net metering rules. Fitch views the potential adoption of a new net metering tariff that addresses current cost shifting issues as positive for TEP.

New Gas Generation: In the fourth quarter of 2014 Fortis injected \\$225 million of equity into TEP to strengthen its balance sheet and to help fund the purchase of a 75% ownership interest in Unit 3 at the 550 MW natural gas-fired Gila River power plant for \\$164 million and to increase TEP's ownership stake in the 387 MW coal-fired Springerville Unit 1 power plant to 49.5% for \\$65 million. The acquisition is consistent with TEP's strategy to diversify its generation fuel mix and to shift towards cleaner generation resources and covers TEP's generation needs through 2018.

Increased Capex Needs: TEP plans to spend \\$1.6 billion on capex through 2019, including \\$494 million this year, levels 10% higher than the preceding four-year period. Capex associated with end of lease ownership purchases at the Springerville station, transmission projects and environmental compliance investments account for the bulk of increased spending levels. Fitch expects capex levels to remain elevated this year due to the purchase of the Springerville coal handling facilities in April and then taper off and average \\$290 million through 2019. Additionally, capex for renewable projects is expected to average \\$30 million per year. The majority of capex is covered by operating cash flows, and Fitch projects TEP to be modestly FCF-negative and expects future funding needs to be met by a balanced mix of debt and equity.

Clean Power Plan: TEP's current strategy to diversify its generation fuel mix away from coal and towards cleaner generation resources including natural gas and solar should leave TEP well positioned to comply with state emission targets under the clean power plan. The EPA issued final carbon emission regulations for existing power plants in August that targets a state wide reduction in carbon emissions of 24% by 2022 and 34% by 2032, using 2012 as a baseline year. TEP's 2014 integrated resource plan to reduce its coal fired capacity by more than 30% over the next five years should largely put them in compliance with emissions targets but additional plant retirements may be necessary.

Ongoing Litigation Proceedings: TEP is involved in ongoing litigation proceedings with third party owners of the coal fired Springerville Unit 1 who own approximately 50.5% of the total 387MW capacity. In December, the Third-Party Owners filed a complaint against TEP in the Supreme Court of the State of New York, primarily alleging that TEP failed to properly operate, maintain, and make capital investments in Springerville Unit 1 during the term of the lease and is seeking \\$71 million in liquidated and other additional damages. TEP has denied the charges and has filed a motion to dismiss certain allegations of the complaint, which is currently pending. Ultimately, the timing and resolution of the proceedings is uncertain, but Fitch does not expect the outcome to place undue financial pressure on TEP.

Dividend Restriction: Per the terms of the merger, dividends to UNS from its regulated utilities cannot exceed 60% of annual net income for a period of five years or until their respective equity/total capitalization ratios reach 50%. TEP exhibits a balanced capital structure and had an equity to capitalization ratio of 47% as of June 30, 2015.

No Cash Taxes through 2019: Fitch does not expect TEP to pay any cash taxes over the next five years due to a significant NOL carryforward position that totaled \\$807 million as of Dec. 31, 2014. TEP's use of NOL carryforwards offsets taxable income and modestly strengthens FFO credit metrics. TEP did not pay any federal or state income taxes for the first six months of 2015.

KEY ASSUMPTIONS

--Assumes a GRC filling in the fourth quarter of this year at a 9% ROE for rates effective Jan. 1, 2017;
--Continued financial support from Fortis;
--Capex of \\$1.6 billion through 2019;
--No long-term bond maturities through 2019.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--A constructive regulatory outcome in TEP's forthcoming GRC;
--Continued financial support from Fortis;
--Sustained debt/EBITDAR metrics of 3.8x or lower over the forecast period.

Negative: A negative rating action is not expected at this time, however, future developments that may, individually or collectively, lead to a negative rating actions include:
--A deterioration of the regulatory environment in Arizona;
--Sustained debt/EBITDAR leverage metrics greater than 4.5x.

LIQUIDITY
Good Liquidity: As of June 30, 2015, TEP had total available liquidity of \\$302 million under its credit agreement including \\$102 million of unrestricted cash and cash equivalents. TEP maintains liquidity through a \\$200 million RCF and an \\$82 million letter of credit facility (collectively, the 2010 credit agreement) that matures in November 2016. TEP's revolving credit facility contains a maximum debt/capitalization covenant ratio of 70%, and, as of June 30, 2015, TEP was in compliance with a debt/capitalization ratio of 53%.

FULL LIST OF RATING ACTIONS

Fitch has affirmed TEP's ratings as follows:

--IDR at 'BBB';
--Short-term IDR at 'F2';
--Unsecured bank credit facility at 'BBB+';
--Unsecured industrial revenue bonds at 'BBB+'';
--Unsecured pollution control revenue bonds at 'BBB+';
--Unsecured notes at 'BBB+'.

The Rating Outlook is Positive.