TEXT-Moody's release on UNS Electric/UNS Gas

(The following statement was released by the ratings agency)

July 8 - Moody's Investors Service assigned a Baa3 rating to the shared senior unsecured $60 million multi-year credit facility of UNS Electric, Inc. (UNS Electric) and UNS Gas, Inc (UNS Gas). The facility is guaranteed by UNS Electric's and UNS Gas' intermediate parent holding company, UniSource Energy Services (UES). UES is a subsidiary of UniSource Energy, Inc (UniSource: Ba1 senior secured (security limited to stock of certain subsidiaries)), a holding company that has as its primary utility subsidiary Tucson Electric Power Company (TEP: Baa3 senior unsecured). The ratings of UniSource and TEP remain unchanged. The outlook for UniSource and its subsidiaries is stable.

The Baa3 rating assigned to the UNS Electric/UNS Gas credit facility reflects the relatively stable and predictable nature of the regulated cash flows produced by these electric and gas utilities as well as the historically strong financial profile of the combined entities which provide the basis for the UES guarantee. For the past several years, cash flow credit metrics at both UNS Electric and UES have been at or above the upper end of the ranges demonstrated by electric utilities rated Baa. For example, the ratios of cash from operations excluding changes in working capital (CFO Pre -- WC) to Debt, calculated in accordance with Moody's standard analytical adjustments, have been consistently above 20%. The Baa3 rating recognizes that cash flow metrics are expected to decline somewhat over the next few years, reflecting the impact of the termination of UNS Electric's full requirements power supply agreement with Pinnacle West Marketing and Trading, as well the continuing capital expenditure programs at both UNS Electric and UNS Gas; however, Moody's anticipates that metrics will generally remain toward the mid-to-upper end of the ranges demonstrated by electric utilities rated Baa.

The Baa3 rating considers the regulatory environment in Arizona, which Moody's has historically considered to be below average for regulatory environments in the United States in terms of supportiveness to credit quality. However, the Baa3 rating also contemplates recent decisions by the Arizona Corporation Commission (ACC) that appear intended to provide more timely recovery of certain costs. For example, in its May 2008 decision, the ACC awarded UNS Electric a forward looking Purchased Power and Fuel Adjustment Clause (PPFAC), with an annual true-up mechanism. Although the initial PPFAC is expected to be capped below the level required to immediately recover UNS Electric's costs for fuel and purchased power, the true-up component is uncapped and is intended to recover excess costs over the following twelve month period. At UNS Gas, rates are adjusted monthly to reflect differences in the average actual cost of gas versus that assumed in rates. In addition, in UNS Electric's recent rate case, the ACC approved the concept of line extension fees, designed to make "growth pay for itself" which should result in an almost immediate recovery of a portion of the capital costs associated with hooking up new customers.

The $60 million UNS Electric/UNS Gas revolving credit facility matures in August 2011. Either borrower may borrow up to a maximum of $45 million as long as the combined amount borrowed does not exceed $60 million. As of March 31, 2008, UNS Electric had $30 million drawn under the facility while UNS Gas had no short-term borrowing outstanding. The facility includes two financial covenants applicable to each borrower: for UNS Electric a maximum debt to capital ratio of 65%, and a minimum interest coverage ratio of 2.25 times, for UNS Gas a maximum debt to capital ratio of 67%, and a minimum interest coverage of 2.25 times. Moody's anticipates the borrowers will remain comfortably within these limits; however, the facility does require a material adverse change (MAC) representation at each new borrowing. In our opinion, the requirement for a MAC representation significantly increases the risk that the credit facility may not be available when liquidity needs are greatest.

The stable outlook for UES reflects the relatively stable cash flows anticipated to be generated by its regulated subsidiaries and Moody's assumption that increases in the cost of fuel and purchased power will, in fact, be recovered on a relatively timely basis. To the extent that deferral balances grow to be materially larger than anticipated, or if the time to recovery is significantly extended, the rating or outlook could be revised downward. Given the anticipated decline in credit metrics, the potential for large deferral balances, and the limited liquidity provided by the joint credit facility due to the MAC clause, an upward revision in the rating or outlook is not likely over the near-to-medium term.

Headquartered in Tucson, Arizona, UniSource is a holding company that provides electricity and natural gas to customers across Arizona through its primary subsidiaries: TEP, a vertically integrated electric utility and UES, whose principal subsidiaries are UNS Electric and UNS Gas. (New York Ratings Team)