-- First mortgage bonds/ secured PCRBs 'BB+';

-- Second mortgage bonds 'BB+';

-- Secured credit facility 'BB+';

-- Unsecured PCRBs/industrial development bonds 'BB-'.

The Rating Outlook is Stable.

The current ratings reflect TEP's weak interest coverage ratios and highly leveraged balance sheet. Favorably, TEP generates free cash flow that should allow for meaningful debt reduction. The high business risk that results from the absence of a power cost adjustment clause or deferral mechanism and the rate cap under its 1999 industry restructuring settlement agreement is largely mitigated by the company's long coal-fired generation portfolio. The second mortgage bonds are rated the same as the first mortgage bonds and the first collateral trust bonds due to the substantial value of the collateral available to creditors secured by first and second mortgage bonds.

The new $401 million credit facility closed on March 25, 2004 and is composed of a $60 million revolving credit facility and a $341 million letter of credit facility. The letter of credit facility supports TEP's $329 million variable rate, tax-exempt bonds. The credit agreement is secured by $401 million in aggregate principal amount of second mortgage bonds and matures on June 30, 2009. Under the terms of the new credit facility, TEP is prohibited from issuing additional first mortgage debt. A provision in the earlier agreement that limited the proportion of TEP net income that can be paid to UniSource Energy (UNS) was eliminated. However, the ACC still limits dividends to 75% of TEP net income.

Importantly, Fitch expects TEP first mortgage debt to be reduced, at the close of the merger, to levels sufficient to trigger fall-away provisions in the utility's first collateral trust indenture. Under the provisions of the first mortgage trust indenture, the outstanding first mortgage lien now securing the bonds will be replaced by a perfected second mortgage lien. As a result, all of TEP's outstanding secured debt will then be secured solely by the second mortgage lien and the first mortgage deed of trust will be terminated.

In November 2003, TEP's direct parent, UniSource Energy (UNS), entered into a merger agreement with Saguaro Utility Group L.P. (Saguaro), whereby Saguaro will purchase all of the UNS common stock for $25.25 per share. Saguaro (which includes limited partners Kohlberg Kravis Roberts & Co., L.P., J.P. Morgan Partners, LLC and Wachovia Capital Partners) has agreed to acquire UNS in a transaction valued at roughly $3 billion, including assumed debt. The leveraged transaction, as planned, will be financed by a $550 million equity investment and $660 million of new debt to be issued by a new holding company that will be the parent of UNS. Two-hundred-sixty three million of the new equity will be invested in TEP and used to reduce utility debt.

Although there is currently no parent-level debt at UNS, if the merger is consummated as planned, TEP will be the indirect subsidiary of a highly leveraged parent company. This concern is mitigated by the pre-funded debt redemption feature of the merger proposal and regulatory provisions limiting dividends to 100% of the utility's net income, based on the utility's proposed post-acquisition capital structure and current ACC limitations. The $263 million equity investment in TEP will accelerate debt reductions previously anticipated to occur over a five-year horizon, thereby easing regulatory restrictions limiting the amount of dividends paid by TEP to its immediate parent, UNS.

The $263 million cash transfer and debt redemption are targeted to improve TEP's regulatory equity to 40% of total capitalization (the calculation by the Arizona Corporation Commission (ACC) excludes capitalized lease obligations) enabling the utility to dividend 100% of net income to its parent. The incremental dividend payment is partially offset by lower interest expense associated with the debt reduction.

Under the terms of the merger agreement, the investor group will pay roughly $875 million for UNS equity and assume about $2.1 billion of debt. The merger has been approved by shareholders and requires regulatory approvals from the ACC, FERC, and the SEC. Management will remain in place and UNS's corporate headquarters will remain in Tucson, Arizona. The merger, if approved, is expected in the fourth quarter 2004.