OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB-' rating on approximately \$16.9 million outstanding Allegheny County Industrial Development Authority, PA non-profit lease revenue bonds (Residential Resources, Inc. [RRI] project), series 2006.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of lease revenues, a mortgage and a fully funded debt service reserve (DSR). Allegheny County, PA guarantees to replenish any draws on the DSR up to \$2.75 million over the life of the bonds (no replenishment has been required to-date or is expected), which provides additional security.

KEY RATING DRIVERS

ESSENTIAL SERVICE PROVIDER: RRI is the primary provider of housing to individuals with intellectual and physical disabilities in the county. This service is a priority for the county and state, which provides some level of stability to housing demand and annual operating revenues. Allegheny county guarantees to replenish draws on the DSR fund up to \$2.75 million, which supports the county's commitment to RRI's operations.

STABLE OPERATING PERFORMANCE: Fitch expects RRI to continue managing successfully through periodic government funding and real estate cycles. RRI's track record of consistent positive operating performance and stable debt service coverage is important to maintaining the current rating level.

VERY HIGH DEBT BURDEN: RRI is highly leveraged with a debt burden (maximum annual debt service [MADS] of about \$2.53 million due in fiscal 2016) that is very high at over 44% of fiscal 2014 operating revenue.

WEAK RESOURCE BASE: RRI's balance sheet ratios are weak for the rating category, and can fluctuate with periodic real-estate transactions and sales.

EFFECTIVE MANAGEMENT: RRI's management team has managed its approximately 194 properties effectively in an environment with client human service providers pressured by state funding. It has also managed well through real-estate cycles. Underlying demand for RRI's specialized housing remains strong, but is driven more by government funding levels than client need.

RATING SENSITIVITIES

MAINTAIN OCCUPANCY: Ongoing housing vacancies above current levels due to state funding pressures or rental rate increases could create operating risks and negatively impact the rating. A relatively stable state funding environment for RRI's human service provider tenants underpins the rating.

DEBT SERVICE COVERAGE: Failure to maintain adequate debt service coverage of scheduled bond and mortgage obligations, calculated by Fitch at 1.3x for fiscal 2014, could trigger a negative rating action.

OPERATING PERFORMANCE: Continued positive operating results, modest growth in balance sheet resources over time and consistently positive MADS coverage support the rating.

CREDIT PROFILE
RRI owns and maintains about 194 properties, housing approximately 952 residents, all for individuals with various physical and intellectual disabilities living in and around Allegheny County, PA. RRI primarily leases its facilities to non-profit social service providers. Only limited housing is rented directly to disabled tenants. RRI lease agreement terms can vary, but are typically between three and 10 years. RRI is a property management organization - it does not provide medical or psychiatric care, or daily living support, to its disabled residents. Its primary income is rental income derived from leases with various non-profit human service agencies. Total operating revenue was \$5.68 million in fiscal 2014 (June 30 year-end).

STABLE OPERATIONS EVEN WITH PRESSURED FUNDING ENVIRONMENT
The rating reflects positive operating performance over the past seven fiscal years (2008-2014). Fiscal 2014 net operating income was \$633,000, an 11% operating margin. Unaudited nine-month results for fiscal 2015 indicate positive performance. State ('AA-', Stable Outlook from Fitch) funding to RRI's various human service provider clients is cyclical, but in fiscal 2015 and 2014 state funding was flat (no cuts). A 10% cut in fiscal 2013 was made through block grants. RRI's operating surplus was sustained even with the cut. Vacancy rates at RRI's properties have not increased materially in recent years, even with constrained state funding. State funding for fiscal 2016 has not yet been finalized.

RRI has a concentrated revenue base from rental income (typically about 84% of fiscal operating revenues), and a small revenue base of just \$5.68 million in fiscal 2014. Management expects modest rental increases to its various human service agencies over the next several years as lease terms become due. In fiscal 2014, RRI's board approved increased rental rates of roughly 2% for those leases up for renewal, the first in several years. Fitch views these factors as limiting RRI's financial flexibility.

Fitch views the organization's positive operating results and essential nature of the services provided as partially mitigating factors against RRI's small size, very high debt leverage, indirect vulnerability to state social service funding, and exposure to the regional real estate market.

HIGH DEBT LEVERAGE BUT ADEQUATE COVERAGE
RRI operates as the real-estate arm for regional non-profit human service agencies. At June 30, 2014, RRI had \$30.1 million of debt, a combination of the series 2006 bonds and various mortgage notes. At this time no new bonded debt is expected, and management anticipates entering only into a limited number of small-property mortgages.

RRI's scheduled debt service is approximately \$2.5 million (the amount changes annually due to bond prepayments). Included in this amount is the series 2006 MADS, which is fairly level at around \$1.65 million in fiscal 2016. Due to principal pre-payments (in addition to scheduled debt service) in recent years, series 2006 MADS has moderated from \$1.85 million at time of issuance.

As a percentage of revenues, the overall MADS burden, including series 2006 debt service and other mortgages, remains very high at over 44% of fiscal 2014 operating revenues. The organization prepays series 2006 bond principal when related properties are sold - recent redemption amounts have been \$525,000 in fiscal 2015, \$595,000 in fiscal 2014, and \$670,000 in 2013. Another redemption is expected in fiscal 2016.

RRI's debt service coverage is adequate and consistent over time. Fiscal 2014 coverage (per the series 2006 bond covenant calculation) was 1.7x, well in excess of the required 1.25x. Because this calculation uses an adjusted gross revenue pledge, Fitch also calculates coverage using audited net operating income and scheduled bond plus mortgage payments. Resulting coverage was adequate at 1.3x in fiscal 2014, similar to fiscal 2013. Interim operating results for the fiscal year ending June 30, 2015 also indicate positive operations and debt service coverage.

LIMITED BALANCE SHEET RESOURCES
RRI has historically maintained a minimal financial cushion, particularly in relation to outstanding debt. RRI's available funds (AF; defined as cash and investments not permanently restricted) totaled \$5 million in fiscal 2014, equal to 99% of operations but a much weaker 16.7% of debt (both bonds and mortgages). This compared to AF of \$5.1 million in fiscal 2013, \$4.8 million in 2012, and \$5.9 million in 2011. Fitch considers available funds ratios to be appropriate to the expense base, but weak relative to outstanding debt.