OREANDA-NEWS. April 22, 2016. Fitch Ratings has affirmed the 'BBB-' rating on approximately \\$16.8 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 on mortgages of bond-funded properties, and a debt service reserve (DSR) of \\$1.844 million. 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 operating revenues. Allegheny County's guarantee to replenish draws on the DSR fund up to \\$2.75 million demonstrates 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], including bonds and unrelated mortgages of about \\$3.08 million due in fiscal 2022) that is very high at over 50% of fiscal 2015 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 184 properties effectively in an environment with client human service providers pressured by state funding, including fiscal 2016 with a significantly delayed commonwealth budget. 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 for social service agencies than client need.

RATING SENSITIVITIES

MAINTAIN OCCUPANCY: Ongoing housing vacancies above current levels could create operating risks and negatively impact the rating. A relatively stable state funding environment for Residential Resources, Inc.'s human service provider tenants underpins the rating.

DEBT SERVICE COVERAGE: Failure to maintain adequate debt service coverage of scheduled bond and mortgage obligations could trigger a negative rating action.

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

CREDIT PROFILE
RRI owns and maintains about 184 properties. These house about 933 residents 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 facility leases with various non-profit human service agencies. Total operating revenue was \\$5.9 million in fiscal 2015 (June 30 year-end).

STABLE OPERATIONS WITH STATE BUDGET DELAYS
The rating reflects positive operating performance over at least fiscal years 2008-2015. Fiscal 2015 net operating income was \\$598,000, a 10.1% margin consistent with prior years. Current debt service coverage for scheduled bonds and all mortgages in fiscal 2015 was 1.3x, also consistent with prior years.

Unaudited eight-month results for fiscal 2016 indicate another positive performance. Commonwealth ('AA-', Stable Outlook) funding to RRI's various human service provider clients is cyclical. In fiscal 2015 and 2014 state funding was flat (no cuts); in fiscal 2016 a budget impasse delayed funding. RRI does not receive direct commonwealth funding; however, its tenant social service agencies do, and a portion of their state funds pay for program facilities (including RRI leases).

Due to Pennsylvania's delayed fiscal 2016 budget, some social service agencies did not receive funding for five to six months. Management reported that agencies serving clients with intellectual disabilities received scheduled monthly contract payments from the commonwealth. However, agencies serving mental health clients did experience delays, as their funding comes through county block grants. RRI was not required to, but opted to allow a few such agencies to defer rent for several months. Management reports that at the end of February, 2016, those rents were current. Additionally, RRI is building modest cash reserves in case fiscal 2017 experiences similar commonwealth budget delays.

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.

REVENUE CONCENTRATION
Most of RRI's operating revenue is from rental income (typically 80%-84% of fiscal operating revenues). It also has a small revenue base, \\$5.9 million in fiscal 2015. Management has implemented modest rental increases to its various social service agency tenants in recent years as leases come up for renewal. In fiscal 2015, RRI's board approved rental rate increases of roughly 1%-2% for renewing leases, similar to the prior year. RRI is very sensitive to its tenants' mission and costs, and as such Fitch views RRI as has having limited revenue generation flexibility.

HIGH DEBT LEVERAGE
RRI is the real-estate arm for many non-profit human service agencies in the region. At June 30, 2015, RRI had about \\$28 million of debt, a combination of the series 2006 bonds (\\$16.8 million) and various mortgage notes (\\$11.2 million). No new bonded debt is expected. Management periodically enters into a limited number of small-property mortgages, directly related to client agency needs. RRI has long stated that it does not purchase speculative properties.

RRI's debt service in fiscal 2015 was \\$3.4 million (the amount changes annually due to bond prepayments), including scheduled bond payments and scheduled/non-scheduled mortgage payments. Scheduled MADS (which amount also changes annually) is about \\$3.07 million in 2020, and reflects several mortgages with small bullet terms. Included in this amount is series 2006 debt service, which is fairly level at around \\$1.65 million. Due to regular extraordinary principal redemptions 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 all mortgage payments, remained extremely high at over 50% of fiscal 2015 operating revenues.

The organization prepays series 2006 bond principal when related properties are sold - recent redemption amounts include \\$100,000 in fiscal 2016, \\$525,000 in fiscal 2015, and \\$595,000 in fiscal 2014. Another special redemption is expected in fiscal 2017. RRI pre-pays both bond- and mortgage obligations when related facilities (most of which are small, scattered-site residential properties) are no longer needed by a social service agency tenant.

ADEQUATE DEBT SERVICE COVERAGE
RRI's debt service coverage is adequate and consistent over time. Fiscal 2015 coverage (per the series 2006 bond covenant calculation) was 1.8x, well in excess of the required 1.25x. Fitch also calculates coverage using audited net operating income, scheduled bond payments, and all mortgage payments (regular and extraordinary). Resulting coverage was adequate at 1.3x in both fiscal 2015 and 2014, similar to fiscal 2013. Interim operating results for the fiscal year ending June 30, 2016 also indicate positive operations and debt service coverage.

LIMITED BALANCE SHEET
RRI has historically maintained a minimal financial cushion, particularly in relation to outstanding debt. RRI's available funds (AF; defined as cash and investments less County collateral funds of \\$1.825 million) totaled \\$5 million in fiscal 2015, equal to 96% of operations and a much weaker 18% of debt (both bonds and mortgages). This compared to AF of \\$5 million in fiscal 2014, \\$5.1 million in 2013, and \\$4.8 million in 2012. Fitch considers available funds ratios to be appropriate to the expense base, but weak relative to outstanding debt.