Fitch Ratings affirms the 'BBB-' rating on approximately $22.315 million
of Allegheny County Industrial Development Authority, PA non-profit
lease revenue bonds (Residential Resources, Inc. Project), series 2006.
The Rating Outlook is Stable.
The bonds are secured by a pledge of lease revenues, a mortgage and a
fully funded debt service reserve (DSR). Allegheny County, PA's guaranty
to replenish any draws on the DSR of up to $2.75 million over the life
of the bonds provides additional bondholder protection.
KEY RATING DRIVERS
STABLE FINANCIAL PERFORMANCE: The 'BBB-' rating reflects Residential
Resources, Inc.'s (RRI) historically positive operating results, which
have generated a minimum of 1.0x maximum annual debt service (MADS)
coverage. Counterbalancing factors include a small, and highly leveraged
operating base and a limited financial cushion.
ESSENTIALITY OF SERVICES UPHELD: The essential nature of the services
that RRI provides to mentally and developmentally disabled residents of
the Commonwealth of Pennsylvania (the commonwealth, rated 'AA+' with a
Negative Outlook by Fitch) is underscored by the limited funding
reductions that the sector has experienced, particularly compared to
other publicly funded programs.
EXPERIENCED AND EFFECTIVE MANAGEMENT: RRI's management team has proven
to be a pro-active and conservative manager of its properties, putting
in place a formal process to handle vacancies and mitigating expense
increases in the face of funding reductions.
WHAT COULD TRIGGER A RATING ACTION
MARGIN DETERIORATION: Given RRI's extremely limited financial cushion,
preservation of the 'BBB-' rating is highly contingent on maintaining a
solidly positive operating margin. A decline, even to the break-even
level, would generate negative rating pressure.
RRI owns and maintains a total of 211 properties (including two
currently under development), housing 971 residents, for individuals
with physical and mental disabilities in and around Allegheny County,
PA. RRI leases its facilities both directly to tenants and through lease
agreements with major service providers. RRI does not provide medical or
psychiatric care to its tenants.
Revenue Base Reliant on Occupancy and State Funding
RRI's small revenue base is heavily concentrated, with rental income
from the properties it owns providing an average of 81.2% of annual
operating revenues, which totaled $5.3 million in fiscal 2011 (FYE June
30). State sources provide the underlying source for nearly all of RRI's
rental income, in the form of block grants to individual service
providers and social security, welfare and section 8 vouchers for
individual tenants. This concentration makes RRI particularly vulnerable
to negative change in the state funding environment, which can trigger
the non-renewal of leases.
While the state's budget has experienced significant shortfalls in
recent years, funding for human services has been somewhat sheltered due
to the essential nature of the services. Funding was held flat through
fiscal 2012, and a reduction was enacted for fiscal 2013. Funding will
be provided in the form of block grants to specific counties, which is
expected to include Allegheny County. The county departments of human
services will then disperse the funds to provider agencies. While the
cuts did trigger a higher than normal level of non-renewals (5%), RRI
expects to continue to collect lease payments into the first quarter of
fiscal 2013 as relocation of tenants is typically not immediate.
To manage the vacancies resulting from the non-renewals, RRI's
management team follows a set protocol to handle the associated
properties. First, RRI attempts to market the property to other human
service providers who are seeking residential facilities. If no match is
found to take over the lease, the RRI puts the property on the
residential housing market. Demand in the residential market within the
county has historically been adequate to absorb the properties in a
timely manner. Historically these practices have been successful, and
vacancies have not typically impacted RRI's annual operating performance.
Operating Surpluses Somewhat Offset Debt Burden
Operations in fiscal 2009 dropped to a deficit level in the face of a
significant, unexpected lease termination of a residential treatment and
private school facility. Ultimately, a settlement was reached with the
tenant, who is required to continue paying a monthly offset payment to
RRI despite having vacated the property. In fiscal 2012, RRI's board
decided to pay off the associated property mortgage to eliminate the
carrying costs. The property, which is significantly larger than the
standard facilities managed by RRI, remains on the market as of the
close of fiscal 2012.
RRI's management team was able to realign operations in fiscal 2010,
generating a 5.9% operating surplus. Fiscal 2011 showed continued
improvement at 9%, and fiscal 2012 is estimated to continue the upward
trend. Due to the state budget cuts for fiscal 2013, RRI is
conservatively anticipating performance to stabilize at or near fiscal
2012 levels despite the decision to hold lease rates flat for the third
Operating results above the break-even level are necessary, given RRI's
high debt burden. Level annual debt service on bonds, notes and
mortgages total approximately $2.8 million per year, or 48.9% of fiscal
2011 revenues. The fiscal 2011 operating surplus provided 1.2x coverage
of this obligation, which is narrow, even for the 'BBB-' rating.
Financial Cushion Narrow, but Increasing
RRI's operating results have also allowed for incremental annual growth
in available funds, defined by Fitch as cash and investments not
permanently restricted. Days cash on hand (DCOH) improved from 209.4 in
fiscal 2010 to 262.4 in fiscal 2011. Given the expected results for
fiscal 2012, DCOH could exceed 300. Cash to debt, however, reached a
minimal 8.3% in fiscal 2011, and may exceed 10% in fiscal 2012.
Particularly given the meager financial cushion vis-a-vis outstanding
debt, Fitch expects balance sheet resources to remain at or near current
levels to maintain RRI's investment grade rating.
Additional information is available at 'www.fitchratings.com'.
The ratings above were solicited by, or on behalf of, the issuer, and
therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria', dated June 12, 2012;
--'Nonprofit Institutions Rating Criteria', dated June 15, 2012.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Institutions Rating Criteria
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