Fitch Rates $25.4MM Residential Resources, Inc. Bonds (PA) 'BBB-'.

NEW YORK -- Fitch has assigned its 'BBB-' rating to the $25.4 million Allegheny County Industrial Development Authority non-profit lease revenue bonds (Residential Resources, Inc. Project), series 2006. The bonds are fixed-rate. The Rating Outlook is Stable. Bond proceeds will be used to advance refund the series 2001 bonds ($19.7 million), refinance 19 taxable mortgages ($4.8 million), purchase several new homes ($956,000), fund a debt service reserve, and pay costs of issuance. The bonds are expected to be sold during the week of July 24 via negotiation by Mellon Financial Markets, LLC.

The 'BBB-' rating is supported by Residential Resources, Inc.'s (RRI) strong profitability, improved liquidity, limited competition, and a debt service reserve replenishment guaranty from Allegheny County. Since the 'BBB-' rating was assigned in 2001, RRI has demonstrated strong financial operations and an improved liquidity position. RRI has maintained a strong excess margin, averaging 6.7% ($353,000 net gain) from fiscal 2001-2005 (June year-end), and posted a 12% margin through the 10 months ended April 30, 2006. Profitability is driven by rental revenue, which represented 84% of total revenue in fiscal 2005. At April 30, 2006, RRI had $3 million of unrestricted cash equating to 290.3 days cash on hand. Liquidity growth has been enabled by strong cash flow from operations and the sale of certain properties.

As a supplier of real estate for human service providers, RRI owns and maintains 196 properties in and around Allegheny County, PA. Due to its unique line of business RRI has very little competition in its service area. Allegheny County has pledged a general obligation debt service replenishment guaranty for an aggregate $2.75 million, which would be renewed when RRI reimburses the County. The guaranty lasts through bond maturity, and is a full faith and credit, general obligation of the County, payable from an unlimited ad valorem tax on all taxable property within the County. To date, RRI has neither requested nor needed the debt service replenishment guaranty.

Primary credit concerns include RRI's high debt burden, risk associated with lease renewals, limited financial flexibility, and reliance on government funding. In addition to RRI's outstanding lease revenue bonds, RRI has $1.8 million in mortgages on various properties, which are included in Fitch's debt service calculations. RRI's overall debt burden is high, with pro forma maximum annual debt service (MADS) as a percent of revenue of 37.1% and 1.8 times MADS coverage by EBITDA through 10 months ended April 30, 2006. In addition, cash to debt as of April 30, 2006 was low at 6.7%.

Although RRI's annual lease renewal rate over the last two years was over 90%, from 2007-2008 more than 40% of RRI's leases will expire, which creates inherent risk. Moreover, there is revenue concentration among RRI's top five tenants, which provided 58% of rental income in 2006, an increase from 43% in 2001. Typical lease agreements are three to five years in length with 2% annual rate increases, which limits RRI's financial flexibility. However, this concern is mitigated by RRI's large fixed expense base, with interest, depreciation and amortization equaling more than 75% of overall expenses in fiscal 2005. Roughly 90% of RRI's revenues come from its tenants via several government programs, which are vulnerable to funding reductions, changes in payment methodology, and budgetary shortfalls.

The Rating Outlook is Stable. Fitch expects RRI to maintain its recent levels of profitability, and believes its 2006 operating budget ($745,000 net gain) is achievable.

RRI owns and maintains 196 facilities that house 939 residents, for individuals with disabilities in and around Allegheny County. RRI does not provide medical or psychiatric services to its tenants. In 2005, RRI had total operating revenues of $4.6 million. RRI has covenanted to disclose to the nationally recognized municipal securities information repositories (NRMSIRs) annual audited financial statements within 180 days of each fiscal year-end, and quarterly disclosure within 45 days of each quarter-end.

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