Nigeria: S&P Ratings downgrade behind the beat, Reaction & implications


Monday, March 23, 2015 2:18 PM / ARM Research


S&P downgrades Nigeria on weakened fiscal picture and heightening political risks


Standard & Poor’s (S&P) lowered Nigeria’s sovereign rating by one notch to B+ last week Friday, citing a weaker fiscal picture on account of the continued downdraft in oil prices, insurgency across parts of the North-East and political uncertainty ahead of 2015 general elections. The cut in ratings is on the heels of a negative credit watch placed on Nigeria in February 2015 and follows similar downgrades by S&P to oil exporters: Kazakhstan, Bahrain, Oman and Venezuela, around the same time.


But markets ahead of ratings in pricing risks


In our view, the downgrade simply extends rating agencies’ track record of largely being behind the curve as developments across the rationale points have moved since the negative watch in February. Specifically on the insurgency, the Nigerian Army aided by neighbouring countries (Chad, Niger and Cameroon) has recaptured 36 towns in what has been the most credible response by the authorities since the start of the six-year insurgency.


On the point about elections, while further delays can never be completely ruled out, the odds appear much lower as things stand.  Similarly, regarding the fiscal picture, whilst the rating agency concerns on oil prices are valid, the more proactive stance by the finance ministry, in contrast to prior years, in adjusting fiscal spending and revenue assumptions provide offsets even as Brent crude prices appear to have settled within a $50-60/bbl trading range—still above the January 2015 troughs from the initial plunge. Of further relevance to the fiscal assessment is the FG’s response in the budgeting framework to the evident revenue pressures, arguably the most proactive and realistic planning response in recent history.


Bolstering our thesis about financial markets moving quicker than ratings in pricing sovereign credit risks, prior to Friday’s downgrade, Nigeria’s Eurobond yields have been trading in line with B-rated African commodity exporters whose yields had risen following the bearish pattern across commodities since Q4 2014. Indeed as with other commodity exporters, Nigeria’s Eurobond yields have largely tracked movement in oil prices with yields climbing 84bps over December 2014 as Brent crude prices plunged 18% MoM. The uptick in Eurobond yields continued in January as oil prices tested new lows before subsequent 62bps shrinkage over February.


Figure 1: Nigeria's yields vs. B-rated African peers


An average 7bps decrease in Nigeria’s three Eurobonds yields to 5.9%, 6.4% and 6.7% for 2018, 2021 and 2023 respectively extends the pattern of further declines in March. Combined with February, this serves up two interesting contrasts. First, with Eurobond yields jumps across countries in S&P’s last downgrade in February: Bahrain (+17bps) Kazakhstan (+30bps) and Venezuela (+103bps) and second with local debt yields continuing to remain elevated following the February political risk shock. The latter suggests credit rather than political concerns carry more weight with Eurobond investors whilst the former hints at these same investors’ comfort with Nigeria’s credit credentials at the already ‘priced-in’ downgrade level.



Likely limited impact on asset classes

The very quicker response of international capital markets than rating agencies in general suggests muted impact on Eurobond yields following the actual downgrade event. Again, comparisons with S&P’s last downgrade provide some illumination as yields on debt of all three countries downgraded in February actually witnessed declines within a week of the downgrade with more recent yield uptick simply signifying a recoupling to recent downdraft in oil prices.  To our thinking, the latter is probably the greater risk to Nigerian asset classes.


Figure 3: Movement in yields of select oil exporters

The real test of any change to credit perception might come from when Nigeria attempts to re-access the international capital markets going forward with the recently announced legislative approval granted for the long discussed $300million Diaspora bond perhaps presenting the first opportunity. To our thinking, we see no cause for unduly worrying about the pricing as Nigeria’s first Eurobond issues in 2011 as a B+ sovereign was at yields of 6.75%—not  far off current—even as Ivory Coast’s February 2015 $1 billion issue at 6.625% provides cause for optimism, especially considering its Euro bond history.

The situation is perhaps not so different for corporate issuers. Here, again, we see other considerations as likely more germane. For banks, asset liability matching and exchange-rate risk management as well as regulatory actions in Q4 14 imposing tighter restrictions on foreign currency borrowing
[3] are likely to be the focus. For Oil and Gas companies, which comprise the second largest class of domestic Eurobond issuers, bearish oil price outlook is more influential in dimming prospects of sizable issuance activity.

On the domestic front, we see still-elevated yield levels as reflective of the dominance of political concerns over any others including tight liquidity conditions for local investors
[4] and FX devaluation for offshore investors and envisage little additional pressure from the downgrade. We derive further comfort for this view from the point that the downgrade does not constitute a trigger for exclusion from bond indices such as the JP Morgan EMGBI, as Nigeria was rated as a B+ prior to the 2012 inclusion, and should not trigger any greater outflows from index trackers themselves, again harking on the theme of being earlier priced-in.
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