Reviews & Outlooks | |
Reviews & Outlooks | |
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Tuesday, June 11, 2019 / 03:47PM / Fitch Ratings /Header Image Credit: Wikipedia
Fitch Ratings has affirmed Lagos State's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B+' with Stable Outlook and Short-Term Foreign-Currency IDR at 'B'. The National Long-Term Rating has been affirmed at 'AA+(nga)', with a Stable Outlook. The ratings on Lagos's medium-term note (MTN) programme and senior unsecured bonds have also been affirmed at 'B+'/'AA+(nga)'.
Under Fitch's new criteria for LRGs, Lagos's IDR is capped by the sovereign (B+/Stable). The ratings reflect the state's weak risk profile by international standards against Fitch's expectations of sound debt sustainability driven by internally generated revenue (IGR), which underpins Lagos's capacity to serve its financial obligations. The ratings also reflect rising but sustainable adjusted debt. These assessments incorporate counterparty risks and the sovereign rating. The Stable Outlook on the IDRs mirrors that on the sovereign.
Lagos is Nigeria's economic powerhouse with per capita
GDP above USD4.000, or double the national average, but is weak by
international standards. Fuelled by public and private investment and a
population over 20 million, Lagos's diverse economy is supportive of the wide
tax base that generates IGRs.
Key Rating Drivers
Revenue Robustness: Midrange
Lagos benefits from a diversified revenue structure
led by IGR, which represented over 70% of its NGN560 billion operating revenue
at end-2018. IGR is driven by moderately cyclical taxes such as PAYE (personal
income tax). The stable tax revenue is counterbalanced by the dynamic
oil-related transfers from the central government (representing less than 10%
of operating revenue) and some volatility of other operating revenue sources
such as sales proceeds, rents, land use charges, fees and fines.
Revenue Adjustability: Weaker
Given that Lagos has no tax-setting power on its main
IGR item, PAYE, Fitch believes that Lagos's fiscal flexibility relies on the
wide but not fully exploited tax base of PAYE, as well as other potential revenue
sources such as land use charges. In Fitch's view, additional revenue streams
should cover the peak-to-trough revenue fall of -5.52% (NGN22 billion)
experienced in 2015 by at least 50%. Lagos is a net contributor to Nigeria's
equalisation system enacted through the Federal Account Allocation Committee
(FAAC).
Expenditure Sustainability: Midrange
Lagos's opex growth averaged 9.6% in 2010-2018, in
line with operating revenue growth of 9.9%, allowing for a stable operating
margin of around 50% on average. In its rating scenario, Fitch expects
operating costs to increase by 9% or less than the country's double-digit
inflation, factoring in a tighter grip on current expenditure and compliance
with expenditure targets, while coping with the expected 33% rise in staff
costs by 2020 due to the minimum wage increase set by the national government.
Expenditure Adjustability: Midrange
There are no mandatory balanced budget rules defined
by the central government for states, which are required to keep their deficits
at 3% of national GDP. In its rating scenario of slow economic growth, Fitch
expects Lagos to continue to post large operating margins at 40%. Capex makes
up 55% of Lagos's expenditure before debt service, keeping the share of
inflexible expenditure well below 70%. Fitch believes that the high level of
capex is necessary to maintain the local attractiveness amid demographic
pressures calling for more services on infrastructure, health and education.
Liabilities and Liquidity
Robustness: Weaker
The national framework for debt is evolving and thus
borrowing limits are quite wide. There are no restrictions concerning debt
maturities, interest rates or currency exposure. Lagos applies a prudential
rule of debt service not exceeding 30% of operating revenues and aims at
reducing its currency exposure at 55% of its NGN850 billion outstanding debt at
end-2018. To ensure timely debt service, its internal debt is assisted by a
state-level irrevocable standing payment order while external debt is served
with deductions from FAAC.
Liabilities and Liquidity
Flexibility: Weaker
Lagos has consolidated access to financial markets
with repeated bond issuances, while domestic counterparties can provide
liquidity lines and short-term credit. Counterparty risk on credit lines is in
the 'B' category, triggering a 'Weaker' assessment for this factor. Lagos
cashes in a sinking fund to support its debt service on bonds and Fitch
prudentially considers its year-end cash as earmarked to offset payables.
Debt Sustainability Assessment: 'aa'
In Fitch's rating scenario, Lagos's debt
sustainability is assessed in the 'aa' category as reflected by a sound payback
ratio (net adjusted debt to operating balance) at around three years in our
2019-2023 rating case scenario. Fitch incorporates Lagos's weak fiscal debt
burden of around 140%, which is high compared with the peer group, and debt
service coverage at around 2x.
Rating Derivation
Lagos's standalone credit profile (SCP) is assessed at
'bb+', reflecting a combination of a weak risk profile and debt sustainability
in the 'aa' category. The notch-specific rating positioning is assessed at the
higher end of the rating category to reflect the strong payback ratio below
five. Fitch does not apply any asymmetric risk or extraordinary support from
the central government. The SCP is capped at the sovereign level. The 'B'
short-term rating is derived from Lagos's Long-Term IDR.
Key Assumptions
Fitch's key assumptions within our base and rating
case for the issuer include:
Rating Sensitivities
Any positive rating action on Nigeria will be reflected on Lagos's ratings, provided that Lagos maintains its strong debt sustainability metrics.
A downgrade of the sovereign's ratings would lead to
corresponding action on Lagos's IDR. A sustained deterioration of the payback
ratio above five years in Fitch's rating case scenario, or a reassessment of
the key risk factors due to unfavourable changes in the economy beyond Fitch's
expectations, could also trigger a downgrade.
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