Fitch Affirms Nigeria's Kaduna State at 'B'; Outlook Stable

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Tuesday, September 14, 2021 / 03:45 PM / by Fitch Ratings / Header Image Credit: MoMAA


Fitch Ratings has affirmed Nigeria's Kaduna State's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' with a Stable Outlook. Kaduna's National Rating has been affirmed at 'A+(nga)'.

The ratings reflect that Kaduna's revenue structure remains dependent on oil transfers despite increasing internally generated revenues (IGR). The ratings also factor in the state's growing debt to fund necessary capex for the development of basic infrastructure and social services. Kaduna's IDRs are aligned with the Nigerian sovereign's and no other rating factor applies to the ratings.

Fitch assesses Kaduna's Standalone Credit Profile (SCP) at 'b', reflecting the combination of a 'Vulnerable' risk profile and debt sustainability metrics in the 'bb' category under its rating case scenario.

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Key Rating Drivers

Risk Profile: 'Vulnerable'

Fitch assesses Kaduna's risk profile as 'Vulnerable', which combines five factors assessed as 'Weaker' (Revenue Robustness and Adjustability, Expenditure Sustainability, Liabilities and Liquidity Robustness and Flexibility) and one factor as 'Midrange' (Expenditure Adjustability). The assessment reflects Fitch's view of a very high risk relative to international peers that the issuer's ability to cover debt service with the operating balance may weaken unexpectedly over the forecast horizon (2021-2025) due to lower revenue, higher expenditure, or an unexpected rise in liabilities or debt or debt-service requirement.

Revenue Robustness: 'Weaker'

Fitch views Kaduna's NGN112 billion operating revenue as dependent on allocations of oil revenue transferred monthly from the Federal Accounts Allocation Committee (FAAC), which represent about half of operating revenue on average, albeit declining (from 57% in 2018 to around 40% in 2020). 2020 FAAC allocations suffered from the sharp decline in oil, prices, which has been partly offset by the national government with draw-downs from cumulated reserves, mitigating Kaduna's transfer decline at -9%. VAT, which is collected by the central government and allocated to the states through the FAAC, remained stable at around 16% of operating revenue.

Kaduna is making major improvements in its IGR collection mechanism. IGR grew by over 50% in 2019 versus 2018, but the pandemic slowed Kaduna's efforts to boost IGR in 2020, which grew by a modest 1%. Kaduna allowed for some tax incentives during the pandemic, including grace periods and minimal tax discounts. Even under a scenario of stressed economy, Fitch expects Kaduna to resume the positive trend of IGR and envisages tax revenue growth of 10% on average in 2021-2025, partly offset by sluggish oil-related revenue.

Revenue Adjustability: 'Weaker'

Kaduna's revenue potential depends on the state's ability to expand its tax bases, in terms of broadening the pool of taxpayers and enforcing tax compliance. The main fiscal revenues are pay-as-you-earn taxes, for which Kaduna cannot set the tax rate, and land charges, for which Kaduna is implementing measures to expand the tax base. The ability to enlarge the pay-as-you-earn tax base is limited by the population's low level of income, with over 50% living below the poverty line.

Expenditure Sustainability: 'Weaker'

Kaduna's varied set of responsibilities ranges from education (25%), healthcare (15%), economic development (over 15%), energy and environment (around 8%). Past expenditure dynamics show a good record of cost control, with operating revenue and expenditure growing at the same pace on average in the last 10 years, around 7%-8%.

Fitch expects the spending to outpace revenue growth in the medium term, in a rating scenario of a prolonged economic downturn. The operating margin will remain positive, but we expect it to halve to around 15% from the last 10-years average of above 30%, in a post-pandemic scenario of more support coming from the state for the economy and healthcare. Capital spending has a key role for Kaduna in its efforts to transition the local economy to a more developed stage and to grow the local tax base.

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. Kaduna's cost structure is moderately flexible, as an average 40% of expenditure is capex, which is largely financed by the operating balance and can be delayed in case of need, as was the case during the last recession in 2015-2016.

During 2020, Kaduna's operating costs declined sharply after a 50% cut in overheads as a consequence of the fiscal tightening implemented by Kaduna's government to cope with the pandemic, counterbalancing the salary growth that followed the minimum wage increase implemented by the national government back in 2019. We expect opex, and in particular overheads, to catch-up from 2021 onwards. Fitch considers that expenditure reduction is moderately affordable, given the high potential to increase the existing level of healthcare and infrastructure services, while enhancements in the procurement process could improve expenditure allocation.

Liabilities & Liquidity Robustness: 'Weaker'

The national framework for debt is evolving and borrowing limits are quite wide. There are no restrictions on debt maturities, interest rates or currency exposure. Over 90% of Kaduna's debt is served from deductions from the statutory allocation, including loans with local banks for salary bailouts, while the remaining part is made up of intergovernmental loans.

At end-2020, 80% of Kaduna's NGN262 billion adjusted debt, when including pensions and contractors' arrears, was in foreign currency. The sharp increase in debt came after the disbursement of a USD350 million loan from the World Bank. The historical average cost of debt is below 1% for multilateral foreign debt, while domestic debt carries interest rates around 10%. Kaduna's debt amortisation profile is smooth with long maturities and sustainable debt service below 1x the operating balance.

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Liabilities & Liquidity Flexibility: 'Weaker'

Fitch deems Kaduna's liquidity as weak as the state has no committed liquidity lines and domestic banks rated in the 'B' category tend to extend credit lines either with short maturities or with Federal Government of Nigeria (FGN) backup through direct deductions from the FAAC for longer maturities. Fitch prudentially considers cash as restricted for payables. Emergency liquidity may also come directly from the federal government, as was the case in 2015-2016, with the Budget Support Facility helping states tackle pressures due to liquidity shortfalls, supporting payment of salaries and pensions.

Debt Sustainability: 'bb category'

In its rating scenario of a prolonged economic downturn, Fitch expects Kaduna's debt-to-operating balance (payback) ratio to sharply increase above 20x (2020: 5.4x) incorporating the effects of an economic downturn. Fitch expects some volatility in the payback ratio in 2021-2022 due to fluctuating oil-related transfers from the FGN and operating spending catching up after the sharp decline in 2020 during the pandemic. Secondary metrics - fiscal debt burden measured by net adjusted debt/operating revenue - could move to above 300%, while the operating balance would cover Kaduna's actual debt service by 1x.

Derivation Summary

Fitch assesses Kaduna's SCP at 'b', reflecting a combination of a vulnerable risk profile assessment and a 'bb' assessment of debt sustainability. The SCP also factors in Kaduna's high debt burden compared with international peers, in particular South American states and provinces. Fitch does not apply any asymmetric risk or ad-hoc support from the central government and assesses intergovernmental financing as neutral to Kaduna's ratings.

The 'B' IDR reflects Kaduna's own payment capacity, while debt-service support from the central government through deductions from the statutory allocation is factored into the debt framework.

Key Assumptions

Qualitative assumptions:

Risk Profile: 'Vulnerable'

Revenue Robustness: 'Weaker'

Revenue Adjustability: 'Weaker'

Expenditure Sustainability: 'Weaker'

Expenditure Adjustability: 'Midrange'

Liabilities and Liquidity Robustness: 'Weaker'

Liabilities and Liquidity Flexibility: 'Weaker'

Debt sustainability: 'bb'

Support (Budget Loans): 'N/A'

Support (Ad Hoc): 'N/A'

Asymmetric Risk: 'N/A'

Sovereign Cap: 'B'

Sovereign Floor: 'N/A'

Quantitative assumptions - Issuer Specific

Fitch's rating case is a "through-the-cycle" scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on 2016-2020 figures and 2021-2025 projected ratios. The key assumptions for the scenario include:

  • about 4% CAGR in operating revenue on average in 2021-2025;
  • 12% CAGR in operating spending on average in 2021-2025; the trend includes opex catching up after the sharp decrease in overheads in occurred in 2020;
  • 1.9% cost of debt in 2021-2025.

Summary of Financial Adjustments

Contractors' and pension arrears reported under Other Fitch Classified debt

Capex figures adjusted to mirror cash-like data

Issuer Profile

Kaduna's fast-growing population of over 8 million residents and the traditionally strong primary sector contribute to weak socio-economic standards. A large informal economy hinders private sector development, which ultimately affects the IGR tax base. Dominant agricultural and service sectors drive the economy, although Kaduna's development plan focuses on the state's rich mineral resources by attracting foreign investors to key industrial projects.

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Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

  • A downgrade of the sovereign would lead to corresponding rating action on Kaduna.
  • A weakening debt sustainability due to unrest damaging economic prospects or undermining oil-related revenue could also trigger a downgrade.


Factors that could, individually or collectively, lead to positive rating action/upgrade:

  • Fitch deems an upgrade of Kaduna's ratings as unlikely due to the state's weak debt metrics. However, a higher overall assessment of its risk profile and a payback below five years on a sustained basis would be positive for Kaduna's ratings, subject to a sovereign upgrade.


ESG Considerations

Kaduna has an ESG Relevance Score of '4' for Biodiversity and Natural Resource Management, revised from '3', due to the state's dependency on oil-related transfers from the sovereign that impact financial operations, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Kaduna has an ESG Relevance Score of '4' for Energy management due to low energy efficiency, intensity, and grid reliance that represent a constraint for the state's economic development, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Kaduna has an ESG Relevance Score of '4' for Human Rights and Political Freedoms due to the presence of ethnic conflicts in the region that impact on core human rights and the treatment of minorities, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Kaduna has an ESG Relevance Score of '4' for Human Development, Health and Education due its Human Development Index lower than the average in Nigeria, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Kaduna has an ESG Relevance Score of '4' for Population and Demographics, revised from '3', due to its below-average socio-economic indicators and the majority of the population living below the poverty line, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Kaduna has an ESG Relevance Score of '4' for Political Stability and Rights as political divisions leading to unpredictable policy shifts with low budget predictability, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.

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