19, 2020 10:55 AM /by Fitch Ratings/ Header Image Credit: Oyibos Online
Fitch Ratings has revised the Outlook on Lagos State's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Stable from Negative and affirmed the IDRs at 'B'.
Under EU credit rating agency (CRA) regulation, the publication of International Public Finance reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status.
Following the recent revision of the Outlook on Nigeria's IDRs (see Fitch Revises Nigeria's Outlook to Stable, Affirms at 'B' dated 30 September 2020), we have taken similar rating action on Lagos as it is rated at the same level as the sovereign and its Outlooks move in tandem with those on the sovereign.
While Nigerian local and regional governments' (LRG) most recently available issuer data may not have indicated performance impairment, material changes in revenue and cost profiles are occurring across the sector and likely to worsen in the coming weeks and months as economic activity suffers and government restrictions are maintained or broadened. Fitch's ratings are forward-looking in nature, and we will monitor developments in the sector for their severity and duration, and incorporate revised base- and rating-case qualitative and quantitative inputs based on performance expectations and assessment of key risks.
The next scheduled review date for Lagos will take place in 2021.
As per Fitch's rating criteria, Lagos's IDRs are capped by the sovereign and its Outlooks reflect those on the sovereign. Rating action on the sovereign or a revision of its Outlook will lead to similar action on Lagos's ratings, provided that Lagos's budgetary performance and debt metrics remain in line with Fitch's expectations.
Risk Profile: Weaker
Fitch has assessed Lagos's risk profile, at Weaker, which combines three factors at Midrange (revenue robustness, expenditure sustainability and adjustability) and three factors at Weaker (revenue adjustability, liabilities and liquidity robustness and flexibility). The 'Weaker' risk profile reflects a high risk that the state's cash flow available for debt service will contract beyond reasonable downturn expectations.
Debt Sustainability: 'aa' category
In Fitch's rating scenario of a stressed economy, Lagos's payback ratio would be close to 4x-5x in the medium term (2019: 3.6x), debt service coverage around 1.2x and the fiscal debt burden towards 150% of operating revenue. In our rating case scenario, Lagos's net adjusted debt would increase to above NGN1.0 trillion in the medium term, reaching NGN1.2 trillion by 2024 to cope with a demanding capex plan, and the operating balance would be around NGN250 million.
Lagos is classified as a type B LRG by Fitch, as it covers debt service with its operating balance. 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 internally generated revenue.
Lagos's Standalone Credit Profile 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 payback ratio below 5x. Fitch does not apply any asymmetric risk or extraordinary support from the central government. The IDR is capped at the sovereign level. The 'B' short-term rating is derived from Lagos's Long-Term IDR.
Qualitative Assumptions and assessments and their respective change since the last review held on 18-Sept-2020 and weight in the rating decision:
Risk Profile: Weaker, unchanged with low weight
Revenue Robustness: Midrange, unchanged with low weight
Revenue Adjustability: Weaker, unchanged with low weight
Expenditure Sustainability: Midrange, unchanged with low weight
Expenditure Adjustability: Midrange, unchanged with low weight
Liabilities and Liquidity Robustness: Weaker, unchanged with low weight
Liabilities and Liquidity Flexibility: Weaker, unchanged with low weight
Debt sustainability: 'aa' category, unchanged with low weight
Asymmetric Risk: n/a
Sovereign Cap: Yes, raised with high weight
Quantitative assumptions - issuer specific
Fitch's rating case scenario is a "through-the-cycle" scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on the 2015-2019 figures and 2020-2024 projected ratios. The key assumptions for the scenario include:
- 8% CAGR in operating revenue on average in 2020-2024, versus 11% in baseline scenario;
- 10% CAGR in operating spending on average in 2020-2024 versus 12% in baseline scenario;
- 10% cost of debt versus 9% in baseline scenario.
Quantitative assumptions - sovereign related
Figures as per Fitch's sovereign actual for 2019 and forecast for 2022, respectively:
- GDP per capita (US dollar, market exchange rate): 2,001.2; 2,279.0
- Real GDP growth (%): 2.2; 3.0
- Consumer prices (annual average % change): 11.4; 13.0
- General government balance (% of GDP): -3.6; -4.5
- General government debt (% of GDP): 26.7; 30.5
- Current account balance plus net FDI (% of GDP): -3.8; 0.8
- Net external debt (% of GDP): 4.1; 6.5
- IMF Development Classification: EM
- CDS Market Implied Rating: n/a
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- A owngrade of the sovereign's ratings would lead to corresponding action on Lagos's IDR.
- A multiple-notch downward revision of Lagos's SCP below 'bb-', which could be driven by a material deterioration of its debt metrics, particularly a sharp increase in the payback ratio sustainably above 5x according to Fitch's rating case, or a reassessment of the key risk factors or risk profile due to unfavourable changes in the economy beyond Fitch's expectations, could also trigger a downgrade.
-A prolonged COVID-19 impact and much slower economic recovery lasting until 2025 would put pressure on net revenues. Should Lagos be unable to proactively reduce expenditure or supplement weaker receipts from increased central government transfers, this could lead to a downgrade.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Any positive rating action on Nigeria will be reflected on Lagos's ratings, provided that Lagos maintains its strong debt payback ratio below 5x according to Fitch's rating scenario.
Committee Minute Summary
Committee date: 9 October 2020
There was an appropriate quorum at the committee and the members confirmed that they were free from recusal. It was agreed that the data was sufficiently robust relative to its materiality. During the committee no material issues were raised that were not in the original committee package. The main rating factors under the relevant criteria were discussed by the committee members. The rating decision as discussed in this rating action commentary reflects the committee discussion.
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.
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