Lagos State Government Defaults On Municipality Note Issue; Investors Fret Over Yields


Tuesday, March 05, 2019    07.55PM / By Teslim Shitta-Bey Managing Editor, Proshare Content  

Lagos State Government’s N4.85bln, 15.75% Series 1, Tranche B, environmental Note (“Municipality  Note”) has run into trouble. The Fixed Income Note, a sub category of the larger N50bln Medium Term Note used to finance the Cleaner Lagos  project of the government is caught in a mesh of politics and bureaucracy. 

The top-rated instrument which attracted a credit rating of A+ by both Agusto Credit Agency and Global Credit Rating Agency (GCR, formerly Duff & Phelps) missed its coupon and principal payment due for Tuesday 5, March 2019.  

The Note with a four and a half year tenor was meant to pay both coupon and principal to investors in the first week of March 2019 but the poor state of the Note’s sinking fund and the slow response of the state’s treasury to the payment of the fixed income obligation has raised anxiety among the Note’s investors.


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Source: Supplemental Information Memorandum, Municipality Waste Management Contractors Ltd

As things stand today, investors are petrified of the growing likelihood that the State Government would skip payment for the month as the administration awaits the outcome of the governorship election to be held on Saturday 9, March 2019. The problem according to sources invested in the Note, is that, “the project which the Note was used in funding has not been able to meet cash flow projections; therefore the State has been required to cover the semi-annual payments from its own operating income. This has proven to be a hard road to travel as the state government has shown that it has little wiggle room for additional debt servicing’’. 

Lagos State is easily the most creative state in the country in terms of fiscal management and growth of internal revenue sources but it is equally the most highly indebted sub-national entity in the country with a domestic debt obligation of N517.4bln. The state is also opaque with its finances and disclosures. While the latter part remains an area in need of improvement, the concern it elicits when defaults occur brings home the point and relationship between generation and utilization of revenue, and the issue of accountability and transparency. 

In this particular instance however, what ought not to be a major problem (as long as financial repayment sequencing is arranged to meet debt obligations in an orderly manner), is now an issue that is currently being tested by its default on its Municipality Note payment for March 2019.


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The State’s Green Note was issued in 2018 as a direct response to addressing the problems of Lagos State’s street sanitation in a sustainable and comprehensive manner. The intention of the Note was to create a framework within which the state government could clean up the environment and recycle waste generated in the process while creating a sub-economy that was self-financing and self-sustaining with the added advantage of a clean cityscape. The Note proceeds was to be used by a state-supported private Special Purpose Vehicle (SPV), Municipality Waste Management Contractors Limited, to acquire modern refuse collection, separation and processing equipment to achieve the goal of collecting refuse and transferring them to designated facilities where they would be processed for conversion into a variety of commercially traded by-products. The project started optimistically enough but has since hit a roadblock. A few of the problems associated with the project include what behavioral economists have called the, ‘law of unintended consequences’. 

Unexpected political and social push backs compelled the government to revisit the business template. The model adopted by the Babatunde Fashola administration in the state (2007-2015) was a private public partnership (PPP) between the Lagos State Waste Management Authority (LAWMA) and private individuals who employed thousands of women who served as roadside cleaners. The arrangement allowed for wide spread engagement of blue collar workers in the state’s waste collection and cleaning business. It equally allowed political party faithful feel sense of belonging, as they saw themselves as part of state governance. 

The new refuse management arrangement adopted by the Akinwumi Ambode’s administration, though extremely laudable, was a disruption of the old order and more importantly, it was a violation of the intrinsic understanding between the administrations party leadership and its grass root party support base. The consequence has been a reversal to the old Private Sector-supported Participation (PSP) and the resumption of the army of female street cleaners across different local governments and council development areas. This has thrown a monkey wrench into the revenue flows expected by the Note Issuer (see Cash Flow Projections  in table below).  


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Source: Supplemental Information Memorandum, Municipality Waste Management Contractors Ltd

The project managers, according to one of the investors in the Note, failed to scale and sequence the project appropriately leading to a situation where the state was left at the mercy of unorganized small-scale private refuse collectors while Municipality Waste Management Contractor was still figuring out how it would arrange the evacuation of refuse to designated waste dumps across far flung locations across the state. The consequence was a rise in sanitary decay and an increase in political pressure for the scrapping of the new arrangement in preference for the old waste management regime. “We paid for a beautiful new idea that had a terrible old burden”, he notes.  

This old burden has led to the project failing to meet the cash flow expectations of the Note’s Information Memorandum and left the state in a financial quandary as the Note’s sinking fund is currently underfunded and has limited capacity to meet the cash flow expectations of the Note investors on a sustainable basis if the short falls in fund accretion persist. The Sinking fund is expected to grow monthly to ensure that investors get paid fixed incomes on a semi-annual basis, but so far the Cleaner Lagos Initiative Note has not received funding from the state government (or the Issuer) since October 2018. Each of the Trustees to the Issue, Proshare investigations reveal, has a fund accretion deficit of at least N1.0bln. The normal practice for such Bonds and Notes is that the Issuer funds the sinking fund on a monthly basis according to a pre-arranged payment plan, thereby building up revenues from which to meet Coupon and Principal payments to investors (see Note Amortization Schedule below).


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Source: Supplemental Information Memorandum, Municipality Waste Management Contractors Ltd


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The Cobra Effect

The Lagos State Government may have been trapped in the Cobra effect. By not meeting the strict payment terms of the Municipality Note, the State government would be conveniently deferring cash outflows before a new administration takes over, but it would also be damaging the state’s credit rating resulting in a situation where the new administration will have to face:

  • A collapse of its Credit rating and a rise in the states cost of funds or its short and medium term borrowing costs which could prove troublesome in months ahead. This could have ripple effect on the state’s fiscal balance as higher short term funding cost would reduce the viability of a number of state projects with low thresholds of net profitability if rates go up.

  • Lower Credit ratings would discourage institutional investors from lending to the state government as their statutes require that they invest only in Bonds or Notes that have ratings not below investment grade or an ‘A’ rating.  


Getting Back on Track

In the course of our investigations we were informed that during our enquiry the State had allegedly started to make arrangements for the payment of amounts due on the Note to the extent of the coupon payments alone. According to the schedule in the Offer to investors this means that the government is making arrangements to pay about N350million. Parties to the Note have been informed informally that the government may make coupon payments by Monday 11, March 2019. This would leave over N400million of due Principal payment outstanding without any clear indication when this will be paid. A text message was sent to the Commissioner of Finance, Lagos State, to clarify the matter, but as at the time this report was published the Commissioner was yet to respond to a request for clarification on the issue of when payment on the Note would be made.  


The Last Word

Financial analysts have noted that current attitude towards the servicing of Lagos State’s Municipality Note’s sinking fund has created challenges for the Notes Trustees as the float income from which they would normally have offset bank transaction charges have been gutted. Although none of the Trustees agreed to speak the matter, it was clear that the state government’s incapacity to build up a reserve for the Note repayment will lead to major operational challenges for the various original parties to the Offer, the Issuing Houses, Brokers, Dealers, Trustees and investors inclusive as yields on the Note get distorted by repayment defaults and uncertainty that was not initially priced into the investment cash flow. The Notes nominal yield is therefore in danger as investors place a heavy discount on it in the secondary markets, as the Note’s price is excepted to somersault resulting in severe capital losses. We hope that action will be taken to urgently address this development.


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