Tuesday, August 07, 2018 08:53 AM / Fitch Ratings
Fitch Ratings has affirmed Lagos State's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'B+' with Negative Outlook and the state's 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' medium-term note (MTN) programme as well as senior unsecured bonds have also been affirmed at 'B+'/AA+(nga)'.
The ratings reflect the state's weak socio-economic indicators by international standards against Fitch's expectations of satisfactory operating performance in the medium term, driven by internally generated revenue (IGR). The ratings also reflect adequate transparency compared with national standards and rising but sustainable debt. The Negative Outlook on the IDRs reflects that of the Federal Government of Nigeria (FGN, B+/Negative).
Key Rating Drivers
Institutional Framework (Weakness/Stable)
A constitutional equalisation system enacted through the Federal Account Allocation Committee (FAAC) pools oil and non-oil revenue collected by the central government and transfers them to local and regional governments. FAAC's funding has proved volatile as Nigeria's federal budget depends on oil for more than a third of its revenue and the severe oil price slowdown from 2012 has resulted in lower transfers to local government entities. For Lagos, IGR contribute far more of Lagos's revenue than transfers from the federal government, mitigating exposure to oil price swings.
Economic development of states is dependent on capital projects, which often face challenging budget implementation and are driven by available funding options. Lagos' foreign debt service is supported by ISPO (Irrevocable Standing Payment Orders) issued by the Federal government to pay bondholders. The amount paid for debt service is then deducted from the states' FAAC share.
Fiscal Performance (Neutral/Stable)
Lagos benefits from a diversified revenue structure led by IGR, which represent over 75% of its NGN490 billion current revenue, thus mitigating the reliance on FAAC allocation from FGN. In its base scenario, Fitch expects the operating margin driven by IGR to remain stable at around 50% in the medium term, comfortably covering debt service by nearly 1.5x. Fitch projects IGR to grow 10%-15% in the medium term but faces downside risk from the large informal economy that accounts for nearly 40% of local tax-related revenue.
In its base case scenario, Fitch expects operating costs to increase less than the country's double-digit inflation, factoring in a tighter grip on current expenditure and compliance with expenditure targets. Fitch believes that the administration's commitment to investment will boost capex over the medium term up to NGN1 trillion over 2018-2020, mostly focused on transportation, water, energy and power, including a minimum of 5% dedicated to upgrading health, educational and social facilities.
Debt and Liquidity (Neutral/Stable)
Lagos' debt will grow over the medium term to up to over NGN1 trillion or over 170% of tax revenue, driven by a demanding capex programme, the negative effect of the naira devaluation on foreign currency-denominated debt and a new borrowings to finance roughly NGN1 trillion investments in the medium term.
Fitch expects long-term debt sustainability to remain compatible with Lagos' rating profile, with an average pay-back (debt-to-current balance) ratio of five years. Fitch expects liquidity to remain ample and, in particular, refinancing risk, to remain under control despite the large capex programme. This is based on Lagos' IGR proceeds, as well as government and bank facilities to fund working capital needs.
Management and Administration (Neutral/Stable)
Lagos' administration is committed to improving transparency and disclosure, emphasising the availability of financial data while working on the transition from a cash-based to accrual-based accounting that, in Fitch's view, will be credit-positive as it restricts the scope for discretionary initiatives. Lagos provides three-year budget and has sophisticated debt management compared with national peers. Fitch believes that cash would remain around 25% of operating revenue, safeguarding Lagos from liquidity pressures.
Lagos' GDP per capita at USD4,500 is weak by international standards. However, Lagos is the main economic hub in Nigeria, accounting for over 20% of GDP, bolstered by the presence of roughly 90% of companies' headquarters and 60% of industrial investments in the country. The economy is well-diversified between services, including information and communication technologies, industry and transports. Fitch estimates that Lagos' young and fast growing population of over 20 million inhabitants will drive the increase of social and healthcare expenditure above one fourth of the state's budget in the forthcoming years.
A sovereign upgrade may be reflected in Lagos's ratings, provided that improvements in budgetary performance result in debt levels at 1x the budget size. Further improvement of the local economy giving additional boost to IGR will also be positive for the ratings.
The ratings of Lagos are aligned with the sovereign's. A downgrade on the sovereign's ratings would lead to a corresponding action on Lagos' IDR. In absence of a sovereign downgrade, declining operating margin, unfavourable changes in the national tax policy, debt rising beyond Fitch's expectations over the medium term, coupled with economic instability, could lead to a downgrade.
2. Fitch Affirms Nigeria''s Lagos State at ''B ''; Outlook Negative