(The following statement was released by the rating agency)
Link to Fitch Ratings' Report(s):
https://www.fitchratings.com/site/re/10117769
Fitch Ratings-Milan-April 09:
Fitch Ratings has downgraded Lagos's Long-Term Foreign- and Local-Currency
Issuer Default Ratings (IDRs) to 'B' from 'B+'. The Outlooks are Negative.
A full list of rating actions is below.
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 downgrade of Nigeria's IDRs (see Fitch Downgrades Nigeria
to 'B'; Outlook Negative dated 6 April 2020 on www.fitchratings.com) we have
downgraded Lagos's IDRs to reflect the Sovereign cap, while its Outlooks move in
tandem with the sovereign's.
The ratings also reflect the state's weak risk profile by international
standards against Fitch's expectations of sustainable debt driven by internally
generated revenue (IGR), which underpins Lagos's capacity to serve its financial
obligations, as evidenced by its Standalone Credit Profile (SCP) of 'bb+'.
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 is 18 September 2020.
Key Rating Drivers
HIGH
Sovereign Cap
As per Fitch's rating criteria, Lagos's IDRs are capped by the sovereign's and
its Outlooks reflect those on the sovereign. Any rating action on the
sovereign's ratings 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.
LOW
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).
Revenue Robustness: Midrange
Lagos's estimated NGN580 billion operating revenue at end-2019 rests on a
diversified tax base driven by IGR(70%), underpinning the state's relative
autonomy from oil-related transfers by the Federal Government of Nigeria (FGN),
which represent 10%-15% of operating revenue. In our rating case of a stressed
economy, we forecast a nominal average 8% increase in operating revenue in
2020-2024, taking into account the VAT rate increase to 7.5% from 5.0% effective
since February 2020 against flat IGR.
Revenue Adjustability: Weaker
Fitch believes that Lagos's fiscal flexibility relies on the wide but not fully
exploited tax base of PAYE (about 75% of IGR), on which it has no tax-setting
power, as well as other potential revenue sources such as land use charges.
Rigid revenue sources represent collectively more than 85% of Lagos's revenue,
driving the Weaker assessment of this factor. Lagos is a net contributor to
Nigeria's equalisation system enacted through the Federal Account Allocation
Committee (FAAC).
In Fitch's view, the maximum peak-to-trough revenue fall of -5.5% (NGN22
billion) in 2015 over the last 10 years could be theoretically offset by at
least 50% with modest additional revenue. However, if another recession should
strike Nigeria as a consequence of the sharp fall in oil prices and prolonged
lockdown measures to face the pandemic, Fitch believes that Lagos will absorb
the revenue shock by reducing its operating margin to about 35% from current
50%.
Expenditure Sustainability: Midrange
In its rating scenario, Fitch expects operating costs to increase by 10% or less
than the country's double-digit inflation, but above revenue growth, driven by
increased costs to cope with the pandemic and support the weakest layer of its
20 million population, while coping with the 60% minimum wage increase decided
back in 2019. Lagos has a diversified set of responsibilities, which include
education (20%) and healthcare (15%), which could come under pressure should the
pandemic spread in the state.
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.
Fitch expects Lagos to cover debt service requirements out of its operating
balance by about 2x. Capex makes up 50% of Lagos's expenditure before debt
service, keeping the share of inflexible costs below 70%.
Under Fitch's revised rating scenario, which incorporates stresses due to the
oil-price shock and the lockdown, Lagos is expected to retain its adjustability
potential even in a scenario of capex declining to around 35% of expenditure
before debt service, as 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-2019. Average cost of debt is around
1% for external loans and above 10% on domestic loans. To ensure timely debt
service, its internal debt is assisted by a state-level irrevocable standing
payment order while external debt is served by FGN through 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 prudently considers its year-end cash as earmarked to
offset payables.
Debt Sustainability: 'aa' category
In Fitch's rating scenario of a stressed economy, Lagos's net adjusted debt is
expected to increase above NGN1 trillion in the medium term, reaching NGN1.2
trillion by 2024. Coupled with an operating balance around NGN300 billion, this
leads to a payback ratio of around four years. 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. Collectively, all these factors lead to
a debt sustainability assessed in the 'aa' category.
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 IGR.
Derivation Summary
Lagos's SCP is assessed at 'bb+', reflecting a combination of a weak risk
profile, or debt tolerance, and its 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 five. 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.
Key Assumptions
Qualitative Assumptions and assessments and their respective change since the
last review held on 27-Mar-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
Support: n/a
Asymmetric Risk: n/a
Sovereign Cap: Yes, lowered 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 2014-2018 figures, 2019 estimated data 2020-2024 projected ratios.
The key assumptions for the scenario include:
- average 8% increase in operating revenue on average in 2020-2024, versus 12%
in baseline scenario;
- average 10% increase 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 2018 and forecast for 2020,
respectively:
- GDP per capita (US dollar, market exchange rate): 1,820.7; 2,004
- Real GDP growth (%): 1.9; -1.0
- Consumer prices (annual average % change): 12.1; 13.2
- General government balance (% of GDP): -4.0; -5.8
- General government debt (% of GDP): 24.9; 31.5
- Current account balance plus net FDI (% of GDP): 1.1; -4.7
- Net external debt (% of GDP): -15.0; -0.2
- IMF Development Classification: EM
- CDS Market Implied Rating: n/a
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating
action/downgrade:
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 or risk profile
due to unfavourable changes in the economy beyond Fitch's expectations, could
also trigger 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 sustainability metrics.
COMMITTEE MINUTE SUMMARY
Committee date: 8 April 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.
Best/Worst Case Rating Scenario
Ratings of Public Finance 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. For more information about the
methodology used to determine sector-specific best- and worst-case scenario
credit ratings https://www.fitchratings.com/site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the
Applicable Criteria.
ESG Considerations
ESG issues are credit neutral or have only a minimal credit impact on the
entity(ies), either due to their nature or the way in which they are being
managed by the entity(ies). For more information on Fitch's ESG Relevance
Scores, visit www.fitchratings.com/esg.
Lagos State; Long Term Issuer Default Rating; Downgrade; B; RO:Neg
----; Short Term Issuer Default Rating; Affirmed; B
----; Local Currency Long Term Issuer Default Rating; Downgrade; B; RO:Neg
Contacts:
Primary Rating Analyst
Chiaramaria Mozzi,
Associate Director
+39 02 879087 231
Fitch Italia Società Italiana per il rating, S.p.A.
Via Morigi, 6 Ingresso Via Privata Maria Teresa, 8
Milan 20123
Secondary Rating Analyst
Pierre Charpentier,
Associate Director
+33 1 44 29 91 45
Committee Chairperson
Vladimir Redkin,
Senior Director
+7 495 956 2405
Media Relations: Athos Larkou, London, Tel: +44 20 3530 1549, Email:
athos.larkou@thefitchgroup.com.
Additional information is available on www.fitchratings.com
Applicable Criteria
Rating Criteria for International Local and Regional Governments (pub. 13 Sep
2019) (including rating assumption sensitivity)
https://www.fitchratings.com/site/re/10087140
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Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/site/dodd-frank-disclosure/10117761
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https://www.fitchratings.com/site/pr/10117761#solicitation
Endorsement Status
https://www.fitchratings.com/site/pr/10117761#endorsement_status
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https://www.fitchratings.com/regulatory
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