(The following statement was released by the rating agency)
Link to Fitch Ratings' Report(s):
https://www.fitchratings.com/site/re/10117766
https://www.fitchratings.com/site/re/10117767
Fitch Ratings-Milan-April 09:
Fitch Ratings has revised the Outlook on Kaduna State's Long-Term Foreign- and
Local-Currency Issuer Default Ratings (IDRs) to Negative from Stable and
affirmed the IDRs at 'B'.
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. The next scheduled review date for Kaduna is 18
September 2020.
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
revised Kaduna's Outlooks to Negative as its Outlooks move in tandem with the
sovereign's.
The ratings also reflect the state's dependence on oil-related transfers from
the Federal Government of Nigeria (FGN), which makes the state's revenue base
quite sensitive to oil prices swings. The ratings further consider Kaduna's
growing debt to fund necessary capex for the development of basic
infrastructures and social services.
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.
Key Rating Drivers
HIGH
Sovereign Cap
Kaduna's IDRs are currently aligned with the sovereign's and its Outlooks
reflect those on the sovereign. A further downgrade of the sovereign's ratings
will be mirrored on Kaduna's ratings.
LOW
Risk Profile: 'Vulnerable'
Fitch has assessed Kaduna's risk profile, or debt tolerance, at Vulnerable,
which combines five factors at Weaker and one factor at Midrange (expenditure
adjustability).
Revenue Robustness: 'Weaker'
About 50% of Kaduna's NGN100 billion operating revenue at end-2019 depends on
allocations of oil revenue transferred monthly from the Federal Accounts
Allocation Committee (FAAC), which are expected to decline by more than 40% in
2020 following the sharp decrease in oil prices. The decline in transfers will
not be offset with the VAT expected increase to 7.5% from 5.0%, which could
bring an additional NGN6 billion additional revenue, by Fitch's estimates.
Improvements in internally generated revenue (IGR), which grew by over 50%
according to preliminary 2019 financials versus 2018, could halt if Nigeria
enters into a new recession and/or if lockdown measures are prolonged.
Revenue Adjustability: 'Weaker'
Kaduna's revenue potential depends on the state's ability to expand its tax
bases, both in terms of broadening the pool of taxpayers and enforcing tax
compliance. The main fiscal revenues are pay-as-you-earn taxes, on 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 low level of income of the population, 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 track record of cost control, with operating
revenue and expenditure growing on average at the same pace in 2010-2018, around
7.5%-8.0%.
Under its revised scenarios of a stressed economy, Fitch expects expenditure to
grow above revenue in 2020 and then adjust in 2021-2024, as the state copes with
the minimum wage increase for public employees amid declining revenue. The
operating margin will remain in positive territory, but is expected to decline
below 15% in case of prolonged lockdown measures calling for more support from
the state for the economy and healthcare.
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 with the operating balance and can be
delayed in case of need, as occurred during the last recession in 2015-2016. In
Fitch's view, expenditure reduction is moderately affordable given the high
potential to increase the existing level of healthcare and infrastructure
services, while improvements in the procurement process could improve
expenditure allocation.
Liabilities and Liquidity Robustness: 'Weaker'
The national framework for debt is evolving and thus 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 through 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-2019, 70% of Kaduna's NGN241.2 billion adjusted debt, when included
pension and contractors arrears, was in foreign currency and the figure is
expected to increase towards 80% for a debt burden of over NGN350 billion by
2024, after the disbursement under the 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
well below 1x the operating balance.
Liabilities and 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 FGN backup through direct deductions from
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 to tackle pressures due to liquidity shortfalls, supporting
payments of salaries and pensions.
Debt sustainability: 'bb' category
According to Fitch's rating case of a prolonged stressed economy, Kaduna's debt
payback ratio (net debt-to-operating balance) - the primary metric of debt
sustainability assessment - could deteriorate to 23 years in the medium term,
incorporating the effects of an economic downturn, corresponding to a 'bb'
assessment. Secondary metrics - fiscal debt burden measured by net adjusted
debt-to-operating revenue - could move above 350% and is assessed at 'b', while
its actual debt-servicing coverage ratio above 1.5x is assessed at 'a'.
Kaduna is classified as type B LRG by Fitch, as it covers debt service with its
operating balance. Kaduna's fast-growing 8.2 million young residents, growing
unemployment rate of around 30%, and a traditionally strong primary sector
contribute to weak socio-economic standards. The public sector is a key employer
in the state, directly and through its planned investment programmes. A large
informal economy hinders private sector development, which ultimately affects
the IGR tax base. Although dominant agricultural and service sectors drive the
economy, Kaduna's development plan is focused on the state's rich minerals
resources by attracting foreign investors to key industrial projects.
Derivation Summary
Fitch assesses Kaduna's Standalone Credit Profile (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 and assessments and their respective change since the
last review 27 March 2020 and weight in the rating decision:
Risk Profile: Vulnerable, unchanged with low weight
Revenue Robustness: Weaker, unchanged with low weight
Revenue Adjustability: Weaker, unchanged with low weight
Expenditure Sustainability: Weaker, 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: 'bb' 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 2015-2018 figures, 2019 preliminary figures and 2020-2024 projected
ratios. The key assumptions for the scenario include:
- 5% increase in operating revenue on average in 2020-2024 versus 8% in baseline
scenario;
- 6% increase in operating spending on average in 2020-2024 versus 8% in
baseline scenario;
- 1.5% cost of debt in 2020-2024.
Quantitative assumptions - sovereign related (note that no weights are included
as none of these assumptions was material to the rating action)
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 would lead to corresponding rating action on
Kaduna's ratings.
- A weakening debt amortisation profile or financial debt growth leading to
consistently higher debt-to-current revenue ratios and an operating balance
insufficient to cover debt service with respect to Fitch's expectations could
result in a downgrade.
Factors that could, individually or collectively, lead to positive rating
action/upgrade:
- Fitch deems an upgrade of Kaduna's ratings as unlikely given the Nigerian
sovereign rating (B/Negative). However, a higher overall assessment of its risk
profile and a payback below five on a sustained basis years would be positive
for Kaduna's ratings.
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.
Summary of Financial Adjustments
Contractors' and pension arrears reported under Other Fitch Classified debt
Capex figures adjusted to mirror Fitch's estimated cash-like data
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
Unless otherwise disclosed in this section, the highest level of ESG credit
relevance is a score of 3 - 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.
Kaduna has an ESG Relevance Score of 4 for Energy Management due to problems
with electricity and dependency on oil-related transfers, 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 conflicts in the region, 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 as the majority of the population lives 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.
Kaduna State; Long Term Issuer Default Rating; Affirmed; B; RO:Neg
----; Local Currency Long Term Issuer Default Rating; Affirmed; 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
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/site/dodd-frank-disclosure/10117760
Solicitation Status
https://www.fitchratings.com/site/pr/10117760#solicitation
Endorsement Status
https://www.fitchratings.com/site/pr/10117760#endorsement_status
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https://www.fitchratings.com/regulatory
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