There is a good news on the economic viability of Lagos state, Nigeria’s economic capital as Fitch Ratings has affirmed Lagos State’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘B+’ with Stable Outlook.
The issue ratings on the MTN programme and senior unsecured bonds, all in local currency, have been affirmed at ‘B+’ and National Long-term ‘AA+(nga)’. The affirmation reflects Lagos’ still weak socio-economic indicators by international standards.
The ratings also reflect the state’s satisfactory debt metrics, Fitch’s expectations of continued robust operating performance over the medium term and Lagos’ improving accountability and transparency management compared with local standards. The Stable Outlook reflects that on Nigeria (B+/Stable). KEY RATING DRIVERS Fiscal Performance Due to a diversified revenue structure mitigating pressures from low oil prices, Lagos recorded in 2015 an operating margin of almost 51.5% (in line with 2014’s), after a 5% drop in operating revenue was offset by a 4% cut to operating expenditure.
Fitch expects operating revenue, mainly driven by the service and tertiary sectors, to grow about 10% in the medium term towards NGN415bn (NGN378bn in 2015). Net internally generated revenues (IGRs, excluding fees and fine and other operating revenue) will average NGN310bn over the medium term, continuing to dominate 75%-80% of total revenue (70% in 2012). This, combined with the commitment of the administration to continue streamlining its operating cost structure (including increased efficiency of cash management by limiting the use of commercial banks to three names), should stabilise the operating margin at the current level over the medium term. #
Management After a 20% drop in 2015 capex as almost half of the year was dedicated to promoting elections, Fitch expects the resulting political continuity will normalise capex back towards NGN250bn per year over the medium term, mostly focused on transport, water, health, education and social protection. We expect management’s efforts to improve transparency and accountability, together with a larger recourse to public-private partnerships, will attract foreign investments and, ultimately, sustain the state’s revenue. These measures, together with the boost from the land use charge, have led the current administration to estimate comfortable overall monthly IGRs of NGN30bn, a level considered by local administrators as necessary to run the affairs of the state. Debt and Liquidity We forecast Lagos’ debt at above NGN500bn-NGN550bn over the medium term, net of repayment provisions, or almost 1x the budget size (nearly NGN615bn at end-2015).
Being largely made up of bonds and external loans (80% of total), debt may suffer from the Naira devaluation, although the risk of repayment concentration will be compressed by the longer maturity of Lagos’ debt (10 years versus previous seven years). Following recent debt renegotiation, which reduced the debt burden to a monthly average interest rate of 12% (from 18%) with savings of almost NGN4bn, Fitch expects debt sustainability to remain sound, with a payback (debt-to-current balance) of three years and debt service coverage below 30% over the next couple of years. Liquidity should not be a risk, as it averages NGN100bn over the medium term and equivalent to approximately 1x annual debt service requirements. Economy Despite its weak socio-economic indicators by international standards, Lagos is considered Nigeria’s economic powerhouse as its local GDP accounts for 20%-25% of national GDP. According to the 2015 GDP breakdown, service, construction, transport and industry make up 90% of the local economy, underpinning the state’s diversified economy, therefore easing the reliance on oil-related activities. These mitigate the risks stemming from potential fiscal pressures as a result of the central government’s responses to low oil prices; inflation; and the continued weakness of the local currency.
Fitch believes that Lagos’ socio-economic indicators will further improve as local GDP growth, which we estimate at 4.5%-5.5% in 2016-2017, is likely to outperform national real GDP growth. RATING SENSITIVITIES A downgrade of the sovereign’s ratings would lead to a corresponding action on Lagos’ IDRs. In the absence of a sovereign downgrade, an operating margin declining towards 30%, unfavourable changes in the national tax policy, debt rising beyond Fitch’s expectations over the medium term and economic instability, even at the local level, could lead to a downgrade.
A sovereign upgrade may be reflected in Lagos’ ratings, provided that improvements in budgetary performance reduce debt levels to 1x the budget size. Further improvement of the local economy giving additional boost to IGRs would also be positive for the ratings.
This rating is also coming at a time when the state is about to begin oil production at the AJE Fields in the coastal boundary of the state.
Lagos state’s statutory revenue form the federation account is expected to increase as a result of the 13% derivation given to oil producing states.
