19 Sep 2014/Fitch Ratings

Fitch Ratings-Milan/Frankfurt/London-19 September 2014: Fitch Ratings has upgraded Nigerian Lagos State’s National Long-term rating to ‘AA+(nga)’ from ‘AA(nga)’. The Outlook is Stable.

The agency has simultaneously affirmed Lagos State’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘BB-‘ with Stable Outlooks and its Short-term foreign currency IDR at ‘B’.

Its NGN275bn MTN programme, together with its NGN57.5bn and NGN80bn bonds, which mature in 2017 and 2019, respectively, have been affirmed at ‘BB-‘ and upgraded to ‘AA+(nga)’ from ‘AA(nga)’.

KEY RATING DRIVERS

The upgrade reflects Fitch’s expectations of the state’s continued solid operating performance, improved transparency and efforts towards an increasingly sophisticated and transparent administration, which is conducive to growing private sector investments.

The rating action reflects the following rating drivers and their relative weights:

High:
Management and Administration: Fitch believes that Lagos management is becoming increasingly more sophisticated. With the aim to progressively improve transparency and accountability to international standards, the state is improving its governance and disclosure, with budgets and quarterly performance being published on the official website. Debt management has also improved, with longer bond tenures and more loans from development banks while ministerial departments continue to bolster collections of local taxes.

Economy: With a local GDP accounting for 20%-25% of the national GDP, Lagos is a key driver of Nigeria’s economy despite being the smallest state by territory. Domestic production is fuelled by its diversified economy as a commercial hub in the country, with service, construction, transport and industry making up 80% of the local economy. Fitch believes that Lagos’ socio-economic indicators will further improve as local GDP growth is expected to outperform the estimated national GDP growth of 7%-8% in 2014.

Medium:
Finance: After recording a strong 57% in 2013, Fitch expects Lagos to see its operating margin stabilise at around 50% in the medium term, supported by growing local taxes, and by the administration’s commitment to keep cost growth in line with inflation (expected at 8%-10% over the medium term). Lagos’ revenue structure is highly diversified compared with the national average, amid continued efforts to expand revenue sources through oil-related projects. Fitch expects Lagos’ revenue to remain driven by services and the tertiary sector Under its base case scenario, Fitch expects internal generated revenues (IGRs) to grow above NGN400bn by 2016, or 80% of total revenue, from about NGN266bn in 2013 (70%), reducing its dependence on federal allocation.

Fitch expects capital spending to remain at NGN250bn in 2014 as Lagos continues to invest in transport (including a light metro transit and a motorway under construction), water, health, education (child-care centres) and social protection. We expect spending to eventually decline in 2015-2016 as a new planning period is phased in after the state elections. This should lead to narrower deficits at Lagos before achieving a balanced budget in 2015, from a peak deficit of 25% of revenues in 2010. Given Lagos’ policy of attracting private sector investments to complement capex funding, Fitch believes this will limit the state’s recourse to debt, which should remain at around two to three years of the current balance.

Lagos’s ratings also reflect the following rating drivers:

Debt and Liquidity: Under Fitch’s base case scenario Lagos’s debt will be at NGN450bn in 2014-2016, with bonds representing about 50% of total debt (down to about 40% when net of repayment provisions made to the sinking fund), in line with 2013 and up from about 30% in 2009, and long-term debt stabilising at about 80% of total debt. These figures, if materialised, will compress the debt to revenue ratio to 90% from the 100% expected for 2014, mirroring improved debt management with fixed repayment schedules, longer maturities and monthly provisions into debt reserve funds. In Fitch’s base case, liquidity should not be a risk, averaging NGN100bn over the medium term, equivalent to approximately 1x annual debt service requirements.

RATING SENSITIVITIES

The ratings could be further upgraded if improvements in the budgetary performance result in debt levels at 1x the budget size, while maintaining a high component of subsidised foreign loans (about 30% at end-2013), in turn lowering the debt servicing burden. Further improvement of the local economy giving additional boost to IGRs would also be positive for the ratings.

Conversely, an operating margin declining towards 30%, unfavourable changes in the national tax policy, debt rising beyond Fitch’s expectations and economic instability, even at the local level, could lead to a downgrade.