October 19, 2020/Fitch Ratings

Fitch Ratings has revised the Outlook on Lagos State’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Stable from Negative 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.

Following the recent revision of the Outlook on Nigeria’s IDRs (see Fitch Revises Nigeria’s Outlook to Stable, Affirms at ‘B’ dated 30 September 2020 on www.fitchratings.com), we have taken similar rating action on Lagos as it is rated at the same level as the sovereign and its Outlooks move in tandem with those on the sovereign.

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 will take place in 2021.

KEY RATING DRIVERS

HIGH

Sovereign Cap

As per Fitch’s rating criteria, Lagos’s IDRs are capped by the sovereign and its Outlooks reflect those on the sovereign. Rating action on the sovereign or a revision of its Outlook 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). The ‘Weaker’ risk profile reflects a high risk that the state’s cash flow available for debt service will contract beyond reasonable downturn expectations.

Debt Sustainability: ‘aa’ category

In Fitch’s rating scenario of a stressed economy, Lagos’s payback ratio would be close to 4x-5x in the medium term (2019: 3.6x), debt service coverage around 1.2x and the fiscal debt burden towards 150% of operating revenue. In our rating case scenario, Lagos’s net adjusted debt would increase to above NGN1.0 trillion in the medium term, reaching NGN1.2 trillion by 2024 to cope with a demanding capex plan, and the operating balance would be around NGN250 million.

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 internally generated revenue.

DERIVATION SUMMARY

Lagos’s Standalone Credit Profile is assessed at ‘bb+’, reflecting a combination of a weak risk profile and 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 5x. 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 18-Sept-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, raised 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 2015-2019 figures and 2020-2024 projected ratios. The key assumptions for the scenario include:

– 8% CAGR in operating revenue on average in 2020-2024, versus 11% in baseline scenario;

– 10% CAGR 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 2019 and forecast for 2022, respectively:

– GDP per capita (US dollar, market exchange rate): 2,001.2; 2,279.0

– Real GDP growth (%): 2.2; 3.0

– Consumer prices (annual average % change): 11.4; 13.0

– General government balance (% of GDP): -3.6; -4.5

– General government debt (% of GDP): 26.7; 30.5

– Current account balance plus net FDI (% of GDP): -3.8; 0.8

– Net external debt (% of GDP): 4.1; 6.5

– 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 multiple-notch downward revision of Lagos’s SCP below ‘bb-‘, which could be driven by a material deterioration of its debt metrics, particularly a sharp increase in the payback ratio sustainably above 5x according to Fitch’s rating case, 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.

-A prolonged COVID-19 impact and much slower economic recovery lasting until 2025 would put pressure on net revenues. Should Lagos be unable to proactively reduce expenditure or supplement weaker receipts from increased central government transfers, this could lead to 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 payback ratio below 5x according to Fitch’s rating scenario.

COMMITTEE MINUTE SUMMARY

Committee date: 9 October 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

International scale credit ratings of Sovereigns, Public Finance and Infrastructure 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, visit [https://www.fitchratings.com/site/re/10111579].

SUMMARY OF FINANCIAL ADJUSTMENTS

Adjustments to 2019 year-end data

Fitch-adjusted debt include Lagos’s bond issuances at end-2019 of NGN170 billion and loans (both foreign and domestic) of NGN615 billion. In its calculation of Lagos’s adjusted-debt figure, Fitch includes NGN6 billion financial leasing for power plants an NGN41 billion pension liability.

Net-adjusted debt corresponds to the difference between adjusted debt of NGN833 billion and funds available at year-end, considered as unrestricted for debt service by Fitch.

Fitch considers that the sinking fund held at Trustees is available for bond repayments.

Lagos’s cash at year-end is considered restricted as the working capital (accounts receivables less accounts payables) is negative.

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’. This means 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.