Monday, October19, 2020 10:55 AM /by Fitch Ratings/ Header Image Credit:  Oyibos Online

FitchRatings has revised the Outlook on Lagos State's Long-Term Foreign- andLocal-Currency Issuer Default Ratings (IDRs) to Stable from Negative andaffirmed the IDRs at 'B'.

Under EU credit rating agency(CRA) regulation, the publication of International Public Finance reviews issubject 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 complywith their legal obligations. Fitch interprets this provision as allowing us topublish a rating review in situations where there is a material change in thecreditworthiness of the issuer that we believe makes it inappropriate for us towait until the next scheduled review date to update the rating or Outlook/Watchstatus.

Following the recent revisionof the Outlook on Nigeria's IDRs (see Fitch Revises Nigeria's Outlook to Stable, Affirms at 'B'dated 30 September 2020), we have taken similar rating action on Lagos as it israted at the same level as the sovereign and its Outlooks move in tandem withthose on the sovereign.

Related Link: Fitch Revises Nigeria's Outlook toStable, Affirms at 'B'

WhileNigerian local and regional governments' (LRG) most recently available issuerdata may not have indicated performance impairment, material changes in revenueand cost profiles are occurring across the sector and likely to worsen in thecoming weeks and months as economic activity suffers and government restrictionsare maintained or broadened. Fitch's ratings are forward-looking in nature, andwe will monitor developments in the sector for their severity and duration, andincorporate revised base- and rating-case qualitative and quantitative inputsbased on performance expectations and assessment of key risks.

Thenext scheduled review date for Lagos will take place in 2021.

Key Rating Drivers

High

Sovereign Cap

As per Fitch's rating criteria, Lagos'sIDRs are capped by the sovereign and its Outlooks reflect those on thesovereign. Rating action on the sovereign or a revision of its Outlook willlead to similar action on Lagos's ratings, provided that Lagos's budgetaryperformance 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 flowavailable for debt service will contract beyond reasonable downturn expectations.

Debt Sustainability: 'aa' category

In Fitch's rating scenario of a stressedeconomy, 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 burdentowards 150% of operating revenue. In our rating case scenario, Lagos's netadjusted 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 theoperating balance would be around NGN250 million.

Lagos is classified as a type B LRG byFitch, as it covers debt service with its operating balance. Lagos is Nigeria'seconomic powerhouse with per capita GDP above USD4.000, or double the nationalaverage, but is weak by international standards. Fuelled by public and privateinvestment and a population over 20 million, Lagos's diverse economy issupportive of the wide tax base that generates internally generated revenue.

Derivation Summary

Lagos's Standalone Credit Profile isassessed at 'bb+', reflecting a combination of a weak risk profile and debtsustainability in the 'aa' category. The notch-specific rating positioning isassessed at the higher end of the rating category to reflect the payback ratiobelow 5x. Fitch does not apply any asymmetric risk or extraordinary supportfrom 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 assessmentsand their respective change since the last review held on 18-Sept-2020 andweight in the rating decision:

Risk Profile: Weaker, unchanged with lowweight

Revenue Robustness: Midrange, unchangedwith low weight

Revenue Adjustability: Weaker, unchangedwith 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 highweight

Quantitative assumptions - issuer specific

Fitch's rating case scenario is a"through-the-cycle" scenario, which incorporates a combination ofrevenue, cost and financial risk stresses. It is based on the 2015-2019 figuresand 2020-2024 projected ratios. The key assumptions for the scenario include:

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

- 10% CAGR in operating spending onaverage in 2020-2024 versus 12% in baseline scenario;

- 10% cost of debt versus 9% in baselinescenario.

Quantitative assumptions - sovereignrelated

Figures as per Fitch's sovereign actualfor 2019 and forecast for 2022, respectively:

- GDP per capita (US dollar, marketexchange 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

RatingSensitivities

 

Factors that could, individually orcollectively, lead to negative rating action/downgrade:

 

- A owngrade of the sovereign's ratingswould lead to corresponding action on Lagos's IDR.

 

- A multiple-notch downward revision ofLagos's SCP below 'bb-', which could be driven by a material deterioration ofits debt metrics, particularly a sharp increase in the payback ratiosustainably above 5x according to Fitch's rating case, or a reassessment of thekey risk factors or risk profile due to unfavourable changes in the economybeyond Fitch's expectations, could also trigger a downgrade.

 

-A prolonged COVID-19 impact and muchslower economic recovery lasting until 2025 would put pressure on net revenues.Should Lagos be unable to proactively reduce expenditure or supplement weakerreceipts from increased central government transfers, this could lead to adowngrade.

 

Factors that could, individually orcollectively, lead to positive rating action/upgrade:

 

Any positive rating action on Nigeriawill be reflected on Lagos's ratings, provided that Lagos maintains its strongdebt payback ratio below 5x according to Fitch's rating scenario.

 

Committee Minute Summary

Committee date: 9 October 2020

There was an appropriate quorum at thecommittee and the members confirmed that they were free from recusal. It wasagreed that the data was sufficiently robust relative to its materiality.During the committee no material issues were raised that were not in theoriginal committee package. The main rating factors under the relevant criteriawere discussed by the committee members. The rating decision as discussed inthis rating action commentary reflects the committee discussion.

Best/Worst Case Rating Scenario

International scale credit ratings ofSovereigns, Public Finance and Infrastructure issuers have a best-case ratingupgrade scenario (defined as the 99th percentile of rating transitions,measured in a positive direction) of three notches over a three-year ratinghorizon; and a worst-case rating downgrade scenario (defined as the 99thpercentile of rating transitions, measured in a negative direction) of threenotches over three years. The complete span of best- and worst-case scenariocredit ratings for all rating categories ranges from 'AAA' to 'D'. Best- andworst-case scenario credit ratings are based on historical performance.

Summary Of Financial Adjustments

Adjustments to 2019 year-enddata

Fitch-adjusted debt includeLagos's bond issuances at end-2019 of NGN170 billion and loans (both foreignand domestic) of NGN615 billion. In its calculation of Lagos's adjusted-debtfigure, Fitch includes NGN6 billion financial leasing for power plants an NGN41billion pension liability.

Net-adjusted debt correspondsto the difference between adjusted debt of NGN833 billion and funds availableat year-end, considered as unrestricted for debt service by Fitch.

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

Lagos's cash at year-end isconsidered restricted as the working capital (accounts receivables lessaccounts payables) is negative.

References For Substantially Material Source Cited As Key DriverOf Rating

The principal sources ofinformation used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level ofESG credit relevance is a score of '3'. This means ESG issues arecredit-neutral or have only a minimal credit impact on the entity, either dueto their nature or the way in which they are being managed by the entity.

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