(The following statement was released by the rating agency)
Feb 27 - Fitch Ratings has revised the Outlook on the Nigerian State of Lagos’s National Long-term rating to Positive from Stable, and affirmed it at ‘AA(nga)'. The agency has simultaneously affirmed the Long-term foreign and local currency ratings at ‘BB-’ with Stable Outlooks, Short-term foreign currency rating at ‘B’ and the Long-term ratings of the NGN50bn and NGN57.5bn bonds, maturing in 2014 and 2017 at ‘BB-’ and ‘AA(nga)'.
The Outlook revision reflects the state’s increasing sophistication in management reflected by improving transparency and debt management amid moves towards a balanced budget by 2015 from a peak deficit of 25% of revenues in 2012 according to preliminary figures, and a stable debt cover ratio by the current balance around three years.
A growing proportion of bond issues, with fixed repayment schedules, longer maturities and monthly provisions into the debt reserves fund, are replacing the traditional concentration of short-term bank loans. Fitch views this as a sign of the state’s improving debt management. Together with budgets and quarterly performance reports, Fitch notes continual improvements in transparency and governance.
Fuelled by public and private investments, as well as an estimated population of about 20 million according to state officials, Lagos’s diverse economy is the leading contributor to Nigerian GDP. Fitch expects the 10% growth in the local economy and the state’s plans to widen the tax base and improve collection methods to boost local tax receipts towards NGN330bn by 2015, up from NGN200bn in 2012, edging towards 80% of annual revenues from 70% of income in the late 2000s.
Maintenance costs for infrastructure built and provision of social services such as health and education could add pressure to Lagos’s budget. However, Fitch expects the state’s commitment to streamlining costs coupled with the maintenance of a steady employee headcount to contain their growth to about 10% per annum over 2013-2015. Rising energy prices meant costs grew by about 25% in 2012, and Fitch expects Lagos’s operating expenses to rise to about NGN230bn by 2015 from NGN185bn in 2012.
Fitch expects capital spending to remain high at about NGN250bn per year over the medium term, as the state continues to invest in transport, water, health, education and social protection. Despite interest expenses rising towards NGN40bn by 2015, the state’s self-financing ratio of investments will remain strong with the current balance funding about 75% of capital expenditure from an average 65% in 2010/12.
The state’s debt will likely stabilise around NGN350bn by 2015, net of repayment provisions, with bonds representing about 50% of total debt from about 30% in 2009. As Lagos stands out for its low dependence on federal allocation and high tax generation, the state was allowed to incur debt accounting for about 100% of revenues rather than the 50% limit stated by Nigerian borrowing guidelines for subnationals. The debt service coverage ratio could likely remain at around 2.5x the operating balance offering additional comfort of debt service sustainability.
The ratings could be upgraded if improvements in the budgetary performance lead to debt stabilising below NGN0.5trn, while maintaining the high 30% component of subsidised foreign loans lowering debt servicing burden, and continual growth of the local economy results in taxes remaining around 75% of total revenues.
Conversely, an operating margin declining towards 33%, changes in the national tax policy penalising Lagos together with debt rising beyond Fitch’s expectations and macroeconomic instability, even at the local level, could lead to a downgrade.