Lagos, 20 January 2020 — Global Credit Rating Co. Limited has assigned an indicative public rating of A+(NG) to Lagos State Government of Nigeria’s (“Lagos State”, “the State”, or “the Issuer”) proposed Programme 3 Series III N100bn Fixed Rate Bonds (“the Bonds”); with the outlook accorded as Stable. The indicative bond rating will expire on April 30 2020.
The assigned indicative public rating of the Bonds are premised on its Senior Unsecured status. Should the status of the Bond differ from that initially contemplated, this could impact the final ratings accorded. The final rating will be accorded upon receipt of satisfactorily signed and executed transaction documents.
RATING RATIONALE OF THE ISSUE
Lagos State Government has recently obtained the requisite approvals to issue up to N100bn Series 3 Bonds, from the Nigerian capital market, under the N500bn Bond Programme (registered in 2016). The proceeds are intended to be utilised for funding various socio-economic infrastructural projects. The Series 3 Bonds are expected to be of a ten-year tenor. Coupon payment obligations on the Bonds will be serviced through monthly transfers from Consolidated Debt Service Account (“CDSA”) and Irrevocable Standing Payment Order (approved by the Federal Ministry of Finance) into the Sinking Fund Account. The monthly funding (N154.5m from CDSA and N1bn from ISPO) will commence immediately upon the Issue of the Bonds, and subsist for 24 months of principal moratorium. Thereafter, monthly funding from the CDSA will increase to N765.6m and will augment the ISPO for servicing both coupon and principal repayments on a semi-annual basis (sixth and twelfth months of each year that the Bonds subsist). The Bonds constitute senior, direct irrevocable and unconditional obligations of the Issuer, ranking pari passu among themselves and with other existing obligations of the Issuer.
The Sinking Fund Account for the Programme 3 Series 3 Bonds will be funded through a combination of Irrevocable Standing Payment Order (“ISPO”) and CDSA transfers. Based on GCR’s analysis of the expected inflows (as reflected in the draft Series 3 pricing supplement), both inflows will only provide 1x coverage of semi-annual interest payments during the moratorium period and 1x cumulative debt service when the 24-month moratorium lapses. As such, there is no additional credit enhancement offered by the contemplated inflows. GCR has accorded an indicative rating of A+(NG) to the proposed Series 3 Bonds’ indicative rating in line with the Issuer’s credit rating.
As the Series 3 Bonds represents senior unsecured obligations of the Issuer, any change in the rating assigned to the Issuer will directly affect the Bond rating. Lagos State’s Issuer rating was affirmed at A+(NG) in December 2019, with the outlook accorded as Stable.
RATING RATIONALE OF THE ISSUER
In May 2019, GCR placed the ratings for Lagos on Ratings Watch as the State had failed to comply with the monthly funding requirements as stipulated by the respective Trust Deeds of the existing Bonds, albeit that all debt service obligations were being made timeously and no defaults were recorded. In December 2019, the State has resumed monthly funding of the Sinking Fund Accounts (“SFAs”) and has committed to ensure compliance going forward. Thus, the rating outlook was amended to ‘Stable’, although, Global Credit Rating Co. Limited (“GCR”) will assess the extent of compliance during 1H 2020 and on an ongoing basis.
Lagos State maintains a systemically important position in the country and continues to pursue an aggressive industrial and socio-economic plan, with the aim of facilitating investment and economic development. This has been largely debt-funded, raising debt to excessive levels in FY18 and 9M FY19. Despite the settlement of some outstanding bonds and commercial loans, gross debt rose by N85bn to N891bn in 9M FY19, at an annualised debt to income ratio of 192%, the highest over the review period. This was primarily underpinned by a substantial rise in outstanding payments to contractors, due to cash flow constraints. The State has indicated that the arrears have reduced to N82bn in November (9M FY19: N141bn; FY18: N203bn) following further payments. GCR takes cognisance that over 87% of debt is long term, affording the State some financial flexibility.
Lagos State intends to issue a new N100bn Bond. This, in conjunction with other planned debt could see gross debt climb above N1tr in FY19. In the absence of commensurate revenue growth as budgeted, gross gearing could register beyond 200% and place pressure on the ratings.
GCR notes the robust internal economy of the State, underpinning strong financial independence from statutory allocations. However, all income items have been somewhat constrained, with internally generated revenue (“IGR”) likely to be slightly below budget. Nevertheless, GCR expects overall income to remain fairly stable, supported by higher statutory allocations. Other key strengths include strong operating surplus, high operating margin and adequate debt service coverage metrics.
While recurrent expenditure has been well managed, the recent implementation of wage increment will likely raise staff cost above 40% of expenditure. This could adversely impact on operating surplus if planned revenue growth is not achieved.
An upgrade is dependent on a meaningful decrease in debt and improvement in credit protection metrics. Nevertheless, demonstrated progress in diversifying the State’s economy and raising IGR and overall revenue, could also lead to firmer credit protection metrics over the medium term. Conversely, a further increase in debt, without proportionate growth in revenue, could lead to negative rating action. A recurrence to non-compliance with the terms of the respective bond issuances could also trigger negative rating action.
NATIONAL SCALE RATINGS HISTORY
* Indicative rating.
+23 41 904 9462-3
APPLICABLE METHODOLOGIES AND RELATED RESEARCH
Criteria for Rating Public Entities, updated February 2018
Lagos State Government Rating Reports (2011– 2019)
Glossary of Terms/Ratios (February 2018)
RATING LIMITATIONS AND DISCLAIMERS
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SALIENT FEATURES OF ACCORDED RATINGS
GCR affirms that a.) no part of the rating was influenced by any other business activities of the credit rating agency; b.) the rating was based solely on the merits of the rated entity, security or financial instrument being rated; c.) such rating was an independent evaluation of the risks and merits of the rated entity; d) the indicative rating is valid until April 30 2020.
Lagos State participated in the rating process via teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible.
The credit rating has been disclosed to Lagos State.
The information received from Lagos State Government of Nigeria and other reliable third parties to accord the credit rating included:
• The audited accounts for the year ended 31 December 2018 (plus four years of comparative numbers);
• The unaudited management accounts for the period ended 31 September 2019;
• The revised budget for 2019;
• A breakdown of facilities available and related counterparties;
• Draft documents relating to the Bond Issue- Pricing Supplements, Trust Deed and Vending Agreement.
• Lagos State Executive Council Resolution; Lagos State House of Assembly Approval; Letter of ISPO Approval from the Federal Ministry of Finance.
• Information specific to Lagos State was also received.
The ratings above were solicited by, or on behalf of, the rated client, and therefore, GCR has been compensated for the provision of the ratings.