OREANDA-NEWS. September 15, 2015.  Fitch Ratings has affirmed Lagos State's Long-term foreign currency Issuer Default Ratings (IDRs) at 'BB-' with Negative Outlook and Short-term foreign IDR at 'B'. The Long-term local currency IDR and the National Long-term rating have also been affirmed at 'BB-' and 'AA+(nga)', respectively, with Stable Outlooks.

The agency has simultaneously affirmed the region's NGN275bn MTN programme as well as its NGN57.5bn and NGN80bn bonds, maturing in 2017 and 2019, respectively, at Long-term local currency 'BB-' and National Long-term 'AA+(nga)'.

KEY RATING DRIVERS

The affirmation reflects Fitch's expectations of Lagos' continued strong operating performance, on-going efforts in improving transparency and the administration's sophisticated management conducive to growing private sector investments. The ratings also take into account the state's weak socio-economic indicators by international standards. The Negative Outlook on the Long-term foreign currency IDR reflects that of Nigeria (BB-/Negative).

Fitch expects Lagos' revenue to remain highly diversified compared with the national average, making the state's budget more resilient to oil price fluctuations. Operating revenue, mainly driven by service and tertiary sectors, is expected to continue growing towards NGN450bn over the medium term (NGN400bn in 2014), while internal generated revenues (IGRs) will dominate at 75%-80% of total revenue (70% in 2012). This, in tandem with the administration's commitment to keep cost growth under inflation (7%-8%), should be conducive to achieving an operating margin of near 50% over the medium term.

Political continuity from the 2015 elections outcome should lift capital spending to NGN250bn per year over the medium term, from about NGN200bn in 2014. Fitch believes that the state will maintain its commitments in investing in transport (including a light metro transit and a motorway), water, health, education (child-care centres) and social protection. We expect the state to achieve an overall balanced budget over the medium term, with a focus on boosting public-private partnerships.

Under Fitch's base case scenario Lagos' debt will stabilise at NGN350bn-NGN400bn over the medium term, net of repayment provisions, or at 1x the budget size. Bonds will represent about 50% of total debt, up from about 30% in 2009 and long-term debt will account for 75% of total debt. The administration's intent to shift the debt mix towards multilateral loans - characterised by longer maturities and a lower burden compared with domestic debt, should strengthen debt sustainability, with a pay-back (debt to current balance) ratio below 3 years, down from 3.5 in 2014. Liquidity, averaging NGN100bn over the medium term and equivalent to approximately 1x annual debt service requirements, should not be a risk.

Despite its weak socio-economic indicators by international standards, Lagos can be considered Nigeria's economic powerhouse as its local GDP accounts for 20%-25% of national GDP. Domestic production is fuelled by its diversified economy, with service, construction, transport and industry making up 80% of the local economy. Given its limited reliance on oil- related activities, Fitch believes that Lagos' socio-economic indicators will further improve as local GDP growth is likely to outperform national real GDP growth, which we estimate at 4.5%-5.5% in 2015-2016.

RATING SENSITIVITIES

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. Also, a downgrade of the sovereign would prompt a similar action on the ratings of the state, as subnationals' ratings usually cannot be higher than their sovereign under Fitch's criteria.

Conversely, the Outlook could be revised to Stale if improvements in budgetary performance result in debt levels at 1x the budget size, while maintaining a high component of subsidised foreign loans (about 35% at end-2014), in turn lowering the debt servicing burden, and provided that the Outlook on the sovereign is also revised to Stable. Further improvement of the local economy giving additional boost to IGR would also be positive for the ratings.