OREANDA-NEWS. 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 issue ratings on the MTN programme and senior unsecured bonds have been affirmed at local currency 'BB-' and National Long-term 'AA+(nga)'.

The affirmation reflects Fitch's expectations of strong operating performance in the medium term, outstanding sophistication and transparency management compared with local standards. The ratings also take into account the state's weak socio-economic indicators by international standards, as well as its satisfactory debt metrics. The Negative Outlook on the Long-term foreign currency IDR reflects that on Nigeria (BB-/Negative).

KEY RATING DRIVERS
Fiscal Performance
Lagos's 2015 budget proved more resilient to the severe oil crisis thanks to its above national average diversified revenue structure. This mitigated risks from potential fiscal pressures from oil responses of the central government, inflation risk and the continued weakness of the local currency. The state recorded a preliminary 2015 operating margin of almost 50%, despite a 5% drop in operating revenue fully compensated by a 6% operating expenditure containment. Operating revenue, mainly driven by service and tertiary sectors, is expected to continue growing towards NGN450bn over the medium term (NGN400bn in 2014), while internally generated revenues will dominate at 75%-80% of total revenue (70% in 2012). Combined with the administration's commitment to keep cost growth (7%-8%) under inflation, this should help stabilise the operating margin at the current level over the medium term.

Management
After a 40% drop in 2015 capex as almost half of the year was dedicated to promoting elections, the resulting political continuity should lift capital spending back towards NGN250bn per year over the medium term. Fitch believes that the state will maintain its commitments in investing in transport (including a light metro transit and a motorway, also thanks to an additional USD200m loan with the World Bank to complete major projects such as the 61km 10-lane Express Way), water, health, education (childcare centres) and social protection. We expect the state will achieve an overall balanced budget over the medium term, with a focus on boosting public-private partnerships.

Debt and Liquidity
Under Fitch's central scenario, Lagos's debt will hover above NGN350bn-NGN400bn over the medium term, net of repayment provisions, or at 1x the budget size. Bonds and external loans should represent about 40% of total debt (which may suffer from the Naira devaluation), meaning long-term debt will account for 75% of total debt, narrowing the risk of repayment concentration (average maturity is now 10 years). Fitch expects debt sustainability to remain sound, with a pay-back (debt to current balance) ratio of three years, also thanks to the restructuring of all outstanding loans (lifting the average maturity 10 years from two, and an average interest rate to12.5% from previous 17%-18%). Liquidity should not be a risk, averaging NGN100bn over the medium term and equivalent to approximately 1x annual debt service requirements.

Economy
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 2016-2017.

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

Conversely, if the sovereign Outlook is revised to Stable the Outlook on Lagos could also be revised to Stable, provided that improvements in budgetary performance result in debt levels at 1x the budget size. Further improvement of the local economy giving additional boost to internally generated revenues would also be positive for the ratings.