Fitch Ratings has revised the Outlook on Kaduna State’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Stable from Negative and affirmed the IDRs at ‘B’.
Under EU credit rating agency (CRA) regulation, the publication of International Public Finance reviews is subject 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 comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status.
Following the recent revision of 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 Kaduna as it is rated at the same level as the sovereign and its Outlooks move in tandem with those on the sovereign.
While Nigerian local and regional governments’ (LRG) most recently available issuer data may not have indicated performance impairment, material changes in revenue and cost profiles are occurring across the sector and likely to worsen in the coming weeks and months as economic activity suffers and government restrictions are maintained or broadened. Fitch’s ratings are forward-looking in nature, and we will monitor developments in the sector for their severity and duration, and incorporate revised base- and rating-case qualitative and quantitative inputs based on performance expectations and assessment of key risks.
The next scheduled review date for Kaduna will take place in 2021.
Key Rating Drivers
High
Sovereign Cap
As per Fitch’s rating criteria, Kaduna cannot be rated above the sovereign and its Outlooks reflect those on the sovereign. Fitch considers that the national government’s role remains predominant in Nigerian intergovernmental relations, as it controls the equalisation mechanism enacted through the system of transfers of oil-related revenue to states. These constitute over 50% of Kaduna’s operating revenue.
Low
Risk Profile: Vulnerable
Fitch assesses Kaduna’s risk profile at ‘Vulnerable’, which combines five factors at ‘Weaker’ (revenue robustness and adjustability, expenditure sustainability, liabilities and liquidity robustness and flexibility) and one factor at ‘Midrange’ (expenditure adjustability). The ‘Vulnerable’ risk profile reflects a very high risk of an unexpected weakening of Kaduna’s ability to cover its debt service needs over the rating horizon.
Debt Sustainability: ‘bb’ category
In its rating scenario of a prolonged economic downturn, Fitch expects Kaduna’s debt-to-operating balance (payback) ratio to sharply increase around 23x (2019:12x) after the full disbursement of the USD350 million loan from the World Bank. Under this scenario, Fitch expects some volatility in the payback ratios in 2020-2021 as a consequence of reduced oil-related transfers from the Federal Government of Nigeria (FGN) and increased operating spending to cope with the pandemic. -The fiscal debt burden – measured by net adjusted debt-to-operating revenue – could move above 300%, while the state will continue to have a good debt servicing coverage ratio above 1.5x.
Kaduna is classified as a type B LRG by Fitch, as it covers debt service with its operating balance. Kaduna’s fast-growing 8.2 million residents and a traditionally strong primary sector contribute to weak socio-economic standards. Dominant agricultural and service sectors drive the economy, but Kaduna’s development plan focuses on the state’s rich mineral resources by attracting foreign investors to key industrial projects.
Derivation Summary
Fitch assesses Kaduna’s Standalone Credit Profile (SCP) at ‘b’, reflecting a combination of a vulnerable risk profile assessment and a ‘bb’ assessment of debt sustainability. The SCP also factors in Kaduna’s high debt burden compared with international peers, in particular South-American states and provinces. Fitch does not apply any asymmetric risk or ad-hoc support from the central government and assesses intergovernmental financing as neutral to Kaduna’s ratings. The ‘B’ IDR reflects Kaduna’s own payment capacity, while debt-service support from the central government through deductions from the statutory allocation is factored into the debt framework.
Key Assumptions
Qualitative Assumptions and assessments and their respective change since the last review on 18 September 2020 and weight in the rating decision:
Risk Profile: Vulnerable, unchanged with low weight
Revenue Robustness: Weaker, unchanged with low weight
Revenue Adjustability: Weaker, unchanged with low weight
Expenditure Sustainability: Weaker, 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: ‘bb’ category, unchanged with low weight
Support: n/a
Asymmetric Risk: n/a
Sovereign Cap: Yes, raised with high weight
Quantitative assumptions – issuer specific
Fitch’s rating case scenario is a “through-the-cycle” scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on the 2015-2019 figures and 2020-2024 projected ratios. The key assumptions for the scenario include:
4.5% CAGR in operating revenue on average in 2020-2024, versus 8% in baseline scenario;
6% CAGR in operating spending on average in 2020-2024 versus 7.5% in baseline scenario;
1.5% cost of debt in 2020-2024.
Quantitative assumptions – sovereign related
Figures as per Fitch’s sovereign actual for 2019 and forecast for 2022, respectively:
GDP per capita (US dollar, market exchange 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
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A downgrade of the sovereign would lead to corresponding rating action on Kaduna.
A payback ratio above 25 years and a weakening amortisation profile leading to a debt service coverage ratio decreasing towards 1x, could result in a downgrade.
A prolonged COVID-19 impact and much slower economic recovery lasting until 2025 would put pressure on net revenues. Should Kaduna be unable to proactively reduce expenditure or supplement weaker receipts from increased central government transfers, this could lead to a downgrade.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch deems an upgrade of Kaduna’s ratings as unlikely due to the state’s weak debt metrics. However, a higher overall assessment of its risk profile and a payback below five years on a sustained basis would be positive for Kaduna’s ratings, subject to a sovereign upgrade.
Committee Minute Summary
Committee date: 9 October 2020
There was an appropriate quorum at the committee and the members confirmed that they were free from recusal. It was agreed that the data was sufficiently robust relative to its materiality. During the committee no material issues were raised that were not in the original committee package. The main rating factors under the relevant criteria were discussed by the committee members. The rating decision as discussed in this rating action commentary reflects the committee discussion.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].
Summary of Financial Adjustments
Contractors’ and pension arrears reported under Other Fitch Classified debt
Capex figures adjusted to mirror Fitch’s estimated cash-like data
Kaduna’s cash at year-end is considered restricted as the working capital (accounts receivables less accounts payables) is negative.
References For Substantially Material Source Cited As Key Driver Of Rating
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
Kaduna has an ESG Relevance Score of 4 for Energy Management due to problems with electricity and dependency on oil-related transfers, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Kaduna has an ESG Relevance Score of 4 for Human Rights and Political Freedoms due to the presence of conflicts in the region, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Kaduna has an ESG Relevance Score of 4 for Human Development, Health and Education as the majority of the population lives below the poverty line, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Kaduna has an ESG Relevance Score of 4 for Political Stability and Rights as political divisions leading to unpredictable policy shifts with low budget predictability, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
– Proshare