Fitch Keeps Oyo Credit Rating at ‘B-‘, Outlook Positive
Fitch Ratings has affirmed Oyo State’s creditworthiness or Long-Term Issuer Default Rating (IDR) at ‘B-‘ with a positive outlook.
In its rating note, Fitch indicated that it assesses Oyo’s standalone credit Profile (SCP) at ‘b’, adding that the state credit ratings reflect its dependency on revenue transfers from the federal government of Nigeria despite improving internally generated revenue (IGR).
The ‘b’ SCP also reflects Oyo’s manageable debt, with limited foreign-currency exposure, Fitch said, capped Oyo credit rating by the sovereign’s ‘B-‘ ratings. Fitch analysts stated that positive outlook on Oyo state credit ratings mirrors that of the sovereign.
Explaining the rationale behind the ratings, Fitch stated that Oyo’s revenue structurally depends on federal transfers, which in turn rely on oil-related proceeds and is therefore sensitive to commodity price swings.
To improve state infrastructure and administration, and to support economic development, Oyo aims to increase capital expenditure and boost internal generated revenue (IGR) but weak socioeconomic conditions make this challenging.
Oyo’s revenue robustness is influenced by the state’s weak socioeconomic profile and reliance on transfers from the federal government, which can be volatile, the rating note stated.
Fitch noted that the statutory allocation increased by about 50% in 2023 due to fuel subsidy removal, naira devaluation, thus, represented 40% of Oyo’s operating revenue.
“We expect it to remain higher than historical levels, owing to a higher naira exchange rate against the dollar that compensates for oil price volatility”. Oyo state channeled part of federal transfers to infrastructure projects, leading to significantly higher capital revenue, according to Fitch.
The ratings agency noted that Oyo state has significantly improved its IGR, which has risen by 16% in the past five years, with tighter control of the informal economy expanding the tax base.
It added that the state’s revenue potential depends on its ability to broaden the tax base and enforce tax compliance. The main fiscal revenue is pay-as-you-earn taxes, on which Oyo cannot set the rate, and land charges, where Oyo continues to target measures to expand the tax base.
Fitch views the state’s ability to expand the tax base as being limited by the large informal economy and the population’s low income, although its lower poverty rate than most other Nigerian states suggests upside potential.
According to Fitch ratings, Oyo has a broad set of responsibilities and high spending needs to support the local economy. The state spending responsibilities, both operating and capital expenditure, range from the social sector (30%, includes education and healthcare) to economic development (over 40%).
The rating note reads that Oyo is exposed to a deteriorating operating environment, which weakens its control over total expenditure growth, affected by high inflation, rising commodity prices, and supply constraints amid naira depreciation.
The Nigerian central government has no mandatory balanced-budget rules for states, which are required to keep their deficits below3% of national GDP. Fitch considers Oyo’s cost structure as fairly rigid, with staff-related payments (including pension) amounting to two-thirds of operating expenses.
“Although capital expenditure represented around 45% of the state’s total expenditure in 2023 (35% in the past five years), we believe there is limited scope to adjust, in light of planned investments in infrastructure.”
Fitch analysts said the national framework for debt is evolving so borrowing limits are quite wide. Nigerian states have no restrictions on debt maturities, interest rates or currency exposure.
Oyo’s debt mostly comprises domestic debt with local counterparties, including several federal government-sponsored facilities, which represented two-thirds of Oyo’s outstanding debt in 2023.
The state’s debt structure is fairly conservative, with amortising repayments over long maturities and fixed interest rates. It noted that Oyo’s debt is largely serviced through deductions from the statutory allocation.
Fitch deems Oyo’s liquidity as weak as the state has no committed liquidity lines and domestic banks rated in the ‘B’ category tend to extend credit lines either with short maturities, or with back-up from the federal government through direct deductions from the Federal Account Allocation Committee (FAAC) transfers for longer maturities.
Fitch conservatively deems cash as restricted for payables. Emergency liquidity may also come directly from the federal government, helping states to meet liquidity shortfalls and fund payments of salaries and pensions.
Oyo had N10 billion in bank overdrafts at the end of 2022, fully covered in 2023 owing to higher FAAC revenue, Fitch revealed. Under Fitch’s rating case, Oyo’s debt payback ratio hovers at around 9x in 2026-2028.
“We override the debt sustainability assessment to ‘a’ as we factor in some volatility in the operating balance and weak secondary metrics, in particular debt service coverage below 1x and our expectation of fiscal debt burden growing towards 200% by 2028”.
Fitch said Oyo’s operating balances have been quite volatile in the past five years and the state resorted to bank overdrafts to meet its cash needs. However, the cash position recovered in 2023 thanks to federal transfer revenue that more than doubled from 2022, the rating note added.
The positive dynamics of IGR further stabilise the operating balance around average 20%. Analysts expect Oyo’s net Fitch-adjusted debt to significantly increase at about N350 billion in the base case, or N570 billion in a rating case of lower oil-related transfers. #Fitch Keeps Oyo Credit Rating at ‘B-‘, Outlook Positive CBN Defends Naira with $39m in Forex Market
