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Fitch Ratings - Milan - 29 Nov 2022: Fitch Ratings has downgraded Lagos State's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'B-' from 'B' with Stable Outlook following the downgrade of the sovereign rating (see Fitch Downgrades Nigeria to 'B-'; Outlook Stable dated 11 November 2022 on www.fitchratings.com). A full list of rating actions is below.

Under applicable credit rating agency (CRA) regulations, the publication of local and regional government 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 schedule in order to comply with the CRAs' obligation to issue credit ratings based on all available and relevant information and disclose credit ratings in a timely manner. Fitch interprets these provisions 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. The next scheduled review date for Fitch's rating on Lagos State is in 2023, but Fitch believes that developments for the issuer warrant such a deviation from the calendar and our rationale for this is set out in the first part (High weight factors) of the Key Rating Drivers section below.

Following the downgrade of Nigeria's IDRs, we have taken similar rating action on Lagos to reflect the sovereign cap. Its Outlooks move in tandem with the sovereign's.

Fitch has revised Lagos's Standalone Credit Profile (SCP) to 'b+' from 'bb+' due to the reassessment of the risk profile to 'Vulnerable'.

KEY RATING DRIVERS

HIGH

Sovereign Cap

As per Fitch's rating criteria, Lagos's IDRs are capped by the sovereign's 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 a system of transfers to states. Therefore, rating action on the sovereign will be mirrored on Lagos, as its SCP is currently above that of the sovereign.

MEDIUM

Risk Profile: revised to Vulnerable from Weaker

Fitch has reassessed the 'Expenditure Sustainability' Key Risk Factor to 'Weaker' from 'Midrange' due to the deteriorating operating environment, characterised by high inflation, which will weaken control of total expenditure growth. According to Fitch's International Local and Regional Government (LRG) Rating Criteria, Lagos's Risk Profile has been reassessed at 'Vulnerable' due to the majority of 'Weaker' key rating factors in countries rated in the 'B' category or below.

Lagos's 'Vulnerable' risk profile reflects a very high risk that the state's ability to cover debt service with its operating balance may weaken unexpectedly over our forecast horizon (2022-2026). This may be due to lower-than-expected revenue, higher-than-expected expenditure, or an unexpected rise in liabilities or debt-service requirements.

Expenditure Sustainability: revised to Weaker from Midrange

Lagos is exposed to a deteriorating operating environment, which that weakens the state's control over total expenditure growth, influenced by high inflation, rising commodity prices, and supply constraint amid naira depreciation. Lagos has a wide set of responsibilities and high need for capital spending to maintain its attractiveness as Nigeria's main economic hub, with demographic pressures on more services on infrastructure, health and education that limit the scope for cutbacks.

For the rationale on the other key rating drivers see the latest published rating action commentary at www.fitchratings.com.

LOW

Debt Sustainability - 'aa' Category

Under Fitch's rating case, Lagos's debt payback ratio (net Fitch-adjusted debt/operating balance) is around 4x in 2022-2026, which is consistent with a debt sustainability assessment in the 'aaa' category. This is offset by weak debt service coverage (1.8x) and a fiscal debt burden rising towards 150%, which is high versus the peer group. This results in an overall debt sustainability assessment in the 'aa' category.

DERIVATION SUMMARY

The combination of Lagos's 'Vulnerable' risk profile and debt sustainability in the 'aa' category lead to a SCP of 'b+'. Fitch does not apply any asymmetric risk or extraordinary support from the central government. Lagos's IDRs are capped at the sovereign level, as the federal government retains predominant influence over Nigerian inter-governmental relations and resource allocation to states.