Lagos State Government 57.5 billion 10% seven year fixed rate bond due 2017 under the 275 billion debt issuance programme

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1 Lagos State Government 57.5 billion 10% seven year fixed rate bond due 2017 under the 275 billion debt issuance programme 2016 Bond Rating Review Report

2 2016 Municipal Bond Rating Review Lagos State Government of Nigeria 57.5 billion 10% Seven-Year Fixed Rate Bond Due 2017 Issue Rating: A+ The Issue rating is valid throughout the life of the instrument but will be subject to annual monitoring and review on the anniversary of the Issue. Previous rating: A+ Good quality debt issue with low to moderate credit risk; strong capacity to pay coupon and principal on local currency debt in a timely manner. RATING RATIONALE Lagos State: A+ Outlook: Stable Agusto & Co. affirms the A+ rating assigned to the Lagos State Government Issue Date: 16 August 2016 Expiry Date: 28 February 2017 ( the Issuer, LASG or the State ) and the 57.5 billion 10% Seven-Year Fixed Rate Bond Due April 2017 ( the Issue or the Bond ). The assigned ratings reflect the Issuer s strong internally generated revenue (IGR) profile and strong capacity to pay coupon and principal on the Bond in a timely manner from its IGR. Unlike many states in the Country, Lagos is not overly dependent on centrally collectible revenue, as the substantial decline in crude oil prices in the international market by more than 70% over the 18 months period ended 31 December 2015, did not significantly impair the State s overall revenue profile. Thus, the State recorded a total revenue (excluding grants) of billion in 2015, which represented, only a 5% decline from prior year. Analysts: Ikechukwu Iheagwam ikechukwuiheagwam@agusto.com Isaac Babatunde isaacbabatunde@agusto.com Agusto & Co. Limited UBA House (5th Floor) 57, Marina Lagos Nigeria LASG s revenue profile was bolstered by a robust IGR which contributed 69% of total revenue in 2015 (2014: 67%), while value added tax and statutory allocation accounted for 19% and 11% respectively. The nucleus of LASG s revenue is pay as you earn (PAYE) personal income tax, which accounted for 54% of total revenue in 2015 (2014: 52%). Going forward, we estimate that Lagos State s IGR will contribute about 72% to revenue in 2016, mainly boosted by the efficient PAYE system. In 2015, LASG s personnel cost rose by 26% to 96.6 billion from prior year and is projected to further increase by 30% in line the 2016 approved budget, from 2015 actual figures. This is all in a bid to provide more employment opportunities through the ministries, departments and agencies (MDAs) for its citizenry. Nevertheless, the three year weighted average ( f) personnel cost to revenue ratio of 24% is within our benchmark for State Governments in Nigeria. The State is one of the few in the Country that did not access the CBN bailout funds to meet outstanding workers salary in As at 31 May 2016, LASG s total debt stood at 563 billion, which consisted of outstanding balances on the State s external loan (52.83%), internal loans (22.96%), net value of bonds in issue (20.92%), contractor arrears (3.01%) and The copyright of this document is reserved by Agusto & Co. Limited. No matter contained herein may be reproduced, duplicated or copied by any means whatsoever without the prior written consent of Agusto & Co. Limited. Action will be taken against companies or individuals who ignore this warning. The information contained in this document has been obtained from published financial statements and other sources which we consider to be reliable but do not guarantee as such. The opinions expressed in this document do not represent investment or other advice and should therefore not be construed as such. The circulation of this document is restricted to whom it has been addressed. Any unauthorized disclosure or use of the information contained herein is prohibited.

3 judgement debt (0.28%). The State s stock of external debt has maturities in excess of 20 years and are all priced at concessionary rates. In addition, the outstanding balance on the bonds in issue represent the net balances on the State s 57.5 billion, 80 billion and 87.5 billion bonds less the monies already set aside in the respective bond sinking fund accounts. Since issuance of the Bond in 2010, semi-annual coupon payments due to bondholders have been paid timely through funding of the 57.5 billion sinking fund account (SFA) from monthly remittance of billion from IGR up until August Following the Bond SFA adequacy assessment carried out in August 2015 and subsequent approval by the Securities and Exchange Commission, Lagos State now makes a monthly IGR contribution of 437 million into the SFA towards meeting the outstanding coupon and principal repayments. Agusto & Co. notes positively that LASG is setting aside sufficient funds into the SFA through monthly deductions from IGR to cover outstanding Bond obligations and we expect this to continue until maturity of the Bond in April ADEQUACY OF SINKING FUND The Lagos State Government issued a 57.5 billion 10% seven year bond in April The Bond is supported by an Irrevocable Standing Payment Order (ISPO) authorizing monthly deduction of appropriate amounts from the State s internally generated revenue (IGR) into a Sinking Fund Account (SFA) towards semi-annual coupon payments and bullet principal redemption at maturity in April The SFA is jointly managed by United Capital Trustees Limited, FBN Trustees Limited, STL Trustees Limited and Union Trustees Limited for the benefit of bondholders. As at 30 June 2016, 79.3 billion had been set aside in the SFA by way of monthly IGR contribution by the State and this earned a cumulative investment income of 13.5 billion. As at the same date, the total sum in the SFA amounting to 92.8 billion was sufficient to cover coupon payment due to bondholders ( 34.5 billion) and bond related expenses ( 1.25 billion), leaving a balance of 57.1 billion. The balance in the SFA as well as monthly IGR deductions of 437 million over the remaining 10 months will be sufficient to cover the outstanding coupon and principal repayment times. As at 30 June 2016, 90% of the outstanding Bond obligations (coupon & principal) is already in the SFA, thus reflecting adequate capacity to meet bond obligations as and when due Municipal Bond Rating Review Report

4 Table 1: Sinking Fund Schedule as at 30 June 2016 Description '000 Total IGR contributions 79,315,125 Investment income 13,525,908 Coupon payment (34,510,921) Principal payment nil Bond expenses (1,255,706) Balance as at 30 June ,074,406 Outstanding ISPO contributions (10 months) 4,371,000 Estimated investment income till maturity 2,193,030 Total expected contributions till maturity 63,638,436 Outstanding bond Obligations (principal & coupon) 63,256,370 Sinking fund adequacy coverage ratio times UTILIZATION OF BOND PROCEEDS - STATUS UPDATE The net proceed of the 57.5 billion Bond ( 56.4 billion) was used to fund ongoing infrastructural projects in the State and also repay existing commercial bank loans. As at 30 June 2016, all the funds earmarked for various projects as stipulated in the Bond prospectus have been utilized. Table 2: Status of Projects as at 30 June 2016 Project Title Various infrastructural projects covering roads, health care, housing & school Amount allocated from Bond ( ) % of bond 35,399,548, % Refinancing of existing bank loans 21,047,478, % Total 56,447,027, proceed utilized OUTLOOK ON BOND REPAYMENT We have estimated a 9% growth in Lagos IGR for 2016 premised on an effective and efficient personal tax administration system been implemented in the State. Consequently, we forecast an IGR of 298 billion in 2016, which will represent about 72% of total revenue, while value added tax and SA will account for 18% and 9% respectively. Agusto & Co. estimates that the total amount required to service all existing Lagos State bond obligations will represent about 17% of projected IGR in In our view, the Issuer has satisfactory capacity to meet the obligations until the Bond is fully redeemed in April We have attached a stable outlook to the 57.5 billion Seven-Year Fixed Rate Bond Municipal Bond Rating Review Report

5 REVENUE & SPENDING 2016e REVENUE 'mns % 'mns % 'mns % 'mns % 'mns % Tax revenue Personal Income Tax 224, % 212, % 213, % 197, % 172, % Share of VAT collected centrally 72, % 73, % 72, % 68, % 61, % Share of other revenues collected 37, % 43, % 58, % 71, % 63, % centrally (Stat. Allocation) Property tax Other taxes 334, % 329, % 344, % 337, % 297, % Non-tax revenue Asset sales Investment income 2, % 10, % 8, % 8, % 12, % Other 75, % 54, % 61, % 37, % 39, % 77, % 65, % 70, % 45, % 51, % TOTAL REVENUE 412, % 394, % 414, % 383, % 349, % Of which internally generated 298, % 273, % 276, % 236, % 219, % revenue (IGR) is Grants 8, , , , ,215.8 TOTAL REVENUE & GRANTS 421, , , , ,940.2 SPENDING Transfers (including pension costs) 5, % 7, % 5, % 5, % 8, % Interest payments 41, % 49, % 56, % 40, % 19, % MDA spending 532, % 357, % 394, % 449, % 359, % TOTAL SPENDING 579, % 414, % 456, % 495, % 388, % MDA spending is made up of Personnel costs 125, % 96, % 76, % 75, % 57, % Purchase of goods & services 137, % 86, % 104, % 99, % 104, % Capital expenditure 269, % 173, % 213, % 274, % 197, % TOTAL MDA SPENDING 532, % 357, % 394, % 449, % 359, % BUDGET BALANCE (157,901.9) (1,228.5) (19,613.5) (104,369.5) (29,207.1) BUDGET BALANCE AS % OF GDP -0.6% 0.0% -0.1% -0.5% -0.2% FINANCING Surplus of prior years 128, , , ,842.0 Domestic borrowing (net) 18, ,895.2 (451.0) 111, ,749.1 External borrowing (net) 52, , , , ,382.0 Other TOTAL FINANCING 70, , , , ,973.1 Foreign Loans- New Borrowings 56, , , , ,041.8 Repayment during the year 3, , , , Foreign loan balance 240, , , , ,028.3 Domestic- New Loans 89, , , , ,929.0 Loan due (repaid) within the year 70, , , , ,179.9 Domestic loan balance 408, , , , , Municipal Bond Rating Review Report

6 KEY RATIOS 2016e Revenue IGR as % of GDP 1% 1% 1% 1% 1% Tax revenue as % of GDP 1% 1% 2% 2% 2% Total revenue as % of GDP 2% 2% 2% 2% 2% IGR as % of total revenue & grants 71% 66% 63% 60% 61% Tax revenue as % of IGR 75% 78% 77% 84% 79% Growth in tax revenue 2% -5% 2% 13% 4% Spending Spending as % of GDP 2% 1% 2% 2% 2% Non-discretionary spending* as % of tax revenue 51% 47% 40% 36% 29% Capital expenditure as % of total spending 47% 42% 47% 55% 51% Payroll as % of revenue 30% 24% 19% 20% 16% Other overheads as a % of revenue 33% 22% 25% 26% 30% Budget balance/revenue -38% 0% -5% -27% -8% Leverage Budget balance ( 'mns) (157,901.94) (1,228.48) (19,613.50) (104,369.54) (29,207.05) Debt as % of nominal GDP 2% 2% 2% 3% 2% Interest payments as % of total revenue 10% 13% 14% 10% 6% Principal due as % of Revenue 99% 67% 67% 70% 53% Financial flexiblity Discretionary revenue** as % of total revenue 58% 61% 67% 68% 75% Net Debt as % of Free cash flow*** 170% 110% 100% 102% 70% Share of savings in "excess crude account" ( 'mns) Non-discretionary Spending as % of total spending 30% 37% 30% 24% 22% * Non-discrectionary spending is made up of statutory transfers, interest payments and personnel costs ** Discretionary revenue is total revenue minus non-discretionary spending *** Free cash flow is defined as revenue minus nondiscretionary spending Municipal Bond Rating Review Report

7 RATING DEFINITIONS Aaa Highest quality debt issue with minimal credit risk; strongest capacity to pay returns and principal on local currency debt in a timely manner. Aa High quality debt issue with very low credit risk; very strong capacity to pay returns and principal on local currency debt in a timely manner. A Good quality debt issue with low to moderate credit risk; strong capacity to pay returns and principal on local currency debt in a timely manner. Bbb Satisfactory quality with moderate credit risk; adequate capacity to pay returns and principal on local currency debt in a timely manner. Bb Below average quality with moderate to high credit risk; speculative capacity to pay returns and principal on local currency debt in a timely manner. B Weak quality with high credit risk; speculative capacity to pay returns and principal on local currency debt in a timely manner. C Very weak capacity to pay returns and principal. Debt instrument with very high credit risk. D In default. Rating Category Modifiers A "+" (plus) or "-" (minus) sign may be assigned to ratings from Aa to C to reflect comparative position within the rating category. Therefore, a rating with + (plus) attached to it is a notch higher than a rating without the + (plus) sign and two notches higher than a rating with the - (minus) sign Municipal Bond Rating Review Report

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