Improved Transparency Earns Rivers ‘B’ Rating With Stable Outlook

Public finances in the Nigerian state of Rivers are characterised by low availability of financial information by international standards.

The state has strong cash holdings, a favorable financing system, and very low debt.

We have assigned a ‘B’ long-term rating to Rivers.

The stable outlook reflects our forecasts for oil prices and production and expected efforts to modernise public finances.

Rating Action

On Nov. 10, 2009, Standard & Poor’s Ratings Services assigned its ‘B’ long-term issuer credit rating to the Nigerian State of Rivers. At the same time, Standard & Poor’s assigned its ‘ngBBB’ Nigeria national scale rating.

The outlook is stable.

This is Standard & Poor’s first rating on a Nigerian regional government.

Rationale

The ratings on the Nigerian State of Rivers are based on the state’s very low-though improving—information quality and disclosure by international standards and weak public finance system, which hinders management capabilities. Additionally, expenditure flexibility is limited because of large development needs that entail capital investment pressure. Also, Rivers has high exposure to oil revenues, which are expected to decline substantially during 2009-2010 compared with 2008.

Positive factors in terms of credit quality are the state’s currently strong cash holdings, low debt, and very healthy operating balance which derives from favourable revenue arrangements allocating a substantial share of the country’s oil revenues to Rivers. The ratings also reflect the government’s commitment to modernise public finances.

The Nigerian public finance system is undergoing reforms in several areas, including transparency, debt management, and fiscal rules. Concerning transparency and disclosure, Rivers comes from a low starting point. The government is, however, taking steps to modernise public sector administration, including a substantial information technologies (IT) upgrade, Standard & Poor’s | RatingsDirect on the Global Credit Portal.

November 10, 2009 and a move toward greater accountability and transparency. Notwithstanding the current weakness of the system, Standard & Poor’s views this ongoing modernisation as a key element of Rivers’ credit profile. If this process were to lose steam, a downgrade would result.

Based on the 2007 and 2008 accounts provided by the state, Rivers posted an excellent budgetary performance in these two years (the after-capex surplus was 22% of total revenues), on the back of buoyant oil prices. This allowed for strong cash accumulation and permitted an ambitious capex effort totalling Nigerian naira (NGN)225 billion (a very high 79% of 2008 estimated total expenditure) without any need to tap the financial markets. We understand that the government is inclined to maintain capex at NGN200 billion, while we forecast that Rivers’ annual oil revenues might be 40% lower on average during the period 2009-2011 with respect to its peak in 2008, largely as a result of lower oil prices and ongoing civil conflicts in the Niger Delta region.

However, we anticipate that Rivers will be able to maintain capex without tapping the financial markets, owing to a boost in internally generated revenue (thanks to the outsourcing of revenue collection with Skye Bank PLC [not rated]) and the use of the state’s large cash holdings (based on information we received, the state had some NGN95 billion at the beginning of November and, according to our forecast, we expect it to have around NGN90 billion at year-end 2009).

Rivers receives oil revenue windfalls from the excess crude account (ECA), although the amount is currently uncertain and subject to oil price volatility. We thus assume that ECA windfalls will gradually decrease in the coming years.

A very substantial part of Nigeria’s natural gas deposits and, to a smaller extent, crude oil production, are located in Rivers. Major operators in the state include the main multinational oil companies, which are accompanied by a cluster of private local companies. Although periodic episodes of violence in the Niger Delta can temporarily affect GDP growth and/or relocate economic activities, oil-related activities bolster sustainable employment in the long run—as evidenced by per capita GDP that is triple the domestic average—and, thus, form a relatively solid tax base.

While our issuer credit rating on Rivers is ‘B’, we would not automatically assign the same rating to Rivers’ debt issuances. Specifically, some types of debt issues could contain structural features that enhance credit quality—for example, an irrevocable standing payment order that authorises the federal government to deduct debt service payments at source from the statutory allocation. In these cases, Standard & Poor’s may analyze the transaction

structure and assign a rating that is different to the issuer credit rating.

Liquidity

At present, Rivers enjoys a very comfortable liquidity position: It has

NGN86.6 billion in local currency and $66 million in U.S. dollars as November 2009, mainly deposited in the First Bank of Nigeria PLC Cash holdings might decrease substantially in the next few years due to the maintenance of strong capex combined with lower oil revenues. In our central scenario (where annual capex does not go above NGN200 billion and accumulated after-capex deficits amount to NGN25 billion in the period (2009-2011), the state’s liquidity should remain above NGN 50 billion at year-end 2011. We understand that Rivers faces no debt repayment in 2010, except for some deductions at source from the Federation account in respect of a NGN3.8 billion foreign loan outstanding at year-end 2008.

Outlook

Our stable outlook is based on Standard & Poor’s current macroeconomic forecast for Nigeria, including oil and gas prices and production. We also assume that revenue collection—contracted to a local bank—will steadily generate around NGN90 billion annually in the coming years. Based on these assumptions, we expect Rivers to continue to generate large operating revenues, which in turn should enable it to carry out some NGN200 billion in annual investments in the period 2009-2011.

In the coming three years, Rivers’ self-financing capacity will also depend on ECA windfalls, whose predictability is low. Consequently, the stable outlook factors in our expectation that Rivers will lower capex if ECA windfalls decline substantially, so as to avoid debt accumulation.

The stable outlook is also based on the state government’s commitment to pursue the main ongoing IT developments, and particularly the full deployment of properly functioning budgetary, accounting, and financial modules. That is, we expect Rivers to disclose sufficient information for a timely and comprehensive assessment and forecast of its budgetary performance and liquidity.

A downgrade could occur if we view that capex efforts are likely to lead to a rapid debt accumulation or if ongoing reforms—particularly regarding transparency and disclosure—lose momentum. Conversely, an upgrade would result if the debt burden remains very low, liquidity is ample, and ongoing reforms yield substantive results.

As part of our surveillance activity, we will periodically request information to assess progress regarding the state’s financial management.