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Cross River State Government of Nigeria Nigeria Local Authority Analysis Security class Issuer rating Series 1: N8bn Fixed Rate Bond Summary of bond programme: Total programme value: N40,000,000,000 Instruments: Various – variable coupon, zero coupon bonds. Coupon rate: Series specific. Maturity: Series specific. Status of bonds: Bonds will constitute an irrevocable obligation of the State and shall be a first-line charge on the Statutory Account of the State. Security: Security for the repayment and other obligations of the Issuer in relation to the Bonds shall be held by the Trustees and shall comprise the ISPO issued by the Accountant General of the Federation as a first line charge upon and payable out of the statutory allocation of the State. Key transaction counterparties: Issuer: Cross River State Government of Nigeria (“Cross River State” or “the State”) Trustees: FBN Trustees Limited, STL Trustees Limited. Lead Issuing House/Underwriter: FBN Capital Limited Reporting Accountant: Akintola Williams Deloitte. Solicitors to the Offer: Banwo & Ighodalo, Agabi, Shinaba, Ogon & Co. Registrars: First Registrars & Investor Services Ltd. Rating methodologies/research: Criteria for rating Public Entities, updated February 2015 Cross River State Government rating report 2014 Market Alert 2015, GCR downgrades five States. Glossary of Terms/Ratios (February 2015) Rating history: Initial Rating: (December 2014) Issuer Rating: BBB(NG) N8bn Series 1 Bond: A-(NG) Outlook: Stable Last Rating: (May 2015) Issuer Rating: BBB-(NG) N8bn Tranche 1 Bond: A-(NG) Outlook: Negative GCR contacts: Primary Analyst: Kunle Ogundijo Credit Analyst [email protected] Committee Chairperson: Dave King [email protected] Analyst Location- Lagos, Nigeria +23 41 462-2545 Website: http://www.globalratings.net Nigeria Local Authority Analysis | Public Rating December 2015 Rating scale Rating Rating outlook Expiry date National National BBB-(NG) A-(NG) Negative November 2016 Summary rating rationale To expand the economy and diversify revenue sources, Cross River State has implemented a number of agro-based programmes aimed at increasing food production, whilst also reducing unemployment. In addition, an improved regulatory framework has been put in place to develop the tourism potential of the State. With statutory receipts averaging 79% of total revenue over the last five years, the State remains vulnerable to the vagaries of the global oil market. Although, in F14, the decline in statutory receipts was partly moderated by higher Internally Generated Revenue (“IGR”), the impact of low oil prices could be more severe in F15 and beyond, and may expose substantial funding gaps over the medium term. IGR growth has remained firm, almost doubling over the six year period to a high N13.4bn in F14, evidencing the relative success of the revenue generation policies being implemented. Nevertheless, IGR remains below the level required to fund recurrent expenditure, with personnel costs surpassing IGR in all the years under review. While cost rationalisation measures in place resulted in a 3% decline in recurrent expenditure to a three-year low of N39.5bn, personnel costs have remained high, consuming a higher 40% of revenue in F14. This remains above Global Credit Rating Co. Ltd. (“GCR”) sustainable benchmark of 35%. As such, staff numbers need to be reduced and in the absence of such action, financial flexibility will remain constrained, with fewer available funds for developmental purposes. Debt profile has remained elevated, rising by N15.1bn to a new high of N74.5bn at FYE14. As a consequence, the gross debt to income ratio rose further to 135% (FYE13: 106%), while net debt to income ratio spiked to 124% at FYE14 (FYE13: 89%). Similarly, liquidity metrics worsened as days cash on hand declined to 56 days from 85 days in F13, following the decline in cash resources. As part of palliative measures to reduce the financial strain on States following the sustained fall in oil prices, Cross River State had commercial loans of N33.8bn converted into Federal Government of Nigeria (“FGN”) bonds (with lower interest rate and longer tenor), whilst also receiving (in 3Q F15) N7.9bn in soft loans from the Central Bank of Nigeria (“CBN”) under a special intervention fund. The negative outlook accorded to the State specifically reflects the high debt levels relative to IGR. The N8bn bond Issuance (issued in May 2015) under the first series is secured by an Irrevocable Standing Payment Order (“ISPO”) issued by the FGN, covering both the interest cost and principal redemption. As a result, a three notch rating uplift is considered appropriate for the bond Issue. Factors that could trigger a rating action may include; Positive change: An upgrade is unlikely in the short term. However, a rebound in oil prices, together with sustained growth in IGR and the demonstrated ability to expand and diversify the State’s economic base, could result in positive ratings action over the medium-long term. Negative change: The ratings could come under further pressure in the event of a sustained decrease in statutory receipts and/or IGR (negatively impacting operating cash flows). Were debt levels to rise further, this could also lead to further deterioration in the ratings. This page is intentionally left blank Nigeria Local Authority Analysis | Public Rating Page 2 Background to Cross River State Cross River State was created on May 27, 1967 and forms part of the 36 States that constitute Nigeria. It is a coastal State located in the south-south region and covers a land area of 20,156km2. Cross River State is bounded to the north by Benue State, to the west by Enugu and Abia States, and to the east by the Republic of Cameroon, with Akwa-Ibom and the Atlantic Ocean to the south. The State has an estimated population of over 3 million inhabitants and the capital city is located in Calabar. The State is currently comprised of 18 Local Government Areas that operate under 3 senatorial districts. Major towns include, Obudu, Ogoja, Akamkpa and Ikom. Being largely agrarian, the Cross River State government has implemented a number of agro-based programmes (including the establishment of large plantations) expected to increase food production, whilst also reducing unemployment and facilitating wealth creation opportunities across the State. Major food crops include yams, cassava, rice and plantain, while cash crops include palm produce, cocoa, rubber and groundnuts. Some large conglomerates recently established large plantations in parts of the State, as part of the private sector partnership with the government. Besides agriculture, major mineral resources in the State include limestone, titanium and hard stone, albeit, commercial exploration is yet to commence. Industrial activity in the State is supported by an airport, which is in close proximity to the seaport, and serves as an alternative to the Lagos and Port Harcourt seaports. Being a major tourist hub, a number of tourist sites and cultural activities have been upgraded to global standards, attracting thousands of visitors all through the year. Major tourist attractions include the Tinapa resort, which serves as a business and leisure resort, as well as the Obudu mountain top, Ikom monoliths, Agbokim waterfalls, Mary Slessor Tomb, Calabar Slave Park and the famous Calabar carnival. N40bn bond issuance programme In 2015, Cross River State Government of Nigeria filed an application with the Securities and Exchange Commission (“SEC”) to issue bonds into the Nigerian capital market, mainly to refinance existing obligations. The debt issuance programme is expected to be continuously available to the State up to the limit of N40bn, and for a period of 2 years. Although, the State had initially applied to raise N31.95bn in bonds under series 1, It was only able to issue N8bn bonds in May 2015, given the unfavourable market condition at the time. The bonds under the programme are expected to be issued in registered form and in series. Each tranche (or series) is subject to a Supplementary Shelf Prospectus and/or Pricing Supplement prepared on behalf of the State by duly appointed Issuing Houses. Key features of the programme include: The bonds constitute direct, unconditional and irrevocable obligations of the State, and shall rank Nigeria Local Authority Analysis | Public Rating paripassu with other senior unsecured obligations of the State. The method of issue for each series issued under the Programme shall be contained in the applicable Pricing Supplement. The series 1 Issue was partly underwritten. Municipal bonds are currently exempt from taxation in Nigeria. A Sinking Fund shall be created for each series in accordance with the provisions of the Enabling Law and the Investment and Securities Act (“ISA”) 2007. Security for the repayment and other obligations of the Issuer in relation to the Bonds shall be held by the Trustees and shall comprise an ISPO1 approved by the FGN as a first line charge upon and payable out of the statutory allocation of the State. As the ratings accorded under the debt issuance programme are linked to the unsecured domestic Naira rating accorded to Cross River State, the focus of the analysis in this report is on the operating & economic environment in which the State functions, as well as the financial performance and profile of the State itself. Unique rating considerations for the N8bn series 1 fixed rate bond are detailed in the final section of this report. Political considerations Political and legislative framework Under the Nigerian federal system of government, there are 3 tiers of government, namely the Federal, State and Local governments. The fiscal decentralisation model in place is aimed at empowering the lower tiers of government. Each tier is responsible for the provision of various government services and has the authority to collect and retain revenues under their respective jurisdictions. The major areas of jurisdiction and sources of revenue currently available to the Federal and State Governments, as well as their respective obligations, are reflected as follows; Table 1: Federal and State government duties and revenue sources Federal government State government Duties Housing Local Government creation Currency & external affairs Legislature Legislature Education Security Housing Electricity supply Water & electricity supply Infrast. expansion & maintenance Road construction & maintenance Distributions to State & Local Gov. Health Revenue sources Company tax Federal account Oil sales Personal income tax* VAT VAT allocation Mineral royalties & rents Derivation income Duties Licenses and fees* *Collected by States. Other revenues collected & held in trust by the FGN It is noted that revenue allocations between the Federal, State and Local Governments change from time-to-time. In this regard, 15% of VAT is retained by the FGN, 1 An ISPO is issued by the office of the Accountant General of the Federation (“AGF”) and represents a first line charge on federally allocated funds Page 3 whilst State and Local Governments are apportioned the remaining 50% and 35% respectively. In terms of federally allocated revenues (excluding VAT), as it currently stands: 52.68% is allocated to the Federal Government, 26.72% to the States and 20.6% to the Local Government Areas. A further 1% each is directed towards the Federal Capital Territory and Ecological Fund. In addition, mineral producing states receive a 13% derivation from the FGN. Political factors The FGN allocates revenue (accruing to the country) among the various tiers of government, and (by law) all activities that relate to commercial mining/exploration of mineral resources fall under its purview; with proceeds distributed per the aforementioned sharing arrangement. Given the low level of internally generated revenue reported by most States (particularly the smaller States), they generally remain heavily dependent on federal receipts to sustain operations. This has been aggravated by the high operating cost structures and growing debt burdens reported by many States, further constraining financial flexibility. Consequently, and given the sustained slump in global oil prices that has grossly reduced federal receipts, many States have been unable to meet recurrent expenditure over recent months, demonstrated by their inability to pay workers’ salaries & pensions and other unsecured creditors. Given the political structures in place and the fact that the FGN has ultimate responsibility for the financial wellbeing of the States and for service delivery to Nigerian citizens, the FGN has developed a financial support structure for States. To this end, a comprehensive relief package has been implemented that will see States benefit from a cash bailout and a restructuring of their commercial debts. The intervention measures include: USD2.1bn (N413.7bn) has been appropriated from all of the tiers of government as a direct cash bailout, in respect of which the States have received their portion. Under a special intervention fund, CBN disbursed a sum of N338bn to 27 States in form of soft loans at negotiated rates, in respect of which Cross River received N7.9bn. Restructuring of commercial debt obligations of States through the Debt Management Office, by extending the tenor of the loans and thereby reducing their annual debt service obligations. In this regard, Cross River had commercial loans of N33.8bn converted into FGN bonds in 3Q F15. Administration and corporate governance The affairs of the State are managed by an elected governor and an executive council, which is comprised of appointed commissioners manning various ministries, departments and agencies. Other arms of government include the Legislature (i.e. the Cross River State House of Assembly), which is responsible for passing Statespecific laws. The Judiciary serves as the third arm of Nigeria Local Authority Analysis | Public Rating government, interpreting and adjudicating on disputes, and is headed by the Chief Justice. Activities of the State are governed under the 1999 Constitution of the Federal Republic of Nigeria. The financial statements of Cross River State have been prepared in accordance with the provisions of the amended Finance (Control and Management) Act 1958 Cap 144 LFN. The Accountant-General is responsible for the preparation and presentation of the financial statements based on section 125(5) of the constitution. Thereafter, it is the statutory responsibility of the Auditor General to form an independent opinion based on the audit of the financial statements. Cross River State’s financial statements are in compliance with Nigeria’s Generally Accepted Accounting Principles and Practices, and other government-prescribed accounting regulations and principles. Further to this, GCR’s rating review of the State is based on audited financials for the four years to 2013, as well as unaudited financial statements for the year ended 2014. Regarding the four years of audited financial statements, the Auditor General issued unqualified opinions. Economic context The successful conclusion of the general elections in April 2015 culminated in the orderly transfer of power to a new government. Coupled with the renewed military offensive against insurgents in the NorthEastern part of the country, this has helped to create a more stable political environment. In contrast to this positive development, the sustained slump in the international price of crude oil has severely affected the Nigerian economy. As crude oil prices have halved since 1H 2014 to trade between USD40-USD60 per barrel, the FGN’s oil price benchmark was reduced to USD53 per barrel for 2015 (from an initial forecast of USD78 for 2014), forcing the Federal Government to revise its budgets downwards (as indicated in the Medium Term Expenditure Framework for 2015 – 2017). Despite the above, the non-oil sector has remained the main driver of the economy over the last few years, contributing in excess of 80% of GDP (on the back of solid growth in trade, textile, telecommunication, real estate and agriculture); albeit that such growth has largely resulted from the multiplier effect of oil revenues across the economy. Conversely, growth in the oil sector (which contributes the bulk of government revenue and exports) has slowed in 2015, with falling prices being compounded by lower crude oil production (mainly due to theft and pipeline vandalism). This resulted in subdued GDP growth of 2.35% in 2Q 2015, from 3.96% in 1Q 2015 and 5.94% in 4Q 2014, with these values being well below the average growth of 6.23% attained in 2014. To support macro-economic stability and halt the decline in foreign reserves, in November 2014 CBN devalued the mid-point of the official currency trading band from N155/USD to N168/USD and simultaneously Page 4 widened the band to +/-5% (from +/-3% previously). Nevertheless, demand for US Dollars continued to exert downward pressure on the Naira in 2015, as revenue from crude oil exports has drastically reduced. Accordingly, the CBN further adjusted the official exchange rate to N196.9/USD in June 2015. Despite these corrective actions, foreign currency reserves had declined to USD31.9bn in July 2015, from USD34.9bn in December 2014. Table 2: Economic indicators GDP (USD'bn) GDP growth (%) GDP per capita (USD) Debt to GDP (%) Oil price (USD per barrel) Avg.inflation rate (%) 2011 411.7 7.4 2012 461.0 6.6 2013 515.0 5.4 2014 568.5 6.2 2015f 581.0 3.0 1,015.8 1,030.2 1,055.8 1,091.6 1,144.0 18.0 19.0 11.0 10.5 8.4 87.0 10.8 86.5 12.2 91.2 8.5 85.6 8.1 50.7 9.7 Avg. exchange rate (NGN/USD) 155.9 Sources: NBS, CBN and World Bank. 158.8 159.3 165.1 197.0 In further support of financial stability, the harmonised cash reserve requirement (“CRR”) on public and private sector deposits was (in November) further reduced to 20%, from 25% in September. In addition, CBN has cut the prime lending rate for the first time in around six years to 11% from a high 13%, in order to increase lending to the real sectors of the economy, including infrastructure, agriculture, solid minerals and power. The relaxation of both the CRR and the interest rate is expected to increase liquidity in the economy, which declined as a result of reduced government spending and the introduction of the Treasury Single Account for all government entities; the latter having been introduced to reduce leakages and improve accountability. Inflation rate eased for the first time in eleven months, falling to 9.3% in October 2015 from 9.4% the previous month (a two-year high), mainly due to slower increases in foodstuff prices and other consumables. Although, the inflation rate averaged 8.1% in 2014, it has consistently risen in 2015, underpinned by the sustained depreciation of the Naira and the country’s persistent current account deficits. Short to medium term economic prospects in Nigeria are mixed. On the one hand, the stable political environment and strong investor interest in the economy are positive. However, the impact of lower oil prices is being felt acutely in 2015 in terms of constrained government spending and the effect of oil revenues across the economy, with overall GDP growth expected to fall to around 3% in 2015. This will delay efforts to reduce the country’s infrastructure deficiencies, while the challenges of erratic power supply and security concerns are likely to persist (especially in parts of the North). However, the youthful urban population, with the increased spending capacity bodes well for future growth, and thus, GDP growth is expected to be in line with the 6% attained over the last decade. Income and expenditure A 5-year historical financial synopsis is reflected at the end of this report and brief comment follows hereafter. The financial statements are based on the Audited Nigeria Local Authority Analysis | Public Rating Financial Statement for the years 2009-2013 These statements are prepared using the cash basis of accounting and are divided into distinct operating and capital income/expenditure statements. The Auditor General of Cross River State gave an unqualified audit opinion on the results for F13. Total revenue peaked at a high N58.7bn in F11, since then, total revenue has evidenced successive declines (albeit marginal) of N55.2bn in F14 (F13: N56.2bn). The initial growth was spurred by much higher statutory receipts, but such receipts have declined as a result of the State’s loss of its designation as an oil producing State (including the 13% derivation fee receivable). Added to this, the sustained fall in global oil prices since 2H F14 resulted in lower statutory receipts of N41.8bn in F14 (F13: N44.2bn). Notwithstanding the relatively small impact of the drop in oil prices on revenue in F14, a much greater impact is expected in F15 and F16 as oil prices have remained fluctuated around the USD40/barrel mark, well below the revised FGN benchmark of USD53/barrel and the highs of over USD100/barrel reported in early 2014. To cushion the impact of reduced revenues on governance, the State has put in place a number of cost rationalisation measures. Key amongst these is a reduction in the cost of government through strict compliance with budgeted expenditure levels and the elimination of non-essential expenditure such as foreign travel. Table 3: Operating cash flow (Nm) Total IGR Statutory allocation Total recurrent inc. Personnel costs CRF Charges Overhead costs Total recurrent exp. Operating surplus Borrowings/others VAT proceeds Loan Repayment Capital expenditure Cash & equiv. F13 F14 Budget F14 % achieved 12,002 44,246 56,248 (21,673) (4,972) (14,176) (40,821) 15,427 49,503 8,025 (935) (68,974) 3,046 13,422 41,790 55,211 (22,020) (5,972) (11,533) (39,526) 15,685 26,179 8,103 (259) (63,641) (13,933) 27,840 50,900 78,740 (23,878) (13,677) (15,310) (52,865) 25,875 87,810 7,167 (804) (122,938) (2,889) 48.2 82.1 70.1 92.2 43.7 75.3 74.8 60.6 29.8 113.1 32.2 51.8 n.a IGR performance has remained strong over the review period, posting 79% growth over the three-year period to N12.7bn in F12. Following a slight decline in F13 (attributed to lower tax income), IGR performance rebounded to register at a peak of N13.4bn in F14. IGR has been underpinned by income taxes, which has comprised over 50% of IGR in most of the years under review. Income tax rose to N6.7bn in F14 from N5.5bn in F13, evidencing some successes in the revenue generation policies and stimulatory economic activities. An analysis of tax income reveals limited concentration risk present as the top ten contributors amounted to a cumulative N1.7bn (13% of IGR). Further contributing to growth, other sources of IGR (including fines and fees, rent/rates, licenses, earnings and sales of government property) almost doubled to N2.6bn in F15 as the State stepped up the enforcement of rules and regulations. In contrast, non-recurring revenue from sundry receipts and refunds amounted to a lower N4bn, while interest and investment income remained negligible at N116m (F13: N228m). Page 5 As a result of cost rationalisation measures, total recurrent expenditure declined by N1.3bn to N39.5bn in F14. This was spurred by a 19% decrease in overhead costs to N11.5bn, following the implementation of stricter expenditure control policies and the reduction of wastages in the system through the elimination of nonessential expenditure. However, in contrast to the cost savings achieved in overheads, consolidated revenue fund charges increased by N1bn to N6bn following higher payments made to retired staff and political appointees. Similarly, a small N347m increase to N22bn was reported in personnel costs, albeit comparing favourably to the excessive increases in previous years. Cross Rivers attributed the stable staff costs to the implementation of regular staff audits and a reduced employment in non-essential positions. Nevertheless, this translated to a higher personnel costs to expenditure ratio of 56% (F13: 53%) owing to the overall decline in total expenditure. Relative to income the staff expenditure ratio edged higher to 40% in F14. The high personnel cost ratio is of concern as it has registered above the GCR sustainable benchmark of 35% in each of the last six years, and at current levels indicates that there is limited scope to cut expenditure further without major retrenchments, which may be politically unpopular. In the absence of such action, however, Cross River’s financial flexibility remains constrained, with few available funds for developmental purposes. Notwithstanding the improved IGR, it still remains well below what is recurred to cover personnel costs. This has entrenched the State’s reliance on the FGN for financial sustenance, with statutory receipts comprised an averaged 79% over the last five years (F14: 76%). On the back of this support, Cross River State has consistently reported operating surpluses over the review period. With surplus remaining flat on N15.7bn in F14, (and much lower than the N26.3bn reported in F11), the surplus margin rose to 28.4%, from 27.4% in F13. In an effort to accelerate the development of infrastructure, the State has maintained a high level of capex spend over the last five years. Although, capex spend registered a lower N63.6bn in F14 from N69bn in F13, it remained much higher than previous years. Since expanding its capex programme in F11, the State has expended a cumulative N238.8bn on social and commercial infrastructure. As in previous years, a significant N46.1bn (73% of capex) was expended in the provision of economic infrastructure, including transportation, agriculture and power. The remainder was expended on social infrastructure, environment and urban renewal and administrative services to the citizens. The industrialisation agenda embarked upon has been largely supported by the robust surpluses, and significant capital receipts. Notwithstanding the progress in attaining its long term developmental targets, sustained funding remains crucial for further progress. Nigeria Local Authority Analysis | Public Rating Funding profile The value of Cross River’s assets declined to N11.1bn at FYE14, from N18.9bn at FYE13. However, this did not arise from a decrease in the real value of assets, but rather from a change in accounting procedures, whereby fixed assets are expensed in the year of acquisition. Cash and equivalents registered at a lower N6.1bn at FYE14 from N9.5bn previously, underlying the increased utilisation of cash resources to fund capex. Nevertheless, this represented a higher 55% of asset at FYE14 (FYE13: 50%), based on the lower assets base. Cash is held solely in Naira denominated current accounts placed with commercial banks in Nigeria. Other current assets reported a 3% growth to N5bn at FYE14, with the bulk representing advances. The State drew down on its entire investment portfolio (recognised as the future generation/reserve fund) during F14, with a negative balance reported at yearend. Assets in the portfolio mainly comprised bonds and money market securities that are supposed to be held in trust by independent trustees and managed by recognised fund managers. GCR is yet to receive the most recent copy of the fund statement from the State in this regard. While details of the State’s borrowings are not reported in the financial statements, schedules provided by the State indicate an increasingly elevated debt profile. In this regard, debt has risen by a net N52.5bn over the five-year review period to N74.5bn at FYE14, with the bulk incurred to sustain the industrialisation drive and to augment dwindling statutory receipts. Of the total debt outstanding at FYE14, a significant N48.8bn/65% of debt relates to internal loans, mainly comprising commercial bank loans, with the largest loan provider being First Bank Plc at N47.7bn/64% of debt at FYE14. Other loans are much smaller and are provided by 3 counterparties. Cognisance is taken of the fact that the State issued N8bn fixed rate bonds in 2Q F15, which would further raise debt, although, this is expected to amortise through semi-annual payments until full redemption in 2022. Table 4: Total debt (Nm) Internal loans Ecobank Plc. First Bank Ltd. Zenith Bank Fidelity Bank Enterprise Bank Diamond Bank Foreign loans Total loans FYE13 40,493 343 37,437 814 1,303 247 349 18,929 59,422 FYE14 48,783 709 47,686 356 32 25,762 74,545 Foreign loans rose by a net N6.8bn to N25.8bn at FYE14. This was due to a mix of new loans incurred as well as the impact on the Naira depreciation on the local currency value of the loans. The bulk of these loans are provided by developmental agencies (including the International Development Association and the African Development Bank), are all USD-denominated and generally reflect concessionary interest rates of around 1% per annum, utilised to finance development in the State. Page 6 Debt and liquidity metrics As a consequence of the rise in debt, the gross debt to income ratio rose further to 135% at FYE14 (FYE13: 106%), while the net debt to income ratio increased to 124% (FYE13: 89%). Similarly, liquidity metrics were also constrained as days cash on hand declined to 56 days (F13: 85 days), following the increased utilisation of cash reserves to finance capex. N'bn 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 Debt: Income Ratio 2010 2011 2012 Gross debt Net debt: Income (RHS) % 140.0 120.0 100.0 80.0 60.0 40.0 20.0 0.0 2013 2014 Gross debt: Income (RHS) Future prospects and forecasts The following operating and capital budget is based on forecasts provided by Cross River State, as approved by the State Assembly under the 2015 Appropriation Act. With projections christened “Budget of Transition”, it has been prepared on the basis of a number of assumptions, in line with FGN benchmarks. These include an average annual crude oil production of 2.28 million barrels per day, an average oil price of USD53 per barrel, and a capex-recurrent expenditure ratio of 60%:40%, in order to quicken the pace of development in the State. In line with previous years, the cardinal point of the forecasts is the continued utilisation of the Medium Term Budgetary Framework (“MTBF”), which has formed the basis for the compilation and implementation of budgets. The use of the MTBF has enabled effective policy introduction, implementation, evaluation and monitoring of all developmental programmes across the State. This has enabled the State to efficiently utilise and allocate limited resources across the various sectors, including, transportation, health and education that have witnessed significant improvements over the last few years. Positively, a number of programmes in the agricultural sector have become fully operational with direct benefits to the indigenes in form of employment and wealth creation opportunities, while also providing a boost to the local economy. Specifically, the recently established (under the FGN agricultural transformation scheme) Growth Enhancement Scheme has provided subsidised fertilizers and improved seedlings to farmers to boost maize, rice and cassava production in the State. Similarly, the agro-business and entrepreneurship centre (Songhai Farm) in Abi local government area commenced operations with the planting of pineapple, pepper and several other crops. The hostel for students was also completed, while a number of the pioneer students (who were previously sent to train at the main Songhai centre in Porto Novo, Benin Republic) now fully engaged at the farm settlement. The centre has Nigeria Local Authority Analysis | Public Rating equipped a number of local farmers with the necessary knowledge and skills for modern farming, while also developing agricultural capacity within the State. A tourism policy document and regulatory framework for the standardisation and licensing of tourism operators in the State has been completed and its implementation commenced in line with global best practices. In addition, the State has begun massive restructuring of tourism sites to upgrade facilities and expand the tourism value-chain. Furthermore, under the joint funding of the State and Bank of Industry, a significant number of small scale enterprises enjoyed credit facilities ranging from N0.05m to N0.25m, while CBN Funded Entrepreneurship Development Centre helped expand the frontiers of a private sector-led economy, training a number of prospective entrepreneurs and supporting others to either start up or expand their businesses. According to the State, the continued implementation of these policies/programmes over the medium term would help raise the level of the IGR collections to sustainably cover recurrent expenditure, enabling federal receipts to be channelled towards developmental programmes. In view of the expected increase in economic activities, which should boost tax income, forecasts indicate IGR will almost double to N25bn in F15. This is premised on the continued implementation of stricter enforcement of rules and regulations and the restructuring of Ministries, Departments and Agencies to function efficiently and generate revenue for the State. In contrast, on the back of the sustained fall in oil prices, statutory allocations are budgeted to decline by 14% to N36bn. Nevertheless, based on the aggressive IGR target, higher total revenue of N61bn is expected for F15. Table 5: Operating Budgets (N'bn) Actual F14 Budget F15 Total IGR 13 25 % Change 86.6 Statutory allocation 42 36 (13.7) 10.7 Total recurrent inc. 55 61 Total recurrent exp. (40) (55) 39.7 Operating surplus 16 6 (62.4) Other capital receipts 34 50 45.7 0 14 n.a (64) (73) 14.1 (14) (3) n.a Borrowings Capital expenditure Cash & equiv. Recurrent expenditure is budgeted to rise to around N55bn in F15, in line with the expected increase in economic activities, given the implementation of the various revenue generation programmes. A portion of expenditure includes interest and principal repayments on existing obligations, including the N8bn fixed rate bond. As a consequence of the higher expenditure, a small operating surplus of N6bn is expected in F15 (F14: N16bn). The State has budgeted to continue with its aggressive infrastructural development programme, and a higher capex spend of N73bn is proposed for F15 (F14: N63.6bn). This will be funded from the surplus, borrowings of N14bn (including the N8bn bond, already Page 7 issued in May 2015) and capital receipts (including grants and VAT receipts) of N50bn. As at 3Q F15, Cross River State had benefitted from the debt restructuring programme introduced by the FGN as part of its palliative measures to address the decline in statutory receipts. In this regard, FGN bonds of N33.8bn have been substituted for existing commercial obligations (representing 82% of bank loans), effectively extending the maturities of these debt obligations for 15-20 years, and thereby reducing annual debt service costs. Following the debt restructuring exercise, gross debt would likely remain around the N70bn mark at FYE15, given smaller payments on the loans, with the gross debt to income ratio estimated to remain high at around 110% at FYE15. Table 6: Revised Amortisation schedule (Series 1: N8bn Fixed Rate Bond) Details of the bond Series 1 bond N8,000m Interest Rate: 17% p.a. fixed Repayment Frequency per 2 (Semi-Annually) annum: Original Term (months): 84 No of payments: 14 ISPO Amount per Month: N168.9m Amortisation schedule (Nm) Year Beg Payment Interest Principal End 8,000 0 8,000 1,997 1,333 665 7,335 1 7,335 1,997 1,215 782 6,553 2 6,553 1,997 1,076 921 5,632 3 5,632 1,997 913 1,084 4,548 4 4,548 1,997 721 1,276 3,271 5 3,271 1,997 495 1,503 1,769 6 1,769 1,997 229 1,769 0 7 Total 13,982 5,982 8,000 Bond rating considerations In performing the above analysis, GCR has considered those factors impacting the general creditworthiness of Cross River State i.e. its Issuer credit rating. However, structural and other enhancements have been (or are expected to be) utilised to improve the credit risk of a specific Issue(s) under the Bond programme. In respect of the above, apart from the scenario of a partial or full guarantee, GCR’s approach to such Issue ratings is to utilise the issuer rating as a base from which credit enhancements are then considered. N8bn Fixed Rate Bond The Series 1 Fixed Rate Bond (issued in May 2015) carries a 7-year maturity (2015–2022), bearing a coupon rate of 17%. Based on the revised amortisation schedule, principal redemption and coupon payments totalling about N999m will be made semi-annually (around N2bn annually), and will be payable in arrears up to and including the maturity date. The primary source of repayment on interest and principal of the bonds issued is via a Sinking Fund. The Sinking Fund is fully backed by an ISPO, approved by the Ministry of Finance. With regards to both interest and principal payments, monthly deductions of N169m will be made from the State’s share of the Statutory Allocation from the Federation Account throughout the tenor of the bond. This equates to ring-fenced debt servicing receipts of over N2bn in a 12-month period. Given this, the ISPO receipts fully cover both the interest and principal payments of the Series 1 bond. In addition, investment income is expected to accrue on balances in the Sinking Fund Account through the tenor of the bond. According to the trustees, after accounting for bank charges, management fees and refunds to the government, there was an accrual of N665m in the sinking fund account as at end September, 2015. Nigeria Local Authority Analysis | Public Rating Page 8 Cross River State Government of Nigeria Income Statement (Naira in Millions except as Noted) 31 December 2010 2011 2012 2013 2014 Income tax Other internally generated revenue Interest and investment income Miscellaneous revenue 4,632.4 742.8 160.5 2,150.4 5,899.5 1,261.3 177.3 1,821.5 8,589.3 1,745.5 147.0 2,252.8 5,526.4 1,476.8 228.3 4,770.6 6,693.9 2,625.2 115.9 3,986.5 Total internally generated revenue Statutory allocation 7,686.1 27,600.5 9,159.6 49,574.6 12,734.6 45,231.9 12,002.2 44,246.2 13,421.6 41,789.6 35,286.6 (12,259.2) (3,239.3) (9,321.5) 58,734.2 (15,454.8) (4,455.4) (12,565.1) 57,966.5 (19,254.0) (5,800.4) (14,577.8) 56,248.4 (21,673.3) (4,971.9) (14,176.0) 55,211.1 (22,020.3) (5,972.4) (11,533.4) 10,466.6 (5,661.1) (5,296.8) 26,259.0 (7,528.4) (7,605.7) 18,334.3 (18,652.1) (3,762.0) 15,427.2 (28,597.0) (935.5) 15,685.0 (25,459.8) (258.5) (491.3) 11,124.9 (4,079.8) (14,105.2) (10,033.3) (1,942.0) 469.2 19,102.3 5,661.1 (23,951.5) (660.9) 7,457.8 20,318.2 7,528.4 (51,089.3) (16,445.7) 13,382.0 21,836.0 18,652.1 (55,056.3) (17,631.9) 26,079.7 31,448.0 28,597.0 (68,973.8) (481.0) 0.0 34,282.1 25,459.8 (63,641.2) (660.9) (16,445.7) (17,631.9) (481.0) (4,380.3) Consolidated revenue fund Capital development fund 23,433.7 (660.9) 34,558.6 (16,445.7) 30,478.8 (17,631.9) 16,373.5 (481.0) 6,340.2 (4,380.3) Total public funds Non-interest bearing liabilities Total liabilities 22,772.8 3,091.4 25,864.2 18,112.9 17,156.0 35,268.9 12,846.9 10,125.8 22,972.7 15,892.5 2,970.2 18,862.7 1,960.0 9,119.6 11,079.5 Investments Cash and cash equivalents Other current assets 4,211.9 9,901.8 11,750.5 4,811.7 22,451.8 8,005.4 4,886.8 13,288.3 4,797.6 4,522.8 9,484.1 4,855.8 (9.2) 6,086.6 5,002.1 Total assets 25,864.2 35,268.9 22,972.7 18,862.7 11,079.5 Total loans* Internal loans External loans 22,059.9 5,571.3 16,488.5 30,236.4 13,439.9 16,796.5 43,262.3 25,708.1 17,554.2 59,422.1 40,493.0 18,929.1 74,544.5 48,783.0 25,761.5 Efficiency Total revenue growth IGR growth Total expenditure growth (including capex) Personnel cost growth Capex growth IGR : Total revenue Non IGR : Total revenue Personnel cost: Total expenditure Operating surplus/(loss) : Total income Capex : Total income 12.8 8.2 (11.0) 9.4 (17.6) 21.8 78.2 49.4 29.7 67.9 66.4 19.2 71.3 26.1 113.3 15.6 84.4 47.6 44.7 87.0 (1.3) 39.0 13.3 24.6 7.8 22.0 78.0 48.6 31.6 95.0 (3.0) (5.8) 16.0 12.6 25.3 21.3 78.7 53.1 27.4 122.6 (1.8) 11.8 (6.0) 1.6 (7.7) 24.3 75.7 55.7 28.4 115.3 Gearing & Liquidity Days cash on hand Total interest bearing debt : total income Net interest bearing debt : total income Total interest bearing debt : total assets Net interest bearing debt : total assets 145.6 62.5 34.5 85.3 47.0 252.3 51.5 13.3 85.7 22.1 122.4 74.6 51.7 188.3 130.5 84.8 105.6 88.8 315.0 264.7 56.2 135.0 124.0 672.8 617.9 Total income Personnel emoluments CRF Charges Overhead costs Operating surplus (deficit) Transfer (to)/from capex and development fund Consolidated revenue fund adjustments Transfer to/ (from) consolidated revenue fund Capital development fund Opening balance Loans/ overdraft Vat proceeds and other Transfer (to)/ from consolidated revenue fund Capital expenditure Closing balance Balance Sheet Key Ratios *Total debt left off balance sheet Nigeria Local Authority Analysis | Public Rating Page 9 This page is intentionally left blank Nigeria Local Authority Analysis | Public Rating Page 10 This page is intentionally left blank Nigeria Local Authority Analysis | Public Rating Page 11 SALIENT POINTS OF ACCORDED RATINGS GCR affirms that a.) no part of the rating was influenced by any other business activities of the credit rating agency; b.) the rating was based solely on the merits of the rated entity, security or financial instrument being rated; c.) such rating was an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the ratings are valid until 11/2016. Cross River State participated in the rating process via teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from Cross River State and other reliable third parties to accord the credit rating included; - the 2014 unaudited financial statements - four years of previous audited accounts - the approved 2015 budget, - Breakdown of facilities available and related counterparties, - Trustees’ report as at September 30, 2015, The ratings above were solicited by, or on behalf of, the rated client, and therefore, GCR has been compensated for the provision of the ratings. ALL GCR CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS, TERMS OF USE OF SUCH RATINGS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS, TERMS OF USE AND DISCLAIMERS BY FOLLOWING THIS LINK:HTTP://GLOBALRATINGS.COM.NG/UNDERSTANDING-RATINGS. 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