Statement by Mr Vincent H C Cheng
Vice-Chairman and Chief Executive

Good afternoon, ladies and gentlemen. Thank you for joining us today.

1998 was a particularly difficult year for the banking sector. The Hong Kong economy suffered its deepest recession on record, with GDP contracting by more than 5%. Against this backdrop, Hang Seng Bank became even more vigilant in its business operations and focused on building on its considerable financial and operating strengths.

In 1998, Hang Seng recorded an operating profit before provisions of HKD10,632 million, a marginal decline of 1.3% compared with the previous year.

Profit attributable to shareholders fell by 27.5% to HKD6,788 million and pre-tax profit decreased by 26.4% to HKD7,976 million. These results were affected by the substantial increase in provisions for bad and doubtful debts, reduced profit on the disposal of fixed assets and investment securities, and the deficit on the revaluation of the Bank's properties. Earnings per share dropped by 26.8% to HKD3.55.

Given the Bank's strong balance sheet, sound business fundamentals and commitment to shareholders, the Directors have recommended that the final dividend be maintained at the previous year's level of HKD2.02 per share. This brings the total distribution for the year to HKD3.42 per share, the same as 1997. The dividend as declared should not be taken as an indication of future dividend levels.

Total assets at the year-end grew by 6.0% to HKD420.3 billion from a year earlier. The return on average total assets was 1.7% compared with 2.4% for the previous year.

Shareholders' funds fell by 13.4% to HKD43.1 billion, and the return on average shareholders' funds was 14.2% compared with 19.1%.

During the year, total operating income was stable, down by a mere HKD6 million to HKD14.5 billion. Average interest-earning assets grew by 6.7% to HKD383.9 billion and net interest income increased by 1.8% to HKD11.4 billion. The favourable impact of higher yields from free funds and interbank assets was offset by lower mortgage loan pricing, rising customer deposit interest costs and the increase in suspended interest following the rise in non-performing loans. The net interest margin fell by 14 basis points from a year earlier to 2.96% per annum.

Other operating income decreased by 6.1% to HKD3.1 billion. An improvement in dealing profit and other income was overshadowed by a 20.8% decrease in net fees and commissions from credit facilities, stockbroking, trade finance and card services.

Operating expenses rose by 3.6%, largely due to a HKD200 million top-up contribution to the staff retirement benefits scheme as a result of the adverse investment environment. The cost-to-income ratio was maintained at a low level of 26.7%, compared with the previous year's 25.7%. If the top-up contribution were excluded, operating expenses would fall by HKD65 million, or 1.7%, and the cost-to-income ratio would be a record low of 25.3% since the figure was first released in 1989. Hang Seng's cost-to-income ratio reflects the Bank's cost-efficiency and remains among the lowest in the banking world.

In November, the Group's premises and investment properties were revalued and of the total revaluation deficit of HKD6.5 billion, HKD6.2 billion represented a reduction in the property revaluation reserve. The balance of HKD305 million marked the fall in value below the original acquisition cost (less depreciation) of bank premises acquired in recent years and was charged to the profit and loss account.

The net charge for bad and doubtful debts rose substantially by HKD1,841 million to HKD2,476 million. This was mainly due to higher specific provisions made for corporate lending, trade finance, taxi loans and residential mortgages as a result of the economic downturn and the fall in collateral value. There was a HKD33 million release in general provisions due to the decrease in customer advances.

The ratio of total provisions to gross advances to customers increased from 1.3% to 2.2% compared with the previous year. The increase was recorded in specific provisions which, at 1.5%, reflected the substantial rise in doubtful debts. General provisions were maintained at about 0.7%, including an additional provision of HKD250 million raised in the end of 1997 which has been left intact in view of the prevailing economic conditions in Hong Kong. The ratio of non-performing advances (net of suspended interest) to gross advances rose to 3.9% from 0.8% a year earlier. Non-performing advances were identified promptly and prudently, with HKD444 million in related interest receivable suspended. In line with our conservative provisioning policy, specific provisions plus collateral value amount to almost 100% of non-performing advances.

Profit on the disposal of tangible fixed assets and investment securities fell by 91.7% to HKD52 million compared with a year earlier due to the substantial reduction in disposal of locally-listed equities.

On the balance sheet, current, savings and other deposit accounts increased by 7.2% to HKD352.3 billion compared with a year earlier. Certificates of deposit in issue increased by HKD5.2 billion to HKD10.7 billion under the Bank's HKD30 billion CD programme to secure longer-term funding and to enhance asset and liability management.

Advances to customers (net of suspended interest and provisions) decreased by 2.9% to HKD198.1 billion. Declines were recorded in lending to most commercial sectors as loan demand slackened in the economic downturn. Residential mortgages reported satisfactory growth, benefiting from more active primary market activities despite the fall in property prices.

The advances-to-deposits ratio fell to 56.2% from 62.1% a year earlier, reflecting the growth in customer deposits and the marginal fall in advances to customers.

Our balance sheet continued to be underpinned by strong liquidity and capital positions. The average liquidity ratio for 1998 increased to 39.2% compared with 38.8% a year earlier. The total capital ratio fell slightly to 21.3% at the year-end compared with 22% a year earlier, affected by the fall in property revaluation reserves. The tier 1 capital ratio rose to 17.5% from 16.3%.

In the unfavourable operating environment, Hang Seng built on its well-established strengths of prudent financial management, efficient operations and service excellence to maintain market leadership. High potential businesses were expanded even though liquidity was preserved to provide ammunition for growth when the economy stabilises.

The emphasis on prudent lending and asset quality was reinforced. During the year, the credit risk management function was restructured to provide integrated risk management.

Our strict expense discipline was further tightened. Business process re-engineering continued to achieve productivity gains and reduce overheads. We were also able to maximise manpower usage and to achieve a negative headcount growth through natural attrition. The total staff number fell by 253 to 7,795 during the year.

In our major businesses, operating profit after provisions from retail banking fell by 15.8%, to provide 54.2% of the Bank's total. Corporate banking reported an operating loss after provisions of HKD543 million, as its provisions for bad and doubtful debts rose to HKD1.8 billion due to corporate lending, trade finance and Mainland-related exposures. The treasury performance was encouraging, with operating profit up by 53.4%, to contribute 20.1% of the Bank's total.

In retail banking, the Bank continued to strengthen one-stop banking and diversify earnings. Personal asset management and insurance capabilities were increased to deliver wealth management to customers. The Hang Seng Investment Series was established as the umbrella brand for the Bank's managed portfolios and under it, several funds were successfully launched. Our personal insurance product range was enhanced and recorded good growth.

Segmentation was further developed to increase cross-selling. At the year-end, nine Business Banking Centres and 10 Bank Smart Prestige Centres had been set up to serve business owners and more affluent customers respectively.

In Hong Kong, 13 new branches were opened to further extend our reach, 10 of which were along the Airport Express and Tung Chung Line. Under a branch rationalisation programme, three branches were merged with others. At the year-end, we had 156 branches.

Treasury recorded encouraging growth in operating income by actively managing the Bank's money market and investment portfolios, and increasing its range of services. Our corporate banking and private wealth management businesses were affected by the economic downturn.

Loans and advances to Mainland customers, including those booked in mainland China and Hong Kong amounted to HKD9.9 billion, about 5% of the Bank's total advances to customers. Lending to Mainland ITICs stood at HKD600 million. Prudent and adequate provisions have been made. Despite some difficulties encountered by several Mainland enterprises, our commitment to mainland China remains undiminished. Last December, we opened our first representative office in North China, in Beijing. An application has also been lodged to upgrade our Shenzhen representative office to a branch.

In the difficult operating environment, Hang Seng's solid performance continued to win recognition. All our ratings were confirmed by Moody's in December. That includes our A3 long-term and Prime 2 short-term foreign currency deposits ratings and financial strength of B. Moody's highlighted the Bank's "powerful income-generating capacity" and "strong income ratios" in its press announcement. We won the top award for customer service in the Hong Kong Awards for Services organised by the Hong Kong Retail Management Association. We were also ranked the No. 1 company in Hong Kong for financial soundness in the REVEW 200: Asia's Leading Companies survey and described as "rock-solid".

Economic conditions are expected to remain very difficult in the first half of 1999 as the territory contends with high real interest rates, rising unemployment, subdued trade and weak consumer spending. We believe the economy should start to stabilise in the second half of the year, although such progress will depend on the extent of continued restructuring to regain competitiveness and also on external developments.

1999 will be another challenging year for banks. Loan demand will remain subdued while asset quality problems are likely to persist. In such a demanding market, Hang Seng will continue to build on its financial and operating strengths to increase performance. We will maintain our focus on cost discipline, operational efficiency and risk management. Segmentation and distribution channels will be further developed to enhance service excellence. In the immediate future, the Bank will expand its emphasis on wealth management and cross-selling to increase non-interest income. There will also be greater efforts to develop services for small-to-mid-sized businesses. Further down the road, we intend to capitalise on new growth opportunities such as the Mandatory Provident Fund.

Given our solid business franchise, we are strategically well-placed to take advantage of the eventual economic recovery.

Thank you.