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

Good afternoon ladies and gentlemen. Thank you for joining us today for our announcement of Hang Seng’s 2004 annual results.

I am pleased to report that Hang Seng achieved record results in 2004 — in attributable profit, return on average shareholders’ funds, operating profit before provisions, pre-tax profit and income from wealth management. This encouraging performance was underpinned by the revival in the local economy, which was driven by increases in re-export trade, a rebounding property market and the large surge in inbound tourist numbers.

Results Highlights

Attributable profit rose to HK$11,395 million, up 19.5% compared with 2003.

Earnings per share increased to HK$5.96, which was 19.4% over the HK$4.99 per share in 2003. We achieved a return on average shareholders’ funds of 27.6%, compared with 23.4% the year before.

Even if we exclude the release in general provisions and the related deferred taxation, attributable profit for 2004 increased by HK$1,191 million, or 12.5%, over 2003.

Reflecting the strength of our core business, operating profit before provisions was up by 3.1% to HK$11,830 million, compared with HK$11,475 million in 2003.

After accounting for a release of HK$814 million in provisions for bad and doubtful debts, operating profit rose by 18.4% to HK$12,644 million, compared with HK$10,683 million the year before.

Pre-tax profit rose by 20.0% to HK$13,367 million.

There were gains of HK$1,203 million on the revaluation of bank premises and HK$772 million on investment properties, which were taken to the revaluation reserves in accordance with the current accounting policy. Under the new Hong Kong Accounting Standard 40 effective from 1 January 2005, the revaluation gain on investment properties will be recognised as current year profit. If Hang Seng had adopted the new standard in 2004 ahead of schedule, the growth in our attributable profit would have been 26.1%.

Total other operating income rose by HK$1,165 million, or 22.4%, to HK$6,363 million in 2004. This represented 39.6% of the Bank’s total operating income, up from 33.8% in 2003.

This was primarily owing to the growth momentum of our wealth management business, which benefited from the active stock market and positive investor sentiment in the year. In 2004, income from wealth management increased by 35.1% to HK$3,438 million and contributed 54.0% of total other operating income.

The strong growth in other operating income offset a decline of HK$489 million, or 4.8%, in net interest income. Our net interest margin narrowed by 24 basis points to 2.04%.

This decline was mainly brought about by the exceptionally low Hong Kong dollar interest rates that caused deposit spreads to be significantly reduced throughout the year. Since the Bank was unable to reduce deposit rates in the low interest rate environment, spreads on Hong Kong dollar deposits fell. Abundant market liquidity further depressed corporate lending margins and created fierce market competition in the mortgage sector, which caused a reduction in portfolio yields and an increase in incentive payments.

The average spread of the securities portfolio was also reduced as higher yielding papers matured and were replaced at lower yields.

These negative impacts were alleviated by a 6.1% increase in our average interest-earning assets of HK$27.2 billion, and a change in our asset mix as we diversified our loan portfolio to higher yielding card and personal advances, trade finance and SME loans. Investment in debt securities increased by 20.1% as funds were re-deployed from short-term interbank placings to debt securities for yield enhancement.

We continued to be well-capitalised with strong liquidity, although our total capital ratio fell to 12.0% at 31 December 2004, compared with 13.2% at 31 December 2003. Our capital base at the year end was maintained at the same level of HK$33.3 billion as at the previous year-end.

The tier 1 capital ratio was 10.8% compared with 11.3% at 31 December 2003.

2004 was the first year under the Bank’s new programme of quarterly dividends for our shareholders. We therefore declared four dividends during the year — three of HK$1.10 per share each and a fourth of HK$1.90 per share. This brought total dividends for the year to HK$5.20 per share, an increase over the HK$4.90 per share in 2003.

Total assets grew by HK$45.7 billion, or 9.1%, to HK$548.6 billion.

The Bank’s asset quality also improved, as non-performing advances in the improving economic climate declined sharply by 58.6% to HK$2,169 million.

Benefiting from the recovery of bad and doubtful debts, there was a significant improvement in the release of provisions during the year. Specific provisions showed a net release of HK$2 million, compared with a net charge of HK$798 million last year. General provisions accounted for a release of HK$812 million.

Total provisions as a percentage of gross advances to customers fell to 0.42% compared with 1.10% at the end of 2003.

Operating expenses rose by 8.2% to HK$4,223 million, mainly due to increases in marketing expenditure, staff costs and other investments necessary for our future development.

Our cost:income ratio rose by 0.9 percentage points to 26.3%, which compared favourably with the industry average increase of 3.0 percentage points to 41.6%. Hang Seng’s cost:income ratio continued to be among the lowest in the world. Attributable profit per employee reached a new yearly high of HK$1.5 million, reflecting the productivity of our staff.

In our main lines of business, Personal Financial Services grew 21.2% and accounted for 51.0% of the Bank’s pre-tax profit in 2004. This line of business continued to be the largest contributor to the Bank’s profit.

Commercial Banking, which reported a growth of 83.1% in profit before tax, contributed 16.1% of the Bank’s pre-tax profit.

Corporate and Institutional Banking in 2004 recorded growth of 6.0% in profit before tax, with an increase of 9.8% in net interest income following a growth of 12.3% in customer advances. Corporate and Institutional Banking contributed 6.1% of the Bank’s pre-tax profit.

Treasury reported growth of 5.5% in profit before tax. Net interest income reduced marginally by 1.1%, as higher yielding securities matured and were replaced at lower yields. Dealing profit rose by 33.1%, reflecting the improvement in proprietary trading, increase in corporate treasury services and the growth in structured investment products. Treasury contributed 18.0% of the Bank’s pre-tax profit.

We recorded good progress during the year in the following areas :

· Wealth management
· Loans and deposits
· Commercial Banking and
· Mainland development

Wealth Management

In a year with low interest rates and an active stock market, our wealth management business recorded income growth of 35.1%, reflecting the strength of our securities services, retail investment product sales and private banking.

We continued to offer products that met the increasingly sophisticated needs of our customers. During the year we launched 29 new investment funds, taking the total number of funds in the Hang Seng Investment Series to 118. Our 96 capital guaranteed funds currently represent the largest group of such funds in Hong Kong.

New investment products launched in 2004 included a Hang Seng Index Exchange Traded Fund; Equity Linked Investment products; and a Hong Kong Property Equity Fund.

Income from retail investment products and fund management increased by 50.8% to HK$1,502 million in 2004.

Hang Seng’s private banking business continued to expand in terms of customer base, product range and investment portfolio. Total funds under management, including discretionary and advisory, grew by 55.4% to nearly HK$90 billion.

During the year we also strengthened our market leadership in insurance, particularly life and medical insurance.

This was achieved primarily by cross-selling to our large customer base. Annualised premiums grew by 43.5% and underwriting income by 22.3%. At the end of the third quarter of 2004, Hang Seng Life ranked number three in terms of annualised contribution for new business in Hong Kong with a market share of 11.2%, compared with 7.7% for 2003.

We introduced a number of new insurance products during the year. These included an outpatient medical plan targeted at retirees and pre-retirees, a lifetime guaranteed savings and protection plan, and a life insurance plan with both protection and savings features.

Increasingly, we are promoting e-Banking as a delivery channel for our wealth management products. At the end of December 2004, more than 430,000 personal e-Banking customers were registered, an increase of 27.6% from the same period the year before. The number of internet transactions represented 27.5% of total transactions in December, compared with 23.1% for 2003. The number of counter transactions in the same period dropped to 12.2% of all transactions from 13.3%.

Loans and Deposits

Advances to customers (net of suspended interest and provisions) recorded an encouraging growth of 9.8% from HK$229.5 billion to HK$251.9 billion, mainly in advances to the industrial and commercial sectors and trade finance. This compared with the Hong Kong banking industry average of 6.4% in 2004.

Customer deposits rose 3.6% to HK$447.3 billion. Together with certificates of deposit and other debt securities in issue, total customer deposits increased by 5.3% to HK$463.4 billion.

Although margins were squeezed in 2004, we were able to increase lending to customers as we diversified our loan portfolio into higher yielding credit card and personal advances, trade finance and SME loans.

Strong growth of 20.3% was reported in credit card advances and 23.2% in other personal lending. The number of credit cards in issue rose by 18.7% to more than 1.15 million during 2004, with card spending increasing by 46.6% as a result of the improving economic environment and the introduction of e-payment services. In 2004 our market share increased for cards in issue, cardholder loans and cardholder spending.

In the highly competitive mortgage market, the average yield on the residential mortgage portfolio, excluding Government Home Ownership Scheme mortgages and staff loans, fell to 202 basis points below BLR for 2004, before accounting for the effect of cash incentive payments. This compared with 177 basis points below BLR in 2003. Private sector residential mortgages rose slightly by 0.5% but mortgages under the suspended GHOS scheme fell by 12.9%.

We were able to achieve a growth of HK$5.4 billion, or 81.0%, in gross advances for use outside Hong Kong mainly due to the growth of our Mainland loan portfolio.

The advances to deposits ratio rose to 54.4% at 31 December 2004, up from 52.2% the year before, as a result of the faster pace of customer advances to customer deposits.

Commercial Banking

Commercial Banking made strong inroads during the year as we increased our business to both the middle market corporate and SME sectors.

Taking advantage of our strong relationship management, customised trade solutions and e-services, we increased total trade finance advances by HK$4.2 billion, or 37.3%, compared with growth of 27.8% for the Hong Kong banking industry as a whole.

In the middle market corporate sector, trade finance and other lending grew by 31.3%. Advances to SMEs recorded especially strong growth, which rose 49.7% in trade finance and lending for the expansion of production capacity and distribution networks, as well as property investment. This was due in large part to the strengthening of our SME business banking team and our focus on high growth industries in the rebounding local economy.

Our Macau branch, which opened in 2004 to serve the trade finance needs of customers there, recorded satisfactory progress.

Mainland Development

We made great strides forward during the year in the development of our Mainland business, a major focus of the Bank’s long-term expansion.

In September we opened a sub-branch in the Gubei district of Shanghai and, last month, our first sub-branch in Shenzhen.

We are also planning to open a new branch in Beijing and a third sub-branch in Shanghai in the second half of 2005.

With the opening of these two new outlets, our Mainland network will expand to six branches, four sub-branches and one representative office in seven cities.

In May we completed the deal for our acquisition of a 15.98% interest in Industrial Bank Co Ltd for a consideration of RMB1,726 million. This has taken our total investment in the Mainland, including our own branch network, to about RMB3 billion.

We look forward to further co-operation with Industrial Bank in regard to such services as credit cards and unsecured personal loans. Industrial Bank offered an international dual currency card bearing the Hang Seng logo in December.

We will also examine other opportunities for strategic and organic growth in the Mainland, such as investments in non-bank financial institutions and the addition of more service outlets in the Mainland.

We will seek further growth opportunities in the liberalising Mainland financial market and will offer new products and services when the regulations allow.

In light of Hong Kong’s increasingly close ties with the Mainland under CEPA, we have been offering a greater scope of Mainland-related financial services here in Hong Kong. Last year, we introduced renminbi deposits, currency exchanges, and remittances for local customers, as well as a renminbi credit card for frequent visitors to the Mainland. To serve the growing number of Mainland visitors to Hong Kong, our ATMs now accept China Unionpay credit cards issued in the Mainland.

Our Hong Kong and overseas customers were also able to invest in A-shares and funds on the China A-share index, after we received a QFII securities investment business permit in May.

Looking ahead

Although our performance in 2004 was encouraging, the year ahead will pose challenges for the banking community in Hong Kong.

Chief among these will be continuing margin pressures, intense competition, rising US interest rates and ongoing macroeconomic controls in the Mainland.

We will continue to expand our wealth management business. In addition to providing more capital guaranteed funds, we will launch more open-ended investment funds and structured products to help investors capitalise on investment opportunities in a rising interest rate environment.

Our relatively low loans to deposit ratio leaves room for growth in our loan portfolio to capitalise on lending opportunities. Consumer lending will continue to be a strong focus this year, following its robust performance in 2004.

This will be the last time that I will be reporting Hang Seng’s annual results to you, as I will be succeeding Mr David Eldon who is retiring as the Chairman of The Hongkong and Shanghai Banking Corporation Limited. I would therefore like to take this opportunity to thank our shareholders, Board, customers and colleagues for all their support over the past seven years.

I am confident that under the leadership of my successor, Mr Raymond Or, and with Hang Seng’s solid asset quality, sound financial position and strong wealth management capabilities, Hang Seng will continue to deliver value to shareholders and customers in the years ahead.

Thank you.