Vincent H C Cheng
Vice-Chairman & Chief Executive
Hang Seng Bank

Ladies and gentlemen. Good afternoon. I am delighted by this opportunity to address this large group of influential fund managers and analysts.

Success is a science -- if you have the conditions, you get the result. Conditions at Hang Seng have steadily produced results. Our underlying strengths deliver shareholder and customer value.

But today's success may not be tomorrow's. Complacency is the Archilles' heel of all successful businesses. That is why Hang Seng has adopted a new strategic plan called Managing for Value which will guide our business development into the next century. As part of this strategy, we are working towards a target of at least doubling shareholder value in five years.

Before I introduce our Managing for Value strategy, I'd like to present a brief overview of the Bank and its performance last year.

Overview of Hang Seng

Hang Seng's focus on prudent management has allowed us to build our business on strong fundamentals which have stood us well in the current economic downturn. They include financial soundness, efficient operations and service excellence.

As a principal member of the HSBC Group, 62.14% owned, Hang Seng contributed 39.1% of the Hong Kong and Shanghai Banking Corporation's attributable profit and 12.6% of the Group's last year. In Hong Kong, we are the second-largest locally-incorporated bank and the seventh-largest listed company in terms of market capitalisation. Our business focus is Hong Kong and mainland China.

Behind our prudent operations is the objective of furthering shareholder interests and enhancing customer services. Our performance has won many reputable ratings and awards, and I'd like to name just a few.

All our ratings from Moody's were confirmed in December. That includes our A3 long-term and Prime 2 short-term foreign currency deposits ratings and financial strength of B -- the highest for banks in Hong Kong. We were No. 1 for customer service excellence in the Hong Kong Awards for Services. We were also ranked the No. 1 company in Hong Kong for financial soundness in the REVIEW 200: Asia's Leading Companies survey.

Hang Seng's 1998 Performance

Last year, Hong Kong suffered its deepest recession on record as GDP contracted by 5.1% and banks reported sharply lower profits. However, they continued to be supported by their high capital adequacy ratios.

Against this backdrop, Hang Seng's operating income remained stable. Operating profit before provisions, at HKD10.6 billion, was a marginal decrease of 1.3% from the previous year.

Attributable profit, however, declined by 27.5% from the previous year to HKD6.8 billion. The result was affected by higher provisions for bad and doubtful debts -- which rose by HKD1.8 billion to HKD2.5 billion, reduced profit on the disposal of fixed assets and investment securities, and the deficit on revaluation of Bank properties.

Addressing Analyst Concerns

I'd like to highlight some features of our 1998 performance by addressing a number of concerns voiced by some analysts.

One area involves our provisioning level. The Bank's gross non-performing advances (net of suspended interest) rose by HKD6.2 billion to HKD7.8 billion at the year-end, representing 3.9% of gross advances to customers. Specific provisions were made for 39.4% of non-performing advances, compared with 70.9% in 1997.

Let me stress that the Bank's provisioning policy is most conservative and that our specific provisions plus collateral value amount to almost 100% of non-performing advances. Our non-performing advances are actually double the HKD4 billion in advances overdue for more than three months. This is because we grade very conservatively and if we spot a problem, we immediately classify the loan as non-performing.

Last year, we took several measures to strengthen prudent lending and asset quality. We dropped our advances-to-deposits ratio to 56.2% at the year-end, from 62.1% a year earlier. This was the result of a 7.2% growth in deposits and a 2.9% decrease in advances. Our credit risk management function was also restructured to tighten controls.

Industry figures published by the Hong Kong Monetary Authority highlight Hang Seng's prudent lending and asset quality. For local banks, loans overdue for more than three months as a ratio of total loans rose to 4.14% at end-December, while Hang Seng's ratio was 1.97%. Rescheduled loans of local banks rose to 1.02% compared with 0.43% for Hang Seng.

Another area we are often questioned about is our exposure to Mainland-related risk. This is manageable. Advances to Mainland customers, including those booked in the Mainland and Hong Kong, amounted to about 5% of the Bank's total advances to customers at the year-end. Lending to Mainland ITICs stood at 0.3% of total lending. Adequate and prudent provisions have been made.

Our loan decisions are based on the underlying business and the credit standing of Mainland enterprises and related companies on a case-by-case basis, and we have adhered closely to the Mainland's debt registration requirements.

Managing for Value

The ability to maximise shareholder value will determine the winners in the next century. Creating shareholder value is not new to Hang Seng. For example, our dividend payout has been high, ranging from 70% of the attributable profit in 1994 to a recommended 96% for last year. Although this cannot be taken as an indication of future dividend levels, we aim at a stable but steadily rising dividend for investors.

Managing for Value is a new HSBC Group-wide initiative and we have adopted the strategy to set the conditions for future success in the fast-changing market. The governing objective is to beat the total shareholder returns performance of a peer group of financial institutions, TSR being the measure of investor capital gains and reinvested dividends over a defined period. The target is to at least double shareholder value in five years.

We are currently translating the governing objective and target into an actionable strategy.

Hang Seng has formulated an Economic Value Added methodology which involves allocating our capital and resources more effectively in businesses, to ensure the projected returns exceed the risk-adjusted cost of capital.

Value-based profitability measures have been adopted and are being used to target higher-value creation at the Bank and to help identify and eliminate bad growth strategies, that is, those that fail to cover the cost of capital. There are however businesses that form an integral part of general banking services but which are value-destroying in nature, and these need to be evaluated from a different perspective.

We are looking further at our capital base. There is some feeling among investors that our total capital ratio, which was 21.3% at end-December, is too high. In the economic downturn, we feel the need to maintain a high capital ratio. But we are reviewing how much capital we need to maximise the value of the Bank and whether there is any suplus cash for returning to shareholders.

Value measurement is being supplemented by value management. We are developing the organisational capabilities that will allow us to keep on finding and implementing higher-value growth strategies than our competitors have. The real changes will be in the everyday behaviour of our managers and staff, in their better decision-making and operations to achieve the Managing for Value target.

Communication of the strategy to staff and the market place is very important. The strategy involves everyone at the Bank and we need staff support and teamwork to achieve the target.

Strategic Imperatives

Just how will we achieve our Managing for Value target? A number of strategic imperatives will power our performance in the next five years. They include:

• The delivery of wealth management to customers

• Increasing personal asset management and insurance capabilities

• Growing services for small-to-mid-sized businesses

• Attracting, retaining and motivating the very best people.

Let's look at these in more detail. A major attraction of wealth management delivery is its high fee generation and low capital intensity. There is vast scope for this business. Per capita GDP in Hong Kong has increased by 350% since 1971. We plan to tap into that wealth as the financial needs of customers become more sophisticated.

In wealth management delivery, significant opportunities exist through increasing the level of cross-selling to our existing customer base. Hang Seng has a large customer franchise and serves more than one-third of Hong Kong's population. We have begun to prioritise and deepen customer relationships through segmentation to facilitate cross-selling.

We are also reaching out to new customers to whom we hope to deliver wealth management. We have been able to target high-net-worth customers through several prestigious credit cards, including the Hang Seng Platinum MasterCard and Hang Seng World MasterCard, the latter being the launch of the most exclusive MasterCard in the Asia-Pacific region.

In other moves, the sales culture of staff is being strengthened and client cross-referral is being promoted across business divisions. More loyalty programmes will be established and financial incentives offered to capture a greater share of every creditworthy customer's wallet.

Our wealth management strategy cannot succeed without strong personal asset management and insurance capabilities, and we are making strides in this area. The Hang Seng Investment Series was established as the umbrella brand for the Bank's managed portfolios last year and under it, several funds were successfully launched. Our insurance product range is being expanded and another major promotion is planned shortly. We are also preparing for the launch of the Mandatory Provident Fund next year and shall be ready to sell MPF products from Day 1.

We shall not limit ourselves to in-house products. We intend to offer clients the best wealth management products available in the market.

The majority of Hong Kong's businesses are small-to-mid-sized. Over 90% of Hong Kong companies employ less than 50 people. By placing greater efforts on growing services for this segment, we shall be able to put additional emphasis on fees and liabilities, and grow products such as insurance, pensions and forex. As part of this, the role of our Business Banking Centres serving business owners is being expanded. This segment would also be a major cross-selling target.

I must add that we are not focusing on smaller businesses at the expense of the corporate lending business. It is however a fact that lending to corporates is capital-intensive and the credit risk is higher. We are therefore moving towards high quality credit in corporate lending, focusing on more infrastructure and non-property-related projects. Asset quality will remain the prime focus.

To do all the above, we shall need to attract, retain and motivate the best people. Hang Seng already has a very good team but we need to build on our expertise, customer orientation and service excellence. There will be increased emphasis on functional management skills and specialisation, including technology, insurance and investment products. The Bank's success is the staff's success and they are being encouraged to share in this by participating in the HSBC Group share option scheme for staff.

Under Managing for Value, all operations will have to improve performance. So even though our cost-to-income ratio of 26.7% last year is among the lowest in the banking world, even though our operating profit before provisions per employee increased by 62% over five years to HKD1.36 million last year, productivity enhancement and cost discipline will remain important. Hang Seng is also increasing its synergies with other members of the HSBC Group to achieve greater economies of scale.

Conclusion

I have only had a short time to speak, but I hope you have been convinced that Hang Seng has set the conditions for future success through Managing for Value.

We are starting from a position of strength and we are confident we can manage the changes. We are a financially strong bank with a good business base, we are technologically robust and cost-effective, and we have a dedicated management and staff team.

Managing for Value will be ongoing. It will increase Hang Seng's competitive, financial and organisational strength not just for the next five years, but into the future.

Thank you.