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

Ladies and gentlemen. Good afternoon. It is a great pleasure to be back at the CLSA investors' forum.

It has been a difficult year. 1998 brought Hong Kong's worst recession since its economic take-off in the sixties. Despite the difficult environment, Hang Seng Bank will continue to expand our business and under our new Managing for Value strategy, our minimum target is to double shareholder value in five years.

Today, I'd like to describe how Hang Seng is creating a higher value organisation to achieve this target. But before that, let's look at the Hong Kong economy, the operating environment and recent Bank performance.

Hong Kong Economy

Economic sentiment has improved since March. Property prices are stabilising and the stock market is more buoyant.

The boost in sentiment has been driven by an apparent positive inflow of funds into Asia. Nominal interest rates have fallen seven times and by a total of 175 basis points since last October to below the pre-Asian crisis level. The local prime rate has dropped to 8.25%, compared with 8.75% in October 1997, giving rise to a Hong Kong-US rate differential close to the pre-crisis level.

However, we are not out of the woods yet. Exports are still lacklustre. The year-on-year decline was 9% in the first quarter of this year, and manufacturers' orders on hand for domestic production remain weak. Private consumption is sluggish.

Local real interest rates are still high at 10.85% versus a pre-crisis level of 3.05% as a result of deflation. Inflation dropped from 5.7% in October 1997 to -2.6% in March this year. But further adjustments are still needed on the cost side if Hong Kong is to increase competitiveness.

Nevertheless, the list of positive indicators is growing. Visitor arrivals increased by 12.7% in the first four months of this year, compared with the same period last year, reflecting a rebound in tourism. The unemployment rate, although still high at 6.2% at the end of March, is rising at a slower rate. The drop in interest rate has eased the burden of home owners who have a mortgage, which in turn could lead to higher consumption.

Real economic activities in other Asian countries are also gathering momentum, suggesting that these economies could have hit the bottom, and overseas investors have revived their interest in the region.

Although we remain cautious at this stage, we may have seen the worst in the first quarter. Depending on external developments, a modest recovery could be achieved in the fourth quarter if the recent positive indicators could be sustained. For the while, we maintain our GDP forecast of -1.5% for this year.

Operating Environment

Amid the difficult operating environment, banks in Hong Kong reported sizeable profit decreases last year, although they continued to be supported by high capital adequacy ratios. This year will continue to be difficult for banks.

Competition is growing more intense, particularly in home mortgages despite the squeeze in interest margins. Banks' enthusiasm for the mortgage business is understandable, given the lacklustre loan demand in other sectors. After plunging over 50% in the past two years, property prices have stabilised and recent sales of new units received favourable responses. Activities in the secondary market have also picked up with falling interest rates. The affordability of home purchases has improved.

Moreover, the default rate of home mortgages is much lower than other types of lending as mortgage loans are mostly made to end-users. The default rate for mortgage loans overdue for more than three months was 1.13% in March.

Private residential mortgages were the only sector among loans for use in Hong Kong to show year-on-year growth, at 6.9%, in March this year. By comparison, total loans for use in Hong Kong fell by 6.9% over the same period.

With the resumption of the government's land sales, there is some revived demand for property loans. As corporate loans are generally collateralised by properties and shares, the rebound in property and share prices in the first quarter should help relieve some pressure on some corporates. Nevertheless, significant loan growth in the corporate sector is unlikely before we see a full recovery of the economy.

Despite the lower interest rates, deposits have continued to grow. In March, total deposits rose by 8.8% compared with the same month last year.

Bank Performance

Hang Seng's focus on prudent management has allowed us to build our business on strong fundamentals which have stood us well in the 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 fifth largest listed company in terms of market capitalisation. Our business focus is Hong Kong and mainland China.

In last year's difficult environment, 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.

But even in the adverse operating conditions, Hang Seng continued to outperform local banks in many areas, according to Hong Kong Monetary Authority figures.

Last year, Hang Seng's 1.7% post-tax return on average total assets was high compared with the 1.01% recorded by local banks. Our net interest margin of 2.96% per annum was compared favourably with the industry's 2.26% per annum. Our cost-to-income ratio of 26.7% --- one of the lowest in the banking world --- was most attractive against the local bank average of 39.6%. Reflecting our strong focus on prudent lending, we dropped our advances-to-deposits ratio to 56.2% at the year-end, below the industry average of 58.9%. And our capital adequacy ratio was a high 21.3% compared with the industry's 18.6%.

Hang Seng's prudent lending and asset quality are further highlighted. For local banks, loans overdue for more than three months as a ratio of total loans rose to 4.03% at the year-end, while Hang Seng's ratio was 1.97%. Rescheduled loans of local banks rose to 1.07% compared with 0.43% for Hang Seng.

In the first quarter of this year, Hang Seng's businesses reflected economic sentiment. Retail banking recorded some improvement over the same period last year. Treasury sustained its satisfactory results and corporate banking put in a steady performance in line with the market. Although the corporate lending market has been quiet, we do see some opportunities coming up later this year, including new technology and infrastructure projects. In both Hong Kong and mainland China lending, asset quality will remain the prime focus.

Creating a Higher Value Organisation

Managing for Value is a new HSBC Group-wide initiative and we have adopted the strategy to set the conditions for future success. We are currently creating a higher value organisation to achieve the target of at least doubling shareholder value in five years.

We have adopted an Economic Value Added methodology which involves allocating our capital and resources more effectively, to ensure the projected returns exceed the risk-adjusted cost of capital.

Business Development

Hang Seng's business development under Managing for Value focuses on increasing fee income and satisfying changing customer needs.

A number of strategic imperatives will power our performance in the years ahead. They include the delivery of wealth management to customers, increasing personal asset management and insurance capabilities, and growing services for small-to-mid-sized businesses.

A major attraction of wealth management delivery is its high fee generation and low capital intensity. Significant growth 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 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 such as the Hong Kong Jockey Club membership cards.

Our personal asset management and insurance capabilities are being strengthened to support wealth management delivery. The Hang Seng Investment Series was established as the umbrella brand for the Bank's managed portfolios last year. Introduced in January, the Hang Seng Global Bond Fund has attracted a total of HKD1.6 billion in just four months.

We see more opportunities in securities trading. Last year, we introduced Hong Kong's first automated securities phone-trading service. We will be launching mobile phone banking in a few months to enable customers not only to make account enquiries and fund transfers, but to buy and sell securities through a mobile phone. Internet banking, with online investment services, will be launched next year.

In insurance, our sales force of registered agents is being increased by 25% to 900 this year. Our insurance product range is also being expanded and we continue to widen our business scope. In March, Hang Seng Insurance Co Ltd became the only Hong Kong company to be appointed an approved reinsurer for the Hong Kong Mortgage Corporation, for its Mortgage Insurance Programme. We are also preparing for the launch of the Mandatory Provident Fund next year and shall be ready to sell from Day 1.

The majority of Hong Kong's businesses are small-to-mid-sized. A working group, led by the Deputy Chief Executive, is overseeing service expansion for this segment, at both the retail and corporate banking levels. By placing greater efforts on this segment, we shall be able to grow and cross-sell products such as insurance, MPF and forex, and put additional emphasis on fee income.

Despite our already low cost structure, we aim at further savings in our business development without compromising quality. We are increasing our synergies with other members of the HSBC Group to achieve greater economies of scale. In the past 16 months, the total number of staff has been reduced by 400 to about 7,650 through natural attrition, despite our increase in branch network and delivery channels.

Conclusion

I'd like to end with my key message today and that is --- Hang Seng is well-placed to achieve its Managing for Value target. We are a financially strong bank with a good customer franchise, we are technologically robust and cost-effective, and we have a dedicated management and staff team.

Under Managing for Value, Hang Seng's corporate performance and business unit targets will be aligned in an ongoing process to increase our competitive, financial and organisation strengths.

Managing for Value will guide every decision the Bank makes, and allow us to maximise growth for shareholders and respond speedily to customer needs.

Thank you.