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

Good morning, ladies and gentlemen. It's a great pleasure to address the Jewels of Asia conference today.

Hong Kong - the Pearl of the Orient - has made a strong comeback after its worst recession on record in 1998. GDP is estimated at 8.5% for 2000, although growth is expected to slow next year in line with the global economy.

Hang Seng Bank's results in the first half of this year exceeded market expectations in the improving economy. However, the banking environment remains tough, with intense competition, weak loan demand and increasing margin pressures. Customer expectations are also becoming more sophisticated with rapid technology changes.

In the tough environment, Hang Seng is building on its strengths as a financially sound and prudently managed bank to maintain market leadership. We are meeting the performance challenge by creating shareholder value and offering customers a wide range of superior services.

Today, I'd like to highlight:

I'd like to begin with a brief overview of where Hang Seng is today. The Bank's business focus is Hong Kong and mainland China. It is the second largest locally incorporated bank in Hong Kong and serves more than one-third of its population.

As a principal member of the HSBC Group, 62.14% owned, Hang Seng contributed 24.67% of the Hongkong and Shanghai Banking Corporation's attributable profit and 11.74% of the HSBC Group's in the first half of 2000.

Our Managing for Value target is to at least double shareholder value in five years. Since the start of 1999 to the end of October, we have achieved a total return of 50.53% for our shareholders.

We announced a record first-half attributable profit of HKD5,195 million in 2000, an increase of 21.9% from the same period last year. Our first interim dividend of HKD2.00 per share was up by 25.0%.

Hang Seng continues to outperform the local banking sector. In the first half of 2000, we recorded loan growth of 7.2% compared with the 7.6% fall recorded by the sector. Our deposit growth of 9.5% was high compared with the sector's 3.7% growth. Our net interest margin of 2.83% was favourable compared with the sector's 2.39%. Highlighting our prudent lending and asset quality, our loans overdue for more than three months as a percentage of total loans were much lower at 2.8%, compared with 5.53% for local banks.

Major challenges ahead

We are not complacent. Major challenges lie ahead for the banking sector and they include:

Nowhere is the margin squeeze more obvious than in mortgage pricing. In Hong Kong, mortgage pricing has fallen from P+1.75% in 1995 to P-2.25% today. Since Hang Seng's average portfolio yield remains well above the market, there is continued downward repricing pressure as we have been matching competitor pricing to maintain market share. Given our mortgage portfolio size, a fall of 50 bps in yield would cost us HKD400 million yearly. We are countering by diversifying revenue sources to increase non-interest income.

In mid-2001, the remaining interest rate rules covering savings and current deposits in Hong Kong are scheduled for removal. Hang Seng has a relatively high proportion of savings and current deposits. Full deregulation could have some adverse impact on bank funding costs although the extent is unclear due to unknown factors such as market liquidity and competitor reaction.

Hang Seng's reputation as a safe haven should provide some leverage. We believe that pricing is not the only determinant of where people deposit their money. A trusted brand name, convenience and the bundling of products are also important, as our internet banking experience has shown. Hang Seng will continue to enhance the features of its deposit services to increase competitiveness. The total customer relationship and tiered pricing will become more important.

Hang Seng is renowned for strict cost discipline. In the first half of 2000, our cost-to-income ratio was a record low 22.6% - among the lowest in the banking world and lower than our return on average shareholders' funds. But we continue to face rising cost pressures. Staff costs made up 57.6% of operating expenses in the first half of 2000 and could increase further, given the upward wage adjustment pressure in the market. After reducing the staff headcount by about 10% since mid-1997, we are also starting to strengthen our workforce to support new businesses.

We are also investing for the future, for example, in our Mandatory Provident Fund (MPF) services. While our sales are very encouraging, returns will only come in over a longer term. IT costs are now our third-largest expenditure item. Although online transactions cost significantly lower, investment in technology is expensive and cost-savings are only a long-term scenario.

Our strict cost discipline and shared technology investments with HSBC, which offer economies of scale, place us in a good position to control costs. We are also re-allocating costs to invest in e-services and increasing productivity and work-streamlining.

Seizing Growth Opportunities

To maximise our franchise, we are expanding non-interest income and higher-margin businesses. These include expanding personal wealth management, our commercial business and in mainland China. We are also rebalancing our loan mix and becoming more aggressive in consumer financing, which offers better margins.

Our wealth management initiatives include investment and insurance services, and target our affluent and mass integrated account customers. By adopting a customer relationship-oriented approach, we aim to increase cross-selling and our share of their wallet.

In the first half of 2000, income from investment and insurance services grew by 64.9% compared with the same period last year. Last month, the Bank set up an Investment Services Division to drive the business. Four new sub-funds have been created under the Hang Seng Investment Series this year, taking the total to 17. Funds managed under the Series grew by 28% to HKD3.7 billion in the first nine months of this year and their sale has been extended to Macau.

Hang Seng Life, a joint venture of Hang Seng Bank and HSBC, was the fastest growing life insurer in Hong Kong in the first three quarters of 2000 in terms of annualised first year premiums, according to a survey by the Hong Kong Federation of Insurers. The growth rate was 50.12% compared with the same period last year.

In consumer financing, increased personal lending and the credit card business will help counter the squeeze in mortgage pricing and the effects of next year's deregulation.

Our commercial banking business, which also offers higher margins, focuses on expanding products and services to small and medium-sized enterprises (SMEs).

Our Mandatory Provident Fund business is performing very well. Our MPF services have so far signed up over 15,000 employers and self-employed individuals, representing an estimated 135,000 enrolled employees.

Long-term growth will be underpinned by expansion in the Mainland. We intend to open one branch or representative office there each year, to take advantage of the vast opportunities that will come with its WTO entry. We recently received permission to open our fourth Mainland branch, in Fuzhou, and have applied to set up an insurance representative office in Shenzhen. We shall apply for a RMB licence in Shanghai when we become qualified at the year-end, and plan to upgrade our Beijing representative office to a branch.

Riding the technology wave

In the technology revolution, we have adopted a clicks-and-mortar approach. We intend to be a significant e-banking force and our e-services are an important part of our integrated multi-channel delivery network.

The response to our launch of e-Banking Services in August has exceeded our expectations. In October, internet transactions made up about 5% of total transactions.

Hang Seng's internet strategy is to:

Despite remarks that we were late in launching internet banking, it has turned out that as an incumbent bank with a strong presence and trusted brand, we have a strong advantage over other banks. Growth has been quick. Since the August launch, we have registered more than 80,000 customers and 3.7 million transactions.

Our e-services have become new channels to implement our overall business strategies. In line with that, the emphasis is on personal wealth management and the commercial segment.

The first phase launch has focused on personal wealth management. The service is available to integrated account customers, and current services cover about 90% of their daily needs.

Indicating our success in reaching our wealth management targets, the number of new integrated account openings a day has doubled since August. Cross-selling opportunities are high. The number of new securities accounts doubled in August. In October, when customers could open securities accounts online, the number of new securities accounts increased fourfold compared with August. Our e-IPO Services have helped attract more online securities customers. We processed about 24,000 online applications for the IPO of the MTR Corporation in September.

Currently, about 36% of our securities transactions by count are conducted over the internet. When straight-through securities trading becomes available on AMS/3, market volume is expected to grow.

We continue to enhance our e-banking services. Chinese internet banking was introduced last month. Phase 2 enhancements will extend coverage to unit trusts, insurance services and loan applications at the year-end.

Bill presentment through the internet will be introduced in the first quarter of next year. We also plan to launch wireless banking next year.

We shall target the B2B segment in the first half of next year, allowing the commercial segment to use the internet for financial management and business operations. Once again, the focus will be on SMEs.

Other banking channels

Our counter transactions fell to 18% of total transactions in the first nine months of this year, compared with 19.4% in the same period last year. In our clicks-and-mortar approach, the role of our branches as sales outlets has been strengthened. The branches are focusing on recruiting customers and cross-selling more complex products.

Branch rationalisation has been underway for some time. We have been merging some branches to improve cost-efficiency while opening new ones in strategic locations. We shall review the impact of internet banking on our branch network before deciding on further rationalisation.

We continue to enhance other non-branch channels. The number of ATM machines will be increased by 16% to a total of about 400 in the two years 2000 and 2001.

We are also expanding our automated phone-banking services while switching the focus of our manned services to increased product cross-selling. An overhaul of our phone-banking systems next year will facilitate the expansion of our phone lines and better customer relationship management.

Conclusion

In the challenging operating environment, Hang Seng is committed to creating and sustaining superior performance. It is a financially-strong bank with a good business base, it is technologically robust and cost-effective, and it has a large customer base and strong distribution network. Given its many strengths, I am confident the Bank is well-positioned to maintain market leadership.

Thank you.