Hang Seng Bk Ltd pt 3/6

HSBC Holdings PLC
03 March 2008


Financial Review

Net interest income

                                                                                                                        
                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Net interest income/(expense) arising from:
- financial assets and liabilities that are 
  not at fair value through profit and loss              16,404           13,689
- trading assets and  liabilities                        (1,753)          (2,039)
- financial instruments designated at fair 
  value                                                      68               44
                                                         14,719           11,694

Average interest-earning assets                         661,469          578,588

Net interest spread                                        1.84%            1.66%
Net interest margin                                        2.23%            2.02%

Net interest income rose by HK$3,025 million, or 25.9 per cent, to HK$14,719
million with a 14.3 per cent increase in average interest-earning assets.

Average customer advances rose 10.4 per cent, with notable increases in mainland
loans, higher yielding card advances, personal loans and trade finance. Ample
liquidity in Hong Kong continued to exert downward pressure on corporate loan
margins. Although activity in the local property market increased, intense
market competition continued to drive down mortgage pricing. Overall, the total
loan portfolio contributed HK$427 million to the growth in net interest income.

Deposit products contributed HK$1,017 million of the increase in net interest
income, benefiting from the 10.4 per cent growth in average customer deposits,
mainly in low cost savings balances, as well as improved deposit spreads.

The contribution from net free funds added HK$468 million to the increase in net
interest income, arising mainly from increases in both market interest rates and
the level of free funds (including non-interest-bearing account balances and net
shareholders' funds).

The debt securities portfolio of life insurance fund investments grew by 41.2
per cent, adding HK$283 million to net interest income. Treasury balance sheet
management income improved as lower-yielding securities gradually matured and
were replaced by higher-yielding securities, which resulted in an HK$830 million
increase in net interest income.

Net interest margin rose by 21 basis points to 2.23 per cent. Net interest
spread increased by 18 basis points to 1.84 per cent, benefiting from wider
deposit spreads and better yields on Treasury balance sheet management
portfolios. The contribution from net free funds rose by three basis points to
0.39 per cent. Including the net increase of HK$357 million in funding swap costs-
which were recognised as foreign exchange losses under trading income- net interest
income increased by HK$2,668 million, or 23.0 per cent, and net interest margin
improved by 16 basis points to 2.16 per cent. 

Compared with first half of 2007, net interest income in the second half
recorded encouraging growth of HK$1,327 million, or 19.8 per cent, with a 6.8
per cent growth in average interest-earning assets. Net interest margin improved
by 22 basis points.

The HSBC Group reports interest income and interest expense arising from
financial assets and financial liabilities held for trading as 'Net trading
income'. That arising from financial instruments designated at fair value
through profit and loss is reported as 'Net income from financial instruments
designated at fair value' (other than for debt securities in issue and
subordinated liabilities, together with derivatives managed in conjunction with
them).

The table below presents the net interest income of Hang Seng, as included
within the HSBC Group accounts:

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Net interest income                                      16,358           13,639
Average interest-earning assets                         643,655          564,027

Net interest spread                                        1.98%            1.83%
Net interest margin                                        2.54%            2.42%

Net fee income
                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

- Stockbroking and related services                       1,985              805
- Retail investment funds                                 1,676              796
- Structured investment products                            661               94
- Insurance                                                 115              108
- Account services                                          284              274
- Private banking                                         1,000              331
- Remittances                                               193              161
- Cards                                                   1,048              860
- Credit facilities                                         110              111
- Trade services                                            406              380
- Other                                                     204              154
Fee income                                                7,682            4,074
Fee expense                                                (796)            (577)
                                                          6,886            3,497

Net fee income rose by HK$3,389 million, or 96.9 per cent, compared with 2006,
to HK$6,886 million. In the second half of 2007, net fee income was HK$1,162
million, or 40.6 per cent, higher than in the first half.

Investment services expanded significantly, capturing the opportunities provided
by the buoyant stock market and favourable investment market sentiment in Hong
Kong. Stockbroking and related services income rose 146.6 per cent, reflecting
the higher transaction volume, and the customer base grew by 19.7 per cent.
Income from retail investment funds increased by 110.6 per cent to reach a
record HK$1,676 million, achieved in large part through the launch of new funds,
particularly those focusing on China stocks. Fund turnover reached a record
HK$68.5 billion. Income from sales of structured investment products grew by
603.2 per cent, mainly reflecting sales of equity-linked instruments. Private
banking investment services income achieved strong results and rose by 202.1 per
cent.

Card services income grew by 21.9 per cent, due to the 8.9 per cent increase in
the number of cards in circulation and the 21.1 per cent rise in cardholder
spending. Remittance, trade services and account services fees grew by 19.9 per
cent, 6.8 per cent and 3.6 per cent respectively.

Trading income

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Trading income:
- foreign exchange                                          861            1,178
- securities, derivatives 
  and other trading activities                              818              152
                                                          1,679            1,330

Trading income rose by HK$349 million, or 26.2 per cent, to HK$1,679 million,
compared with 2006. The HK$317 million fall in foreign exchange income was
attributable mainly to two specific items not related to normal foreign exchange
trading. First, an exchange loss of HK$461 million was incurred in 2007 (HK$104
million in 2006) on forward contracts used in 'funding swap' activities^ in the
balance sheet management portfolios. Second, capital funds of HACN injected in
US dollars pending approval to convert into renminbi were recorded at historical
rate. The subsequent revaluation loss of the US dollar funds against the
renminbi, amounting to HK$171 million in 2007, was recognised as a foreign
exchange loss. Excluding these two items, efforts to expand proprietary trading
and customer-driven business saw normal foreign exchange trading rise by HK$211
million, or 16.5 per cent.

Income from securities, derivatives and other trading grew significantly by
HK$666 million, or 438.2 per cent, attributable to the improvement in trading
results and the growth in trading volume. Profit earned on equity-linked
products structured for customers accounted for HK$470 million of the growth.

For the second half of 2007, trading income grew by HK$511 million, or 87.5 per
cent, to HK$1,095 million, attributable mainly to the rise in normal foreign
exchange profit and profit earned on equity-linked structured products.

^Treasury from time to time employs foreign exchange swaps for its funding
activities, which in essence involve swapping a currency ('original currency')
into another currency ('swap currency') at the spot exchange rate for short-term
placement and simultaneously entering into a forward exchange contract to
convert the funds back to the original currency on maturity of the placement. In
accordance with HKAS39, the exchange difference of the spot and forward
contracts is required to be recognised as foreign exchange gain/loss, while the
corresponding interest differential between the original and swap funding is
reflected in net interest income.

Net income from financial instruments designated at fair value

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Net income on assets designated at fair
  value which back insurance and 
  investment contracts                                    1,903              910

Net change in fair value of other financial 
  instruments designated at fair value                        4              (11)
                                                          1,907              899

Financial instruments designated at fair value reported a net income of HK$1,907
million, compared with HK$899 million in 2006, reflecting the remarkable
investment performance and growth of the life insurance fund portfolios.

Other operating income

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Rental income from investment properties                    139              186
Movement in present value of in-force long-term
  insurance business                                        397              363
Other                                                       211              296
                                                            747              845

Analysis of income from wealth management business

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Investment income:
- retail investment funds                                 1,676              796
- structured investment products^                         1,492              513
- private banking^^                                       1,009              340
- securities broking and related services                 1,985              805
- margin trading and others                                  78               65
                                                          6,240            2,519
Insurance income:
- life insurance                                          2,055            1,476
- general insurance and others                              348              318
                                                          2,403            1,794
Total                                                     8,643            4,313


^Income from structured investment products includes income reported under net
fee income on the sales of third-party structured investment products. It also
includes profit generated from the selling of structured investment products in
issue, reported under trading income.

^^Income from private banking includes income reported under net fee income on
investment services and profit generated from selling of structured investment
products in issue, reported under trading income.

Wealth management income increased by an impressive 100.4 per cent to HK$8,643
million. Investment services income grew by 147.7 per cent, reflecting record
investment product sales and a high level of stock market activity, while
insurance business income rose by 33.9 per cent.

The buoyant stock market stimulated demand for investment fund sales, which
reached a record HK$68.5 billion, representing a 149.5 per cent increase over
2006. This achievement was facilitated by the bank's efforts to offer a wide
choice of funds from both Hang Seng Investment Management and third-party
providers - ranging from high-growth China and emerging market equity funds to
fixed-income funds - to meet the various investment strategies and risk
appetites of different customers. The successful launch of new funds under the
Hang Seng investment fund series (for example, the Hang Seng Consumer Sector
FlexiPower Fund, which was the first consumer sector fund focusing on the 
Mainland and Hong Kong securities which are listed on the Stock Exchange of
Hong Kong) and the good performance of existing thematic funds, particularly the
Hang Seng China Equity Fund, also boosted investment fund income. Funds under
management (excluding private banking) rose by 32.3 per cent to HK$82.1 billion
compared with 2006 year-end. As a result of this outstanding performance,
investment fund income (including sales commission and management fees) rose a
significant 110.6 per cent to reach a record HK$1,676 million.

The bank continued to make good progress with sourcing and distributing
competitive structured products packaged by both Hang Seng and third-party
providers, registering a 12.1 per cent rise in turnover and a record 190.8 per
cent increase in structured investment product income, primarily related to
equity-linked instruments.

The bank continued to expand its e-service channels and mobile communication
services to better cater for the needs of customers. A mobile phone trading
service was launched during the year to capture more business opportunities and
help customers to manage their securities investment portfolios more easily and
effectively in the buoyant investment conditions. Riding on a spate of IPO
activity in Hong Kong, the bank further enhanced its IPO subscription services
to meet customers' needs and participated in certain IPO activities by
leveraging its extensive network, customer base and funding capabilities.
Through effective marketing campaigns and personalised services, the bank grew
its number of securities accounts by 19.7 per cent and successfully boosted its
trading volume by 148.4 per cent. The positioning of the bank's business
increased stockbroking and related service income by 146.6 per cent to HK$1,985
million.

Private banking continued to make remarkable progress, supported by the further
strengthening of its relationship management team and investment services
support. Investment services income for 2007 was more than double that reported
for 2006. Customer base and assets under management rose by 19.8 per cent and
39.8 per cent respectively.

Life insurance registered encouraging income growth of 39.2 per cent to reach
HK$2,055 million (analysed in the table below). Life insurance business ranked
number one in Hong Kong in terms of new regular premiums on non-linked insurance
products for the first three quarters of 2007 and premium income grew by 24.7
per cent. The bank advanced its strategy to capture a greater share of the
retirement planning market by expanding its product range, launching the
'Critical Illness Life Insurance Plan' and 'Flexi-Income Life Insurance Plan'
during the year. Investment returns were higher, reflecting the growing
portfolio size and higher equity returns from the buoyant stock market. The
increase in movement in policyholders' liabilities is largely in line with the
increase in premium income.

General insurance income also increased by 9.4 per cent to HK$348 million, due
mainly to the growth in premiums earned from general accident protection.

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Life insurance:
- net interest income and fee income                        943              665
- investment returns on life insurance funds              1,903              910
- net earned insurance premiums                           9,394            7,534
- claims, benefits and surrenders paid                   (1,285)          (1,014)
- movement in policyholders' liabilities^                (9,315)          (6,991)
- reinsurers' share of claims incurred and
  movement in policyholders' liabilities                     18                9
- movement in present value of in-force
  long-term insurance business                              397              363
                                                          2,055            1,476
General insurance and others                                348              318
Total                                                     2,403            1,794

^Including premium and investment reserves

Loan impairment charges and other credit risk provisions

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Loan impairment (charges)/releases:
- individually assessed                                    (250)            (107)
- collectively assessed                                    (326)            (145)
                                                           (576)            (252)
Of which:
- new and additional                                       (702)            (423)
- releases                                                   64              106
- recoveries                                                 62               65
                                                           (576)            (252)

Other provision                                               _              (12)

Loan impairment charges and other
  credit risk provisions                                   (576)            (264)

Loan impairment charges and other credit risk provisions increased by HK$312
million, or 118.2 per cent, to HK$576 million. There was an increase of HK$143
million in individually assessed provisions, due mainly to higher charges and
lower releases for several commercial customers.

Of the collectively assessed charges, HK$253 million was made on the card and
personal loan portfolio, representing a rise of 82.0 per cent over 2006 but due
mainly to the 34.2 per cent growth of this portfolio. The delinquency rate and
level of loan losses continued to be satisfactory. A charge of HK$73 million was
made on advances not identified individually as impaired, compared with a charge
of HK$6 million made in 2006, reflecting the 10.4 per cent growth in gross
advances to customers and the update of the historical loss rates used for 2007.

Operating expenses

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Employee compensation and benefits:
- salaries and other costs                                2,443            2,188
- performance-related pay                                 1,095              382
- retirement benefit costs                                   47              124
                                                          3,585            2,694
General and administrative expenses:
- rental expenses                                           379              267
- other premises and equipment                              820              829
- marketing and advertising expenses                        601              447
- other operating expenses                                  884              671
                                                          2,684            2,214

Depreciation of business premises and equipment             348              323
Amortisation of intangible assets                            33               10
                                                          6,650            5,241

Cost efficiency ratio                                      26.6%            29.0%

Staff numbers^ by region                            At 31 Dec07       At 31Dec06

Hong Kong                                                 8,033            7,748
Mainland                                                  1,097              661
Others                                                       60               55
Total                                                     9,190            8,464

^Full-time equivalent

Operating expenses rose by HK$1,409 million, or 26.9 per cent, compared with
2006. Of the 33.1 per cent increase in employee compensation and benefits,
salaries and other costs increased by 11.7 per cent, in line with the increase
in headcount and annual salary increment. The important contributions of Bank
staff in achieving significant growth in total operating income led to a 186.6
per cent increase in performance-related pay. General and administrative
expenses increased by 21.2 per cent. Rental expenses rose due to increases in
rents for branches in Hong Kong and new branches on the Mainland, as well as
additional rental costs after the disposal of the Hang Seng Building in May 2006
and the renting of the new 'megasite' back office centre. Marketing expenditure
was higher, with increased promotion of credit cards and investment and
insurance products as well as brand-building initiatives both in Hong Kong and
on the Mainland. Depreciation charges rose by 7.7 per cent, mainly the result of
the increase in fair value of business premises. The bank's mainland operations,
which expanded its network from 15 to 25 outlets and its staff from 661 to 1,097
members during 2007, also contributed to the increase in operating expenses.

The number of full-time equivalent staff rose by 726 compared with 2006
year-end. New staff in Hong Kong accounted for 39.3 per cent of the increase in
headcount, with new talent hired to further expand private banking's financial
advisory team and PFS and CMB's relationship management and wealth management
teams as well as to support IT systems development and enhancement. The number
of staff at mainland branches accounted for 60.1 per cent of the rise in
headcount, attributable mainly to the establishment of HACN and expansion of its
network of outlets.

The cost efficiency ratio for 2007 was 26.6 per cent, compared with 29.0 per
cent in 2006.

Profit on disposal of fixed assets and financial investments

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Profit on disposal of available-for-sale securities         449              338
Profit less loss on disposal of fixed assets                267              505
                                                            716              843

Profit on disposal of available-for-sale financial investments was HK$111
million higher than in 2006. Profit on disposal of fixed assets, mainly
properties, fell to HK$267 million, due to the non-recurring gain made on the
disposal of the Hang Seng Building at 77 Des Voeux Road Central in 2006.

Gain on dilution of investment in associate

During the year, the bank's associate, Industrial Bank Co., Ltd ('Industrial
Bank') issued new shares. The bank did not subscribe for any additional shares
issued under this offer and, as a result, its interest in Industrial Bank's
equity decreased from 15.98 per cent to 12.78 per cent.

The net assets of Industrial Bank increased substantially when it received the
proceeds from the new issue. After the new issue, the group's share of the net
assets of Industrial Bank increased by HK$1,465 million compared to the share of
the net assets immediately before the IPO. This increase in the group's share of
net assets was regarded as a gain arising from deemed disposal of part of its
interests in Industrial Bank and has been presented in the consolidated income
statement.

The gain resulting from the dilution of the group's investment in Industrial
Bank was HK$1,465 million. The dilution of the interest does not affect the
classification of the group's investment as an investment in an associate.

Tax expense

Taxation in the consolidated income statement represents:

                                                     Year ended       Year ended
Figures in HK$m                                         31Dec07          31Dec06

Current tax - provision for Hong Kong profits tax
Tax for the year                                          2,771            2,188

Current tax - taxation outside Hong Kong
Tax for the year                                             29               36

Deferred tax
Origination and reversal of temporary differences            65             (175)

Total tax expense                                         2,865            2,049

The current tax provision is based on the estimated assessable profit for 2007,
and is determined for the bank and its subsidiaries operating in Hong Kong by
using the Hong Kong profits tax rate of 17.5 per cent (the same rate as in
2006). For subsidiaries and branches operating in other jurisdictions, the
appropriate tax rates prevailing in the relevant countries are used.

Earnings per share

The calculation of earnings per share in 2007 is based on earnings of HK$18,242
million (HK$12,038 million in 2006) and on the weighted average number of
ordinary shares in issue of 1,911,842,736 shares (unchanged from 2006).

Dividends per share

                                    Year ended                        Year ended
                                       31Dec07                           31Dec06
                          HK$             HK$m              HK$             HK$m
                    per share                         per share

First interim            1.10            2,103             1.10            2,103
Second interim           1.10            2,103             1.10            2,103
Third interim            1.10            2,103             1.10            2,103
Fourth interim           3.00            5,736             1.90            3,633
                         6.30           12,045             5.20            9,942







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