Edited Transcript of 0011.HK earnings conference call or presentation 3-Aug-20 5:00am GMT – Yahoo Finance

Central Aug 3, 2020 (Thomson StreetEvents) — Edited Transcript of Hang Seng Bank Ltd earnings conference call or presentation Monday, August 3, 2020 at 5:00:00am GMT

Morgan Stanley, Research Division – Head of ASEAN Banks Research and Executive Director

* S. Huang

Good afternoon, ladies and gentlemen. Due to the COVID-19 situation, we’re bringing you these results by audio webcast only. On the line are Hang Seng Bank’s Vice Chairman and Chief Executive, Ms. Louisa Cheang; and our Chief Financial Officer, Mr. Andrew Leung. Other members of our senior management team, as shown on the webcast screen, are also present. They will all be available to answer your questions later.

Now I hand over to our Chief Executive to start the presentation. Mr. Cheang, please.

Thank you, May. Good afternoon, ladies and gentlemen. Thank you for joining this audio webcast. For a more detailed look at our 2020 half year results. The first 6 months of 2020 were extremely challenging for all businesses, despite what we might have hoped for earlier in the year, the economic and total impact of the COVID-19 pandemic remains a reality in economies here and around the world.

In addition, Hong Kong is continuing to grapple with the adverse effects of long-term issues such as international trade tensions and social situation at home. As would be expected, the difficult environment has had an adverse impact on our first half results, particularly when compared with a strong first half in 2019 while our fundamentals remain solid, with strong capital base, healthy liquidity position and stable market share, attributable profit fell by 33% to $9,143 million.

The financial performance was affected by 4 main factors: first, contractions in net interest income and net interest margin in the low interest rate environment; second, a drop in insurance business income, reflecting significantly lower investment returns due to market volatility and a decline in new business sales; third, increase in expected credit losses; and fourth, net deficit in property revaluation.

I will provide more details later in the financial overview. However, I wish to point out that the financial figures themselves do not tell the whole story of Hang Seng in the first half. Our key priorities in the first 6 months of the year were to protect the health and safety of our customers and employees, provide uninterrupted banking and wealth management services and offer fast and hassle-free support to client-facing hardships.

At the same time, we continue to invest in technology, build new segments and drive business expansion to ensure we are well positioned to capture opportunities when markets rebound. Thanks to our continued investment in innovation and technology, we were able to respond swiftly and seamlessly to a sharp increase in customer demand for digital banking services, amidst social distancing and COVID-related health concerns. Year-on-year, the number of new Personal e-Banking registration and usage of our Personal Banking mobile app in Hong Kong both increased by 2/3.

In the first half alone, we rolled out around 210 new digital innovations and enhancements, significantly equating the 150 we launched during the whole of 2019. A number of the new digital services and products caters specifically for needs of the younger customers, helping them save and invest while enhancing financial inclusion. Digital innovations also cut transaction times and streamline application processes for our commercial customers. Our ability to continue improving service experience and outcomes has resulted in demonstrable increases in our competitive and brand strength. In a survey conducted in the second quarter of this year, Hang Seng was 1 of the 2 major banks ranked the first in customer service. We also ranked the first for inclusion among key target customer segments, young people under 30 years of age rated us the top bank for customer service. Mainland customers viewed Hang Seng as the #1 bank in Hong Kong for creative financial management solutions.

As a bank with deep roots in Hong Kong, we are sensitive to the pressures that the pandemic has put on different parts of the community. We are an active participant in various government schemes to offer economic relief to customers in need. We also donated $10 million to provide academic support to children from underprivileged families impacted by the extended suspension of classes.

While technology is an important part of our customer-centric approach, our staff remains our primary competitive advantage. Under difficult circumstances, our employees have demonstrated flexibility and professionalism to minimize any disruption in service for customers.

Our initiatives to make it easier for our people to perform at a high level while maintaining a positive sense of well-being, are being well received and appreciated. A recent survey indicated that the vast majority of staff feel positive about our efforts in supporting them during this period.

Now, let’s look deeper in our first-half financial performance. As mentioned earlier, volatile market conditions have had a significant impact on our financial performance. Net operating income fell by 20% to $17,427 million. Operating profit fell by 28% to $11,134. If we exclude change in ECL and other credit impairment charges, operating profit declined by 20% to $12,894 million. When compared with the second half of 2019, operating profit dropped by 15% and operating profit, excluding change in ECLs, was down 10%.

Looking at the key factors that most affect our bottom line. Net interest income fell by 7% to $14,792 million, a drop of $1,061 million compared with $15,853 million in the same period last year. Increased volumes from balance sheet growth and a 5% growth in average interest-earnings assets were outweighed by the impact of declining interest rates, which contributed to the overall narrowing of net interest margin. NIM fell by 25 basis points to 1.96%, reflecting the flow-through of declining HIBOR and compression in loans and deposit spreads.

Noninterest income dropped by 33% to $4,395 million.

Net fee income fell by 9%. The launch of our stand-alone securities trading app facilitated a positive growth in fee income from stockbroking and related services. However, this was more than offset by the fall in fee income from the severe disruptions of industrial and commercial activities and a drop in card-based retail spending as people stayed at home due to the pandemic.

Net trading income and net income from financial instruments designated a fair value through profit or loss together grew by 27%, due mainly to increased income from foreign exchange and derivative trading activities in the volatile foreign exchange market.

Net income from assets and liabilities of the insurance business measured at fair value recorded a loss of $1,284 million, a reduction of $2,348 million from a gain of $1,064 million for the same period last year, reflecting unfavorable movements in global equities market, with investment risk partly shared by the policyholders.

There was also a drop in net insurance premium income with an offsetting movement in policies liabilities and movement in present value of in-force long-term insurance business, due mainly to the decline in new business sales that resulted from the challenges created by COVID-19 situation.

Change in ECLs and other credit impairment charges was $1,760 million, an increase of $1,250 million compared with $510 million in the same period last year. I wish to point out the significant year-on-year increase results from the update to the key variables in our credit risk assessment model to reflect expected future impact of continuing uncertainties over COVID-19 and international trade policies.

Overall, credit qualities remain robust. Gross impaired and advances as a percentage of gross loans and advances to customers stood at 0.32% at the end of June 2020. That number was 0.22% at 2019 year-end and at the end of June last year.

Pragmatic cost containment measures and business efficiencies realized through improved operational processes and earlier investments in business infrastructure lowered operating expenses by 1%. Compared with the second half of 2019, operating expenses reduced by 6%. At 32.8%, our cost efficiency ratio continues to compare favorably with the local industry average. Following downturn of the property market, investment property revaluation also recorded a deficit of $428 million, a decrease of $615 million from a gain of $187 million for the same period last year.

Attributable profit fell by 33% to $9,143 million, with net interest income, noninterest income, ECLs and property revaluation being the 4 main factors making a significant impact on the profit line.

Earnings per share were down 34% at HKD 4.64 per share. And profit before tax fell by 33% to $10,619 million. Compared with second half of last year, attributable profit and earnings per share fell by 18% and 20%, respectively, and profit before tax dropped by 18%.

Return on average ordinary shareholder equity was 10.7% compared with 17% for the first half of 2019. Return on average total assets was 1.1% compared with 1.7% for the first half of last year.

At 30th June 2020, our common equity Tier 1 capital ratio was 16.3%, and our Tier 1 capital ratio was 18%, compared with 16.9% and 18.7%, respectively, at 31st December 2019. Our total capital ratio was 19.7% compared with 20.8% at 2019 year-end.

Taking into account our regulator’s advice to conserve capital to meet future potential challenges caused by the COVID-19 situation, the directors are continuing to adopt a prudent approach in managing the bank’s business, including determination of dividend payments. As such, the directors have declared a second interim dividend of $0.80 per share, bringing the total distribution for the first half of 2020 to $1.90 per share.

Gross advances to customers were $958 billion, up by 1% compared with the end of 2019. Loans for use in Hong Kong rose by 2%. Lending to corporations and individuals grew by 3% and 2%, respectively. Loans for use outside Hong Kong declined by 1%.

Customer deposits, including certificates of deposit and other debt securities in issue, were up 4% at $1,302 billion.

Wealth and Personal Banking recorded 26% year-on-year decrease in operating profit, excluding change in ECLs and other credit impairment charges to $6,297 million. Operating profit dropped by 33% to $5,557 million, and profit before tax decreased by 35% to 500 — for $5,468 million.

Despite successful deepening customer relationships to grow our balance sheet, with a 3% rise in average customer deposits and 7% increase in average customer advances, declining interest rates squeezed interest margins, resulting in a 6% year-on-year drop in net interest income to $8,138 million.

Net interest (sic) [noninterest] income fell by 46% to $2,078 million, reflecting the volatility in global investment markets, which had an adverse impact on investment returns from our life insurance portfolio and our customers’ investment activity.

Wealth management income fell by 40%, due in part to many customers delaying the long-term investment decision in the uncertain market conditions.

Insurance income fell by 60%, reflecting the significant drop in investment returns from the life insurance portfolio and the decline in new business. We enriched and expanded our range of products, including those leveraging the government’s tax concession measures. We also supported customers by providing additional coverage for COVID-19 with no extra premium required.

On a more positive note, the launch of Hang Seng Invest Express, our new stand-alone securities trading app, helped drive growth in securities revenue and turnover of 40% and 58%, respectively.

Market challenges aside, our core performance remained solid. Our enhanced data analytic capabilities and more agile business structure enabled us to anticipate changing customer needs, and act swiftly to offer suitable products and services. This brought us new business and a 13% year-on-year rise in Prestige and Preferred Banking customer base.

Our comprehensive digital services channels enabled customers to continue banking easily and safely, resulting in substantial growth in a number of general banking transactions and key product transactions conducted by our Personal Banking Mobile App.

In May, we received the prestigious “Best Mobile Banking App” award in the Asian Banker’s International Excellence in Retail Financial Services Awards 2020. A benchmark report published by a global consulting firm in June noted that our mobile banking app is a top performer in Hong Kong for features and user experience.

We continue to add service value with the launch of online in-app financial tools, such as Savings Planner, SmartInvest and SimplyFund. They are designed to meet budgeting and investment simple, particularly for younger customers. With among the lowest minimum investment requirements in the market, just $1 for our new SimplyFund portfolio of funds, these new services helped our digital investment customer base grew by 23% year-on-year.

We remained a market leader for residential property loans, achieving a 2% rise in mortgage balances in Hong Kong compared with the end of 2019. Our new mortgage business continued to rank among top 3 in Hong Kong. And we will maintain leadership position for unsecured loans drawdowns.

Commercial Banking reported a 35% year-on-year drop in both operating profit and profit before tax to $3,227 million. We recorded a large increase in ECLs and other credit impairment charges, due partly to the updating of certain assumptions under our risk assessment model. We contained impaired loans to gross advances at a low level of 0.49%, compared with 0.34% at the end of December and 0.35% in June last year.

Operating profit, excluding change ECLs and other credit impairment charges decreased by 21% to $4,048 million.

Net interest income was down by 13% to $4,532 million, with a 5% growth in average loan balances, outweighed by the impact of low interest rates on deposit interest income.

Noninterest income fell by 26% to $1,145 million. Investment services income grew by 13%, reflecting successful assets to capture business opportunities in securities-related services amid volatile markets. However, this was more than offset by a decline in fee-generating businesses due to widespread disruption in commercial activities across all sectors.

However, as with our retail operations, we maintained robust but prudent business momentum and continue to strengthen our market position to support the business community.

Our active participation in syndicated lending saw us attain the #1 ranking in the Mandated Arranger Lead table for Hong Kong and Macau Syndicated Loans for the first half of 2020 in terms of number of deals.

Facilitated by more agile operational infrastructure, our deep understanding of customers’ businesses enabled us to move strictly to offer appropriate support and solution in a highly challenging environment. As of April this year, our market share of deferred principal repayment loans approvals was 21%.

Designed to reduce time-to-cash for customers, our first-in-market online application platform for the SME Financing Guarantee Scheme was well-received, accounting for 30% of the number of applications we have received as of 30th June.

Digital service enhancement to help customers save time, access information more easily and make faster decisions, including expanding the capabilities of BERI, our commercial banking AI chatbot, to provide advice on trade-related matters. Customers using our mobile app-based One-Click Time Deposit can also place time deposits and preapproved preferential interest rates with just one single click.

Global banking and markets together reported a year-on-year increase of 15% in operating profit, excluding change in ECLs and other credit impairment charges to $2,845 million, and a 9% growth in both operating profit and profit before tax to $2,646 million.

Global Banking registered a 2% decrease in operating profit excluding changing ECLs and other credit impairment charges to $1,142 million. Operating profit and profit before tax both dropped by 11% to $994 million, due mainly to the upward revision of ECLs.

Net interest income was broadly on par with a year earlier at $1,224 million, due partly to our lending portfolio optimization strategy. Our cash management services have become even more digital. Proactive initiative to offer customers tailored banking solutions helped drive a 2% increase in deposit base compared with December last year. We also assist clients facing economic difficulties through participation in government financial relief scheme.

A new Debt Capital Market Origination team leverages our strong customer relationship and effective cross-business collaboration to rapidly identify new needs in fast-moving markets, resulting in a pickup in fee income.

Global markets report a 30% increase in operating profit, excluding change in ECL and other credit impairment charges to $1,703 million. Operating profit and profit before tax both increased by 27% to $1,652 million.

Net interest income increased by 15% to $1,196 million, reflecting successful actions by the balance sheet management team to manage interest rate risk effectively, defend the interest margin and achieve yield enhancement while upholding prudent risk management standards.

Noninterest income increased by 39% to $784 million. The volatile foreign exchange market, together with the changing interest rate environment, drove an increase in nonfund income from sales and trading activities. We continued with collaborative cross-bank initiatives to deepen penetration of Global Market products among commercial and capital banking customers.

Established in the second half of 2019, our Repo Trading department contributed to the growth and diversification of our revenue base in the first half of this year.

Our strong core-border capabilities enabled us to maintain good momentum in our Mainland-related business. Despite the difficult economic environment, Hang Seng China recorded a 12% year-on-year increase in net operating income before loan impairment charges. Profit before tax grew by 11%.

To provide active support for the development of new markets, our subsidiary, Hang Seng Indexes Company Limited launch Hang Seng TECH Index just last week to threat the 30 largest innovative technology companies listed in Hong Kong. We aim for our Hang Seng TECH index to become another flagship index for Hong Kong market, alongside the Hang Seng Index and the Hang Seng China Enterprise Index.

Looking ahead, COVID-19, trade tension, geopolitical tension and other uncertainties at home and abroad are expected to bring continued disruption to industrial and commercial activity, reduce consumer spending and suppress investment appetite. The persistencies of low interest rate will put further pressure on net interest margin and returns from interest-earning businesses. These market-driven factors will continue to challenge top-line performance.

We will be vigilant in continuing costs and proactively manage our credit risk while remaining true to our central operating principle of providing high-quality banking and wealth management services to customers.

Despite the ongoing challenges, we remain confident in the strength of our customer-centric growth strategy for the long term. Our service innovations and proactive approach are helping us build our portfolio and capture business among new customer segments. There will always be a need for banking and financial services. It is important that we continue to invest wisely for the future in technology, in new markets, new segments and new products to rebound from our solid fundamentals when the external environment improves.

Our competitive edge is also sharpened by our highly-performing culture and encouraging good collaboration and creativity among the team. Our employees are innovating and making significant contributions in adding real values and delivering positive outcomes for our customers. To support the performance potential of our dynamic team, we will continue to invest in talent development and in our people’s overall well-being.

In the difficult first half, every member of the Hang Seng team has stepped up, not only to ensure our customers continued to enjoy high levels of service, but also to support each other. I wish to express heartfelt thanks to my colleagues for their exemplary efforts and invaluable contribution. Together with the management team, we will continue to drive the bank towards long-term sustainable success. Thank you.


Unidentified Company Representative, [3]


Thank you, Louisa. We’ll now begin our question-and-answer session. (Operator Instructions). Ni Chen? Ni Chen, do we have any questions?


Questions and Answers


Operator [1]


Yes. The first question, we have Yafei Tian from Citi.


Yafei Tian, Citigroup Inc., Research Division – Assistant VP and Analyst [2]


I have two questions, if I may. The first one is around net interest margin. So looking at the decline in first half, is it possible to break it down to us from a Q-on-Q perspective? What is the exit net interest margin for the quarter?

And along the same line, given that HIBOR has continued to decline since the second quarter level, will there be any outlook in terms of second half where the net interest margin could be by end of this year?

And the second question is around — we noticed that Q-on-Q dividend is further declined, and the first half payout ratio is only slightly above 40%. This is also much lower than last year’s 64%. What would be the dividend policy for this year?


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [3]


On the first question, can I have Andrew, our CFO, for the answer? And then I can talk about dividends.


Wing Lok Leung, Hang Seng Bank Limited – CFO [4]


Okay. Yafei, the net interest margin was declining during the first half of 2020. For the first quarter, the net interest margin was around 2.13%. And on the second quarter, the net interest margin was 1.8%. So demonstrating the softening of the market interest rate in the second quarter, in particular, towards the end of, say, May and June and further coming into July, actually, the interest rates continued be dropping, disclosed in the figure. At the end of June, the 1-month HIBOR was 44 basis points. But at the end of last week and today, the 1-month HIBOR was only 25 basis points. So the, say, exit net interest margin may not have fully reflected the continued drop in the high coverage or the interbank rate in the second half of the year.


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [5]


I will answer the questions about the dividend policies. First of all, our dividend policies are determined by a number of factors, including profitability, regulatory requirement, growth opportunities and also the forward economic outlook. For this year, the uncertainty and the challenge of COVID-19 has bring the global economy into unprecedented challenge.

And I know some of the other regulators, the bank regulators in Hong Kong has notified banks to suspend dividend payment. However, they have cautioned us that we should be conserving capital to meet the potential challenges and also support the economy in Hong Kong. And therefore, the Board approved the $0.80 second quarter interim dividend for the bank, and adding up to $1.90 for the first half. The bank’s capital position continued to be strong. We will continue to review our dividend payment for the rest of the year. And if the situation improves and/or deteriorate, we will adjust the dividend accordingly. So hopefully, we will continue to generate long-term sustainable returns for our shareholders.


Operator [6]


The next question is from Jemmy Huang from JPMorgan.


S. Huang, JPMorgan Chase & Co, Research Division – Financial Analyst [7]


Also, two questions from me. The first one is on asset quality. Just — could you let us know how also the asset part of the migration on the quarter-on-quarter basis in the first quarter and also second quarter?

And also, Louisa, I think that you mentioned around $82 million loans you have provided for the — ready program. Any color in terms of the asset quality condition for this particular portfolio? This is the first question.

Second question is if I calculate the risk-weighted asset density, which is the total risk weighted asset divided by your total assets, I think it’s increasing. And also the RWA growth is also higher than the total portfolio growth. So we think these are, [popularly], density changes, is there anything related to the loan downgrade, and therefore, increasing in risk weights for EBT or loan segments as a result?


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [8]


Thanks, too. I think both questions should be tuned by CRO, Chee.


Yeo Chee Leong, [9]


Right. Thank you. Okay, on the asset quality, there are some deterioration in the second quarter. If you refer to the ECL, stage 1 moving to stage 2 is around HKD 294 million. The stage 2 moving to stage 1 is $237 million. So there’s a net movement of about HKD 57 million.

Having said that, the amount is not very significant compared to the overall loans and advances. As you can see, if we also look at how we classify investment-grade versus noninvestment grade. As of 30th of June, investment-grade portfolio represents about 62% of our book, and sub investment-grade is 37%.

In terms of the movement, it’s actually around 1.7% moving from investment-grade to subinvestment grade.

On the other question on the RWA over total assets. RWA has actually also increased just very marginally. Total credit RWA increased by about 5.5% compared to the end of last year. But at the same time, the total exposure default has also increased by about 4%. So you will see that the increase in credit RWA is actually largely — part of the reason is due to the increase in loans and advances and the increase in our ability, due to credit deterioration, is also quite marginal.


Wing Lok Leung, Hang Seng Bank Limited – CFO [10]


And then maybe Let me make I can supplement that. The risk weighted asset in total actually increased by 4.3% as compared to the end of last year. Basically, the loan growth, one of the driver into the increasing the credit RWA.

But there’s another RWA increase attributable to — sorry, the credit migration. The related RWA increase related migration was $6.5 billion, which is amounting to 1.2% of the total RWA.

Other factors that also lead to increase in RWAs relating to the market risk RWA arising from the interest rate and FX positions in our treasury operation. So other than that, the overall increase is RWA is still manageable. It does not expect any, say, material concern that we should bring to your attention.


Operator [11]


We now have Nick Lord from Morgan Stanley.


Nicholas Lord, Morgan Stanley, Research Division – Head of ASEAN Banks Research and Executive Director [12]


Can I just come back on net interest margin? And I’m just trying to understand. I mean you said obviously that our exit NIM, you gave a Q1 and a Q2 NIM, and you said the exit NIM at the end of Q2 was lower. I just wonder if you could maybe give us a number on that. And then could you just talk a little bit about the asset repricing? So I know a lot of things are happening at the moment. A lot of banks are seeing an increase in liquid assets, which is driving down net interest margin. So I just wondered if you were saying the same thing. And are these accelerating the pace of asset repricing? And if you could give us sort of the repricing duration so we could work out maybe what the impact might be in 2021 then as well.


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [13]


Andrew, please.


Wing Lok Leung, Hang Seng Bank Limited – CFO [14]


Okay. Again, for the net interest margin, just to repeat that the first quarter net interest margin was 2.13% and the second quarter net interest margin was 1.8%. So that is the exit net interest margin for the second quarter.

Relating to the asset repricing, this is a little bit complicated because of, say, some of the principal moratorium and also relief measures that we have granted to the borrowers. So it’s likely that the negotiation will be done upon the, say, expiry of the principal holiday. We are expecting that for the (inaudible) — the credit pricing will still be very tight because of the competition for quality loans.

On the SME, because of the heightened risk, this is chance actually, we will reprice the portfolio in order to, say, we would — to compensate for the additional risk that we are taking. But so far, we are seeing, say, in general, more pressure on the overall low pricing. Because banks are more geared to take up more quality loans. So we are not very, say, optimistic regarding the significant improvement in the margin.


Operator [15]


The next question is from Gurpreet Sahi from Goldman Sachs.


Gurpreet Singh Sahi, Goldman Sachs Group, Inc., Research Division – Equity Analyst [16]


I have this question regarding the loans and the deferrals, so payment deferrals or any sort of moratorium. First of all, can you provide a number, maybe I missed it during the presentation as to how much of the total loan book is exposed to such kind of moratoriums and any split? And then second is there are talks around extending the moratorium beyond October. So what are the thoughts from the result, the bank management, would be helpful to know.


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [17]


Well, I think maybe, Chee, you can answer the first one?


Yeo Chee Leong, [18]


Sure. A total of 2,600 customer has been granted loan moratoriums, within which, Personal Banking represents about 900 and the balance in wholesale banking. In terms of loan amount, Personal Banking-wise, mortgage is 275 — I beg your pardon, sorry, in terms of the Personal Banking, mortgage amount is $2.5 billion. For nonmortgage, it’s $668 million. So total is about $3.2 billion. So wholesale is — the amount is $78.8 billion. So in terms of total amount versus our total loans and advances is less than 10%.

With regards to the expansion, we are in discussion with HKMA on the further extension. Details are not finalized yet. But we will try our best to help our customers as much as we can. But at the same time, we are committed of the credit quality that we will have to maintain.


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [19]


I agree with Chee Leong. There will certainly be — certain factor in certain industry, certain group of customers that are most very affected by COVID-19, but it might not be across the board. So we’re depending on how the HIBOR situations evolve in the next month or so.


Operator [20]


We now have Steven Chan from Haitong International.


Steven Chan, Haitong International Research Limited – Executive Director [21]


I have three quick question. First of all, about the expected credit loss, what proportion of that is related to management overlay? That’s the first one.

And second one is, I think we have seen net loss for associated company, and you mentioned that is also related to revaluation deficit of some investment property. And I double checked your associate company, only 1 company is where — is , right, that is called [Barrel Gate] investment, but we do not have much knowledge for that. Because for the past few years, we have never seen that happening. So just want to know, could you give more color about this associated company Barrel Gate .

And what’s the size of the investment property in this company? So that’s the second question.

And third question, on the positive side, we are seeing quite good growth in your Mainland China profit. I just want to know how you — what’s the key earnings driver of this growth for the China operating profit? And what’s your outlook for your Mainland China operation in the second half?


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [22]


And I’ll have Chee Leong answer the first questions about the management overlay. And then CFO will answer the questions about Barrel Gate and I’ll come back to China.


Yeo Chee Leong, [23]


Okay. On the ECL overlay, for the first half of this year, the ECL calculation is a little bit different from what we have done in previous years. In the past, what we have — what we do with our model is that we have a central scenario and then a top side scenario and a down side scenario.

From second half of last year, you’ll recall that we have a second downside scenario, which is what we call additional down side scenario. And then we based — based on that scenario to do an adjustment, which is what we called the overlay.

For this year, it is a little bit different. This year, we created 4 scenarios like what we’ve done in the past. But all the 4 scenarios goes into to the engine to generate an expected credit loss. There is no some so-called [met-up] already per se.

Having said that, with the output, we also — we look at the reasonableness of the output. And then we apply what we call extra credit adjustment using name by name, sector by sector approach to look at whether the adjustment in the ECL is reasonable. That adjustment is used to compare against the model and make suitable adjustment in there.

If I break down the net ECL, the $1.76 billion in the ECL change for the first half, 51% or $904 million relates to stage 1 and 2. Within which, approximately about half of which will be relating to the additional down side scenario.


Wing Lok Leung, Hang Seng Bank Limited – CFO [24]


Okay, Steven, back to your second question, looking to the details of the associated company. The associated family company is investment property holding company. So as of the, say, investment of the holding company is a prime office building, together with some retail force in Causeway Bay and we own 24% of the related company, and so it will be equity accounted for. Because it is an investment property, so the accounting policy for the associate company will be valued, the investment property, on a regular basis and any service on arising from property devaluation or deficits will be taken to the P&L.

And because of the — trade is soft and also the, say, retail sales, impact by the COVID-19, you can see that a lot of the property evaluation in Hong Kong so far are in deficit. And that was also the case in our, say, associate companies within the property. And because of the equity contact, we also shared a loss arising from the reversion deficits of related properties.


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [25]


And then the third question is about China. Although the total contributions for China to our entity performance was still relatively small for first half, I’m pleased to see the growth in China. Amidst that — they are also — they have also gone through the COVID-19 challenges. The growth is mainly driven by, first of all, the growth of the total assets, which is 7.9%, both loan and deposits has good growth.

Second, very prudent control in terms of expenses to make sure that we actually have a year-on-year reduction from expenses. There is also a significant increase in ECL as similar to the Hong Kong situation. But with the growth in customer relationship and also the total assets, it has been able to drive an 11% increase in bottom line. Another factor that also affect the good performance of China is the strong collaborations with the Hong Kong team. We basically have a lot of clients overlapping with each other, so we understand their portfolio and have been able to control the credit quality, which is a very important factor for doing business in China. We have actually lately launch a service that allow customers that have account in both Hong Kong and China to be able to see your balances and also will make money online. So those are some of the things that we will be developing in order to build a much tighter relationship with our Mainland operation.


Operator [26]


And now we have Alex Zhou from UBS AG.


Huanan Zhou, UBS Investment Bank, Research Division – China Financials Research Analyst [27]


My question is a quick follow-up on the asset quality. We saw quite a significant increase in terms of the stage 2 exposure. May I confirm whether that is primarily driven by the loans on the moratorium?

And the second thing is if I look at the ECL coverage for the stage 2 exposure, that seems to be — to have been diluted somewhat in the first half. So how should I make up this sort of lower ECL coverage ratio for the stage 2 exposure? And if the stage 2 increase was driven by the loans on the moratorium, may I ask on the work subsidences, which you sort of downgrade further those exposure to stage 2 or increase the ECL coverage for the 6 quarters.


Wai Wan Cheang, Hang Seng Bank Limited – Vice-Chairman & Chief Executive [28]


Chee Leong, please.


Yeo Chee Leong, [29]


Okay. On the asset quality stage 2, the increase in stage 2 is not primarily due to the moratorium that we offered. We have done an analysis. The ECL impact from the moratorium currently is very minimal. But of this increase in stage 2 are some customers moving from stage 1 to stage 2. But in terms of the asset quality, they remain very satisfactory.

Just for reference, the assets under good book in our wholesale portfolio, it still represents 99% of our total wholesale portfolio. And compared to the end of last year, the change is very, very marginal. When we look at downgrade to stage 3, we will closely monitor the conduct, and we create vehicles to help with our customers. We constantly do assessment of the credit quality, and if we think that the — a particular loan is not expected to be repeat, we will — according to the accounting policy, we will adjust to stage 3.

Your other question on the ECL coverage. Just for comparison, if we look at average stage 3 ECL in the last 3 years, the current stage 1 and 2 balances for Hong Kong is about 6.8x, and for China is 3x. If we look at the last 12 months, net ECL is a rolling 12 months, ECL — stage 3 ECL. At Hong Kong, we are looking at 2.8x and China 13x. So we feel that the current ECL coverage is still very acceptable.


Wing Lok Leung, Hang Seng Bank Limited – CFO [30]


Your sentiment, Alex, your question regarding the coverage ratio for stage 2 seems to be lowered in the first half as compared to last year. That was because when there are some stage 1 migrations to stage 2. Some of those stage 1 customers actually are very good customers. So even though they may be migrated to Phase II, they associated ECL coverage should be lower than the average of the total stage 2 portfolio. So it will dilute the ECL coverage ratio for the stage 2 portfolio.

Reminded that the classification of stage 1 and stage 2 are not depending on the absolute probability of the [forbearance edges] depending on whether there’s significant increase in credit risk. And for very good customers, there may be some slight changes in the, say, grade leading to the migration to stage 2. But the related ECL will still be very low, even though they are moving to stage 2. And that’s the reason why those migrations will dilute the overall coverage for the stage 2 ECL percentage.


Unidentified Company Representative, [31]


Thank you, gentlemen. Thank you, Louisa. This will bring our annual session of the 2020 interim results to a close. Thank you, everyone, for joining us. Thank you.


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