Hang Seng Bank Limited 2010 Results

28 February 2011 

HANG SENG BANK LIMITED

2010 RESULTS - HIGHLIGHTS

·; Attributable profit up 14% to HK$14,917m (HK$13,138m in 2009).

·; Profit before tax up 13% to HK$17,345m (HK$15,400m in 2009).

·; Operating profit up 7% to HK$14,085m (HK$13,214m in 2009).

·; Operating profit excluding loan impairment charges and other credit risk provisions up 3% to HK$14,475m (HK$14,026m in 2009).

·; Return on average shareholders' funds of 22.8% (22.9% in 2009).

·; Assets up 10% to HK$916.9bn (HK$830.7bn at 31 December 2009).

·; Earnings per share up 13.5% to HK$7.80 per share (HK$6.87 per share in 2009).

·; Fourth interim dividend of HK$1.90 per share; total dividends of HK$5.20 per share for 2010 (HK$5.20 per share in 2009).

·; Capital adequacy ratio of 13.6% (15.8% at 31 December 2009); core capital ratio of 10.8% (12.8% at 31 December 2009).

·; Cost efficiency ratio of 33.7% (32.6% in 2009).

Within this document, the Hong Kong Special Administrative Region of the People's Republic of China has been referred to as 'Hong Kong'.

Contents

12 Results Summary

15 Customer Group Performance

21 Mainland Business

22 Consolidated Income Statement

23 Consolidated Statement of Comprehensive Income

24 Consolidated Balance Sheet

25 Consolidated Statement of Changes in Equity

27 Consolidated Cash Flow Statement

28 Financial Review

28 Net interest income

30 Net fee income

31 Trading income

32 Net income/(loss) from financial instruments designated at fair value

32 Other operating income

33 Analysis of income from wealth management business

35 Loan impairment charges and other credit risk provisions

36 Operating expenses

37 Gains less losses from financial investments and fixed assets

38 Tax expense

39 Earnings per share

39 Dividends per share

39 Segmental analysis

41 Analysis of assets and liabilities by remaining maturity

43 Cash and balances with banks and other financial institutions

43 Placings with and advances to banks and other financial institutions

44 Trading assets

45 Financial assets designated at fair value

46 Advances to customers

46 Loan impairment allowances against advances to customers

47 Impaired advances and allowances

48 Overdue advances

49 Rescheduled advances

49 Segmental analysis of advances to customers by geographical area

50 Gross advances to customers by industry sector

52 Financial investments

54 Amounts due from/to immediate holding company and fellow subsidiary

companies

55 Interest in associates

55 Intangible assets

55 Other assets

56 Current, savings and other deposit accounts

56 Certificates of deposit and other debt securities in issue

57 Trading liabilities

57 Other liabilities

58 Subordinated liabilities

59 Shareholders' funds

60 Capital resources management

62 Liquidity ratio

63 Reconciliation of cash flow statement

64 Contingent liabilities, commitments and derivatives

67 Statutory accounts and accounting policies

68 Comparative figures

68 Property revaluation

69 Foreign currency positions

69 Ultimate holding company

70 Register of shareholders

70 Proposed timetable for 2011 quarterly dividends

70 Code on corporate governance practices

70 Board of Directors

71 News release

Comment by Raymond Ch'ien, Chairman

Our focus on strengthening Hang Seng's platform for long-term growth produced solid results in 2010.

As the global economic recovery progressed, we took steps to maintain our leading position in traditional areas of banking and capitalise on new business opportunities, achieving increases in both net interest and non-interest revenue streams. The success of our approach saw income growth in the second half of the year outpace that of the first half, despite increasingly competitive operating conditions.

As economic confidence returned, we used our ability to get products to market rapidly to capture the shift in investment sentiment, driving good increases in both personal and corporate wealth management business.

We leveraged our strong balance sheet, excellent market knowledge and effective credit risk management system to expand lending portfolios, underpinning the rise in net interest income.

We continued to support local industry through active participation in government-sponsored lending schemes as well as efforts to improve the access and delivery of services for SME customers.

Our rapid response to the further opening up of renminbi banking in Hong Kong strengthened our status as a preferred partner for trade-related financial services and demonstrated our cross-border capabilities.

In 2010, Hang Seng Bank (China) Limited purchased headquarters premises in Shanghai and opened two new outlets in the Pearl River Delta region, underlining our commitment to the mainland China market. We achieved increases in our mainland customer and deposit bases, further improving prospects for long-term business growth, and we continued to collaborate with our strategic mainland partners - Industrial Bank and Yantai Bank - to good effect. In the first half of the year, we took up our full entitlement under a rights share issue by Industrial Bank.

Financial Performance

Operating profit excluding loan impairment charges and other credit risk provisions rose by 3% to HK$14,475m. Operating profit grew by 7% to HK$14,085m, with the stabilisation in economic conditions and our good management of credit risk driving a 52% improvement in loan impairment charges and other credit risk provisions to HK$390m.

Profit before tax was up 13% at HK$17,345m. Profit attributable to shareholders rose by 14% to HK$14,917m. Earnings per share were up 13.5% at HK$7.80.

We continued to build good business momentum during the year to record increases in operating profit excluding loan impairment charges and profit attributable to shareholders of 11% and 14% respectively in the second half of 2010 compared with the first half.

Higher performance-related pay as well as more investment in marketing to support future growth saw operating expenses rise by 8% to HK$7,355m. Our cost efficiency ratio for 2010 was 33.7%.

Return on average shareholders' funds was 22.8%, compared with 22.9% a year earlier. Return on average total assets was 1.7%, the same as in 2009.

At 31 December 2010, our capital adequacy ratio was 13.6% compared with 15.8% at the end of the previous year. The decline mainly reflects our participation in Industrial Bank's rights issue and the rise in risk-weighted assets. Our core capital ratio was down 2.0 percentage points at 10.8%.

The Directors have declared a fourth interim dividend of HK$1.90 per share, payable on 30 March 2011. This brings the total distribution for 2010 to HK$5.20 per share.

Outlook

Large-scale fiscal and monetary stimulus initiatives launched in the wake of the international financial crisis supported a rebound in the global economy in 2010. However, the recovery has occurred on two distinct tracks, with fast growth in emerging economies but slower progress in advanced economies.

The resurgence in export activity and robust domestic consumption underpinned GDP growth in Hong Kong and on the Mainland, although the pace began to moderate in the second half of the year.

With many stimulus programmes now being phased out, challenges remain. The US Federal Reserve's announcement in November of another round of quantitative easing underlines the continuing fragility of the US economy, while many countries in Europe have instituted austerity measures as they attempt to restore fiscal discipline and address unprecedented levels of sovereign debt.

These developments may dampen export demand in 2011. In addition, the persistence of low interest rates and excess market liquidity are fuelling concerns over inflation and asset price bubbles. However, unemployment in Hong Kong remains low and overall market sentiment is upbeat. Along with the major boost to construction provided by several large government-led infrastructure projects, this should support domestic consumption, helping to cushion the effects of any slowdown in the external sector.

Despite recent measures to curb rising inflation and property prices on the Mainland, steady income growth and the government's efforts to promote private consumption through its 12th five-year plan should sustain strong domestic demand, which will be the primary driver of GDP growth in the short term.

In uncertain market conditions, our competitive strengths will ensure we maintain our leadership in areas such as mortgages, credit cards and commercial lending. We will use our trusted brand, time-to-market capabilities and extensive range of service delivery channels to capture new business opportunities. We will also continue to build on the good progress we have made in strongly positioning ourselves to achieve sustainable growth.

Review by Margaret Leung, Vice-Chairman and Chief Executive

The operating environment was very competitive in 2010 as banks sought to capitalise on improved investment sentiment and the upturn in economic activity. Backed by our trusted brand and strong financial fundamentals, our timely actions to meet the changing needs of customers reinforced our leadership in traditional bank services and strengthened our position in new areas of business - supporting good growth in the customer bases, revenue and profit of our core business lines.

Low interest rates had an adverse effect on deposit spreads and returns from Treasury's balance sheet management portfolio. While remaining vigilant in managing credit risk, we redeployed the commercial surplus to expand lending, outperforming the market for growth in customer advances and increasing our share in the competitive credit card and residential mortgage sectors.

We achieved year-on-year growth in net interest income, building good momentum throughout the year to record higher net interest income and net interest margin in the second half of the year compared with the first half.

With our strong wealth management and cross-border commercial banking capabilities, we also achieved a second-half growth trend in net fee income - supporting a solid rise in fee-related revenue for the year.

We launched new mainland-focused investment products and increased our retail investment fund market share, reaffirming our reputation as a leading fund manager and distributor in Hong Kong.

Innovative initiatives to support business customers with operations in Hong Kong and on the Mainland established us as a market leader for cross-border renminbi financial services. We are now well positioned to capture a growing share of this rapidly expanding sector.

A new iPhone application for foreign exchange margin trading and the expansion of trading services on our online business banking platforms helped customers take timely advantage of investment opportunities. At 31 December 2010, our Personal e-Banking and Business e-Banking customer bases were up 10% and 19% respectively compared with a year earlier.

Customer Groups

Personal Financial Services recorded an 8% increase in profit before tax to HK$7,872m. Operating profit excluding loan impairment charges grew by 5% to HK$7,865m. Operating profit was up 9% at HK$7,656m.

Despite downward pressure on mortgage pricing and deposit spreads, we achieved a 4% rise in net interest income to HK$8,485m by expanding our loan portfolios.

Unsecured lending grew strongly, recording a 52% rise in profit before tax when compared with 2009, attributable to impressive business momentum and improved loan quality. Our new Hong Kong dollar China UnionPay credit card helped support an 11% increase in the card base, which passed the major milestone of two million cards in circulation. Card spending and receivables increased by 18% and 14% respectively. Strong growth of 29% was registered for personal loans. Overall, loan impairment charges dropped by 46% in 2010.

We reinforced our strong position in the residential mortgage sector. We outperformed the market for new mortgage registrations and increased our share of mortgage business.

We used our ability to bring products to market rapidly and our extensive distribution network to capitalise on the improvement in investor outlook, achieving a 9% increase in wealth management income to HK$5,092m. We maintained growth during the year, recording a 4% rise in wealth management revenue in the second half of 2010 compared with the first half.

Investment income was up 10% at HK$2,786m. Timely new products, including the Hang Seng RMB Bond Fund, supported a 181% increase in retail investment fund sales and an 85% rise in investment fund fee revenue. Funds under management (including private banking) exceeded HK$150bn for the first time. Our focus on excellent service and the diversity of the investment products we offer underpinned the 25% increase in service fee income in private banking.

Our enhanced online securities services and innovative iPhone application for foreign exchange margin trading drove increases in the number of securities and margin trading accounts.

We strengthened our position as a prominent provider of retirement planning solutions and insurance coverage for different life stages by launching new products and enhancing protection under existing plans. Life insurance income rose by 10%. Total life insurance policies in-force and annualised premiums grew by 9% and 13% respectively.

We were named 'Company of the Year' in Benchmark's Wealth Management Awards 2010 and 'Best Local Private Bank in Hong Kong' by Euromoney for the second consecutive year.

Commercial Banking took good advantage of the global economic recovery and the further opening up of renminbi financial services in Hong Kong. Profit before tax rose by 42% to HK$3,748m, reflecting broad-based income growth as well as a 36% improvement in loan impairment charges. Operating profit, excluding loan impairment charges, was up 34% at HK$2,671m.

We took steps to facilitate commercial activity. Our cross-border and renminbi offerings helped companies capitalise on new business opportunities while managing risk, driving a 225% increase in trade finance. Our financial support for SMEs through Hong Kong government-initiated lending schemes had topped HK$18.4bn by the end of 2010. We used technology to reduce turnaround times for new and renewed lending and credit facility decisions. These efforts helped drive a 102% increase in customer advances to HK$167.5bn, with a 58% rise in related net interest income.

Customer deposits rose by 14%, but pressure on spreads resulted in a 19% fall in deposit net interest income.

We established a leadership position for renminbi commercial banking services that will provide an excellent springboard for future growth. Among other initiatives, we became the first bank in Hong Kong to establish a prime rate and to lead-arrange a syndicated loan denominated in renminbi.

Close collaboration between commercial banking teams in Hong Kong and on the Mainland and new strategic alliances with mainland partners enhanced our cross-border service proposition and proved a valuable source of referral business. At the end of 2010, we had over 58,000 commercial renminbi accounts and our renminbi cross-border trade-related business exceeded RMB35bn.

Net fee income rose by 9%, supported in part by an enriched portfolio of corporate wealth management products and enhanced online investment services.

Corporate wealth management income rose by 27%, representing 13% of Commercial Banking's total net operating income before loan impairment charges.

Stronger internet-based business banking platforms helped drive continuing customer migration to online channels. At 31 December 2010, the number of Business e-Banking customers had reached over 92,000. The number of online business transactions in 2010 grew by 19% compared with a year earlier.

Corporate Bankingrecorded a 38% increase in profit before tax to HK$1,266m. Operating profit rose by 40% to HK$1,261m. Operating profit excluding loan impairment charges was up 29% at HK$1,264m.

Total operating income rose by 25% on the back of a 24% increase in net interest income to HK$1,440m.

Tighter regulations in the Hong Kong and mainland property markets and intensifying competition among lenders created new challenges for traditional drivers of Corporate Banking growth. We took steps to further diversify the revenue base, leveraging our strong customer relationships and good market knowledge to capture more business in a broader range of industry sectors and actively explore new opportunities created by the growing demand for cross-border financial services. Customer advances and deposits grew by 32% and 34% respectively.

Treasury's profit before tax fell by 1% to HK$3,361m. With increased loan demand from business customers, a substantial proportion of the commercial surplus was redeployed to support commercial lending. Good growth in trading income, a disposal gain and an increase in share of profits from associates was more than offset by the adverse effects of continuing low global interest rates on net interest income, which dropped by 35% to HK$1,403m. Operating profit fell by 24% to HK$2,207m.

We took steps to improve the investment mix under the balance sheet management portfolio by disposing of selected instruments and investing in high-quality debt securities, which generated a HK$95m disposal gain. The active management of the portfolio led to a 30% increase in net interest income in the second half of 2010 compared with the first half despite the challenging market conditions.

Closer collaboration with business banking colleagues and efforts to meet the growing demand for renminbi-denominated products drove the 10% increase in trading income to HK$1,162m.

Mainland Business

Hang Seng Bank (China) Limited moved forward with its strategy for long-term development with the RMB510m purchase of headquarters premises in Shanghai. With the opening of two cross-location sub-branches under CEPA VI in 2010, Hang Seng China now has 38 outlets across 13 Mainland cities.

An enhanced customer referral mechanism, good cross-border commercial banking capabilities and a diverse portfolio of products proved valuable in attracting new business and building a broader platform to sustain growth in deposits. The mainland personal and commercial banking customer bases increased by 15% and 14% respectively year-on-year.

The expansion of wealth management offerings underpinned a 17% rise in the number of Prestige Banking accounts. Along with enhancements to services for commercial customers, this rise helped drive a 76% year-on-year increase in deposits - improving balance sheet strength. With continuing emphasis on credit quality over portfolio size, advances to customers increased by 28%.

Hang Seng China's profit before tax recorded solid growth, with the 24% rise in total operating income more than outweighing increases in loan impairment charges and operating expenses.

Collaboration with Hang Seng's strategic mainland partners, Industrial Bank and Yantai Bank, continued to extend our reach in regions with good economic growth potential.

A Winning Strategy

The economic rebound boosted international trade and investment markets in 2010 but the outlook for 2011 remains uncertain. With stimulus initiatives winding down, many of the world's advanced economies are still grappling with major monetary and fiscal issues, which may subdue export demand.

Although upbeat consumer and business sentiment should continue to support domestic demand, a slowdown in the external sector would create new challenges for Hong Kong. Despite recent measures to curb economic overheating, domestic consumption on the Mainland looks set to remain robust, underpinning continued growth - albeit at a more moderate pace.

Our long-term goals are to be the leading personal and private bank for affluent and middle-class customers in Hong Kong and on the Mainland, and the leading trade bank in Greater China.

To achieve these objectives, we have identified business priorities that capitalise on our competitive strengths and support sustainable growth.

Hang Seng's strengths are its unique market positioning, comprehensive wealth management capabilities and extensive business referral network.

The rapidly growing middle and affluent classes on the Mainland are seeking new investment opportunities at home and in Hong Kong. With our good cross-border reach and trusted brand, we are strongly positioned to meet their needs.

In support of achieving our goals, we will maintain our excellent service level. We will make further investment in technology and launch service innovations to facilitate transactions and capture more business, particularly in the Prestige Banking segment and among young people. We will develop new applications for personal mobile devices to provide convenient access to account and market information. We will work to drive continuing good growth in deposits in Hong Kong and on the Mainland, providing a solid foundation for business expansion.

We have placed ourselves at the leading edge of the wealth management and offshore renminbi financial services markets. We will continue to make good use of our product development capabilities and well-established service platforms to become the preferred bank in these rapidly growing sectors.

Our strong cross-border banking proposition is proving an important tool as we work to become the leading trade bank in Greater China.

Treasury will continue to develop effective hedging solutions and new renminbi-related products for customers, and Commercial Banking has enhanced online banking services to support renminbi account enquiries and transaction instructions. We will remain close to customers and to mainland regulators to ensure we stay ahead of the game.

Enduring characteristics of Hang Seng's success are a willingness to aim high in setting our business objectives and our focus on serving customers well by providing financial solutions that are tailored to their needs. We have a winning strategy for maintaining a strong position in traditional business lines and for taking the lead in key areas of new business to deliver long-term growth.

Results summary

Hang Seng Bank Limited ('the bank') and its subsidiaries ('the group') reported an audited profit attributable to shareholders of HK$14,917m for 2010, up 13.5% compared with 2009. Earnings per share were HK$7.80, up HK$0.93 from 2009. Profit attributable to shareholders for the second half of 2010 increased by HK$989m, or 14.2%, when compared with the first half.

Operating profit excluding loan impairment charges and other credit risk provisions grew by HK$449m, or 3.2%, to HK$14,475m. Although Hong Kong's economy improved solidly on the back of the strong rebound in exports, the operating environment for banks remained challenging with the persistence of low interest rates and intensifying market competition. Net interest income registered an increase of 2.0%, underpinned by strong loan growth. Supported by the improvement in investment sentiment, non-interest income grew by 10.9%. While continuing to carefully manage costs, investment for future growth led to an 8.4% rise in operating expenses compared with 2009. The bank built encouraging business momentum, resulting in an 11.3% increase in operating profit excluding loan impairment charges and other credit risk provisions in the second half of the year compared with the first half.

Net interest income rose by HK$277m, or 2.0%, to HK$14,300m. Net interest margin for 2010 was 1.78% - down 12 basis points compared with 2009. Net interest spread narrowed by 12 basis points to 1.72%, while contribution from net free funds remained the same as in 2009 at 0.06%. Good growth in customer advances, an 8.9% rise in average interest-earning assets and improved loan spreads were partly offset by the continuing compression of deposit spread and the repricing of assets at lower market interest rates.

Net fees and commissions increased across core business lines, resulting in an overall rise of HK$576m, or 13.3%, to HK$4,897m. Wealth management business continued to be a key driver of income growth. The improvement in investor sentiment and low interest rate environment stimulated demand for investment products. The bank capitalised on this by promoting enhanced yield investment opportunities to cater for a wide range of customer risk appetites. Supported by the bank's reputation as one of Hong Kong's leading fund providers, investment fund sales grew by 180.8% compared with the previous year. Insurance agency fee income rose by 34.7%, due mainly to strong sales of a life protection with return insurance product. In the improved market conditions, private banking service fee income increased by 24.0%, with private banking leveraging its core strengths of a diverse suite of investment products and client service excellence. The credit card business continued to grow and sustain the market share in terms of card base, receivables and spending, supporting a 3.5% rise in fee income. Benefiting from the recovery in global export demand and the expansion in scope of offshore renminbi business, remittances and trade-related fee income grew by 19.4% and 19.3% respectively. Credit facilities fee income increased by 44.4%, mainly reflecting higher fees from corporate lending. With the bank registering lower stock-market trading turnover and keen price competition, stockbroking and related services income fell by 6.3%.

Trading income increased by HK$136m, or 7.1%, to HK$2,059m. Foreign exchange income fell marginally by HK$24m, or 1.3%, attributable to decreased net interest income from funding swaps and lower customer demand for foreign exchange-linked structured products as well as increased losses on the revaluation of certain US dollar capital funds - maintained in the bank's mainland subsidiary bank and subject to regulatory controls - against the renminbi. Excluding the above items, efforts to expand proprietary trading and customer-driven business saw foreign

exchange trading income rise by HK$72m, or 4.7%, compared with 2009. Income from securities, derivative and other trading activities rose by HK$160m, or 122.1%, driven by the improvement in derivatives trading.

Income from insurance business (included under 'net interest income', 'net fee income', 'net income from financial instruments designated at fair value', 'net earned insurance premiums', 'movement in present value of in-force insurance business' within 'other operating income', and after deducting 'net insurance claims incurred and movement in policyholders' liabilities') grew by HK$217m, or 9.0%, to HK$2,624m. The bank continued to enhance its leading position in life insurance by providing a diverse range of retirement savings and protection products. Net interest income and fee income from life insurance business grew by 18.4%, due primarily to the increase in the size of the life insurance funds investment portfolio. The investment return on the life insurance funds investment portfolio also improved, recording a gain of HK$287m in 2010 compared to a gain of HK$17m in 2009.

Net operating income before loan impairment charges and other credit risk provisions increased by HK$1,018m, or 4.9%, to HK$21,830m.

Operating expensesrose by HK$569m, or 8.4%, to HK$7,355m. The bank continued to carefully manage its costs, but made new investments on the Mainland and in business development in Hong Kong to support long-term growth of core income streams. Excluding mainland business, operating expenses rose by 7.1%, mainly due to increases in staff-related costs, marketing expenditure and processing charges. Mainland-related operating expenses rose by 16.8%, attributable mainly to the expansion of the bank's wholly owned mainland banking subsidiary, Hang Seng Bank (China) Limited ('Hang Seng China'), from 36 to 38 outlets, and an increase in headcount.

Loan impairment charges and other credit risk provisions improved significantly, falling by HK$422m, or 52.0%, to HK$390m. Individually assessed impairment charges dropped by HK$124m, or 40.0%, reflecting lower impairment charges made on corporate and commercial banking customers in 2010 as a result of the upturn in economic conditions and the bank's good risk management control. Collectively assessed allowances dropped by HK$298m, or 59.4%, to HK$204m, with lower charges on the credit card and personal loans portfolios as a result of improving delinquency rates and the declining bankruptcy trend. Impairment allowances for loans not individually identified as impaired also improved, due to lower historical loss rates with the improvement in global credit markets.

Operating profit rose by HK$871m, or 6.6%, to HK$14,085m.

Profit before tax increased by 12.6% to HK$17,345m after taking the following items into account:

·; a 39.8% (or HK$74m) fall in gains less losses from financial investments and fixed assets;

·; a 93.3% (or HK$235m) increase in net surplus on property revaluation; and

·; a 52.2% (or HK$913m) increase in share of profits from associates, mainly from Industrial Bank.

Consolidated balance sheet and key ratios

Total assets rose by HK$86.2bn, or 10.4%, to HK$916.9bn. Customer advances increased by HK$128.0bn, or 37.1%, with strong growth in trade financing, corporate and retail lending and mainland loans. Despite the keen market competition, the bank's residential mortgage business continued to record good growth and sustained its market share in terms of total mortgage lending. Customer deposits and certificates of deposit and other debt securities in issue increased by HK$46.7bn, or 7.0%, to HK$710.3bn, driven in part by strong growth in renminbi deposits. At 31 December 2010, the advances-to-deposits ratio was 66.5%, compared with 51.9% at 31 December 2009, reflecting the faster pace of loan growth in 2010. Financial investments and trading assets decreased by 17.5% and 60.9% respectively, attributable primarily to the redeployment of the commercial surplus to support loan growth.

At 31 December 2010, shareholders' funds (excluding proposed dividends) were HK$66,379m, an increase of HK$7,864m, or 13.4%. Retained profits rose by HK$5,214m, mainly reflecting the growth in profit after the appropriation of interim dividends. Benefitting from the stabilisation in credit markets, the available-for-sale investment reserve recorded a surplus of HK$202m, compared with a deficit of HK$257m in 2009. Buoyant property prices underpinned the HK$1,541m increase in the premises revaluation reserve.

The return on average total assets was 1.7% (1.7% for 2009). The return on average shareholders' funds was 22.8% (22.9% for 2009).

At 31 December 2010, the capital adequacy ratio was 13.6%, down from 15.8% at the end of 2009. The core capital ratio was 10.8%, compared with 12.8% a year earlier. The ratios were calculated in accordance with the advanced internal ratings-based approach under the Banking (Capital) Rules issued by the Hong Kong Monetary Authority for the implementation of Basel II. The fall in both capital and core capital ratios largely reflects the combined effect of a reduction from the group's capital base as a result of its participation in Industrial Bank's rights issue in 2010, and an increase in risk-weighted assets. This was partly offset by the growth in profit after accounting for dividends in the year, the net difference from the HK$4.5bn repayment and HK$6.0bn new issue of subordinated debt, and the increase in fair-value gain on the revaluation of properties which, after adopting the amendments to HKAS 17 'Leases' in 2010, included leasehold land held under a long lease for the bank's headquarters building.

The bank maintained a strong liquidity position. The average liquidity ratio for 2010 was 38.1% (calculated in accordance with the Fourth Schedule of the Hong Kong Banking Ordinance), compared with 48.1% for 2009, due mainly to the redeployment of liquid assets to support customer loan growth.

The cost efficiency ratio for 2010 was 33.7% compared with 32.6% in 2009.

Dividends

The Directors have declared a fourth interim dividend of HK$1.90 per share, which will be payable on 30 March 2011 to shareholders on the register of shareholders as of 15 March 2011. Together with the interim dividends for the first three quarters, the total distribution for 2010 will be HK$5.20 per share.

Customer group performance

Personal Financial Services ('PFS') recorded a profit before tax of HK$7,872m for 2010, up 8.5% compared with 2009. Operating profit excluding loan impairment charges rose by 5.5% to HK$7,865m.

Net interest income grew by 3.5% over 2009, with the expansion in deposits and lending portfolios more than compensating for the squeeze on the net interest margin and severe price competition.

Unsecured lending grew strongly to achieve a 51.9% rise in profit before tax when compared with a year earlier, attributable to the impressive business momentum and improved loan quality. PFS took successful steps to increase the credit card base, which surpassed the two million mark, supporting year-on-year increases in card spending and receivables of 18.4% and 13.9% respectively. Personal loans grew by 29.1% to HK$4.6bn. Overall loan impairment charges dropped by 46.1% in 2010.

Against a backdrop of intense market competition and new government measures to cool property speculation, the residential mortgage business achieved good growth in 2010 to remain a top three mortgage lender and sustain its market share.

With new regulations governing investment business, PFS implemented the physical segregation of banking and investment services and reconfigured the investment sales process to maintain business momentum under the new operational structure. New products were launched to capture the shift in investor appetite in the changing market conditions. Wealth management income grew by 9.0% year-on-year and by 4.1% in the second half of the year compared with the first half.

Investment-related income increased by 9.8%, driven in part by an 85.1% rise in revenue from investment funds business. Timely new products, including the Hang Seng RMB Bond Fund, supported growth of 180.8% in retail investment fund sales as well as a significant increase in the bank's investment fund market share. Stockbroking and related services fee income grew by 16.2% in the second half of 2010 compared with the first half.

New life insurance plans offering improved protection propositions proved effective in driving sales. Income from the life insurance business grew by 9.7% compared with 2009. Total life insurance policies in-force and annualised premiums rose by 8.6% and 13.3% respectively.

Hang Seng continued to be recognised as the leading wealth management bank in Hong Kong, receiving awards including 'Best Domestic Bank in Hong Kong' from The Asset for the 11th consecutive year, 'Company of the Year' in Benchmark's 2010 Wealth Management Awards and 'Best Local Private Bank in Hong Kong' from Euromoney for the second year in a row.

Personal e-Banking grew its registered customer base by 10.2% compared with the end of 2009 to reach 1.1 million. PFS continued to implement service innovations, including the development and launch in August 2010 of a first-of-its-kind iPhone application to support foreign exchange margin trading. As of December over 435,000 customers had added their support to the bank's environmental efforts by registering to receive electronic rather than paper statements through the e-Statement service - a 30.3% increase compared with a year earlier.

Commercial Banking ('CMB')achieved a 42.1% increase in profit before tax to HK$3,748m. CMB's contribution to the bank's total profit before tax increased to 21.6%, up 4.5 percentage points from 2009. Operating profit excluding loan impairment charges was up by 34.3% to HK$2,671m, due mainly to increases in net interest income from advances and net fee income. With improving market conditions and a continuing emphasis on risk management, loan impairment charges fell by 36.0%.

Against a backdrop of economic recovery and the rebound in exports, CMB's swift response to the increase in demand for financing saw customer advances increase by 102.1%, underpinning a 57.8% rise in net interest income from lending. The influx of liquidity into the region drove a 14.5% rise in customer deposits. However, with continuing pressure on spreads, deposit-related net interest income fell by 19.0%.

Supported by a comprehensive business development plan and the bank's strong internal infrastructure, CMB was quick to respond to the further relaxation of the scope of renminbi business in Hong Kong in early 2010, rolling out a comprehensive range of renminbi commercial banking services and establishing the bank as a pioneer in this expanding area of business. Hang Seng was the first bank in Hong Kong to set up a renminbi prime rate and to sign a renminbi syndicated loan. CMB has developed a full suite of renminbi commercial banking products including, but not limited to, renminbi commercial finance, renminbi savings and current accounts, and renminbi factoring and solutions. At the end of 2010, we had more than 58,000 renminbi commercial accounts and had helped settle more than RMB35bn in renminbi cross-border trade-related business.

To assist commercial customers in growing their cross-border business and to establish a dynamic customer referral channel, CMB closely collaborated with Hang Seng China and several strategic partners on the Mainland, including Industrial Bank and China Export and Credit Insurance Corporation (SINOSURE). This collaboration has enhanced CMB's ability to offer one-stop commercial banking solutions and capture an increasing share of cross-border business flows.

CMB worked to provide timely, competitive corporate wealth management products to its customers, focusing particularly on those in the top-end segment. Enhanced corporate insurance products were marketed on various platforms, including wealth management and yield enhancement. Underwriting procedures were streamlined to improve service efficiency.

Income from corporate wealth management business increased by 26.6% and contributed 13.4% to CMB's total net operating income before loan impairment charges in 2010.

With strong roots in its local communities, CMB continued to be an active player in government-backed schemes to support small and medium-sized enterprises. Since late 2008, the bank has approved about 6,800 applications with a total loan amount of more than HK$18.4bn under the government-backed SME Loan Guarantee and Special Loan Guarantee schemes, with market shares of 25% and 15% respectively at the end of 2010.

CMB customers continued to migrate to online and automated banking channels. At 31 December 2010, over 92,000 customers had registered for the bank's Business e-Banking service, up 19.3% compared with a year earlier. The number of online business transactions grew by 19.0%.

Corporate Banking ('CIB') experienced an intensification of market competition in 2010. With the uneven pace of global economic recovery, many banks turned their attention to Asia, leading to growing competition among lenders. Property-related financing has traditionally been an important element of CIB's business. With tighter government regulation in the property sector both in Hong Kong and on the Mainland, CIB took steps to diversify its revenue base, leveraging its strong customer relationships and good industry sector knowledge to capitalise on new business opportunities created by the growing demand for cross-border financial services.

CIB's advances to customers and customer deposits grew by 32.4% and 34.5% respectively compared with a year earlier.

Operating profit excluding loan impairment charges was HK$1,264m, an increase of HK$285m, or 29.1%. Operating profit was up 40.0% at HK$1,261m.

Treasury ('TRY') recorded a profit before tax of HK$3,361m, in line with 2009. With increased loan demand from business customers, a substantial proportion of the commercial surplus was redeployed to support commercial lending. Operating profit was down 24.3% at HK$2,207m.

Trading income increased 10.2% to HK$1,162m and disposal gains rose by 162.5% to HK$95m, but these increases were more than offset by the 35.1% decline in net interest income to HK$1,403m.

With abundant market liquidity and the fragile nature of the global economic recovery, interest rates remained at low levels. Yield curves were also relatively flat, particularly in the first half of the year. Net interest income fell to HK$609m in the first half of the year, but TRY's active management of the balance sheet management portfolio saw net interest income rebound by 30.4% to HK$794m in the second half of the year.

TRY placed more emphasis on high-quality debt securities, particularly government-guaranteed papers and high-quality corporate debt securities, and capitalised on market opportunities to dispose of selected securities. These actions helped improve the investment mix of the balance sheet management portfolio and generated a disposal gain of HK$95m, while remaining in line with the bank's prudent risk management strategy.

Trading income increased by HK$108m, or 10.2%, to HK$1,162m, mainly contributed by the improvement in foreign exchange income and derivatives trading, boosted in part by strong demand for renminbi-denominated products and derivatives following the further liberalisation of renminbi business in Hong Kong.

Mainland business

Hang Seng Bank (China) Limited ('Hang Seng China') opened two cross-location sub-branches under CEPA VI during the year, bringing its mainland network to 38 outlets across Beijing, Shanghai, Guangzhou, Dongguan, Shenzhen, Fuzhou, Nanjing, Hangzhou, Ningbo, Tianjin, Kunming, Foshan and Zhongshan. The bank also has a branch in Shenzhen for foreign currency wholesale business and a representative office in Xiamen.

Hang Seng China continued to further enrich and diversify its wealth management product offerings and enhance its Commercial Banking capabilities to capture good growth opportunities. Close collaboration between Commercial Banking teams on the Mainland and in Hong Kong helped to support solid growth in both the personal and commercial customer bases - which increased by 15.3% and 14.4% respectively compared with a year earlier.

Customer advances recorded growth of 28.4% to HK$36.4bn compared with 2009 year-end. Customer deposits grew by 76.1%, underpinned by the increase in the mainland customer base.

Hang Seng China's profit before tax (excluding exchange losses on US dollar capital funds) recorded a growth of 139.8% compared with 2009, with growth in both net interest income and non-interest income offsetting increases in operating expenses and loan impairment charges.

The purchase of headquarters premises in Shanghai in 2010 demonstrated the group's long-term commitment to the mainland market and is supporting the continued development of Hang Seng China.

The bank's strategic alliance with Industrial Bank Co., Ltd. ('Industrial Bank') continued to generate good results. The bank took up its full share entitlement under a rights issue by Industrial Bank and increased its equity interest in the mainland bank from 12.78% to 12.80% at 31 December 2010.

The HSBC Group reports interest income and interest expense arising from financial assets and financial liabilities held for trading as 'Net trading income' and arising from financial instruments designated at fair value through profit and loss 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 interest income and interest expense of Hang Seng, as included within the HSBC Group accounts: