The 2012 annual result presentation of BOC Hong Kong (Holdings) Limited. I'm Ronick Chan, Board Secretary and Head of Investor Relations. Before we begin our presentation, may I draw your attention to this slide for our forward-looking statement disclaimer. Now, let me introduce our senior management team. With us today are Mr. Gary He, Vice Chairman and Chief Executive. Mr. Gao Yingxin, Executive Director and Deputy Chief Executive. Mr. Zhuo Chengwen, Chief Financial Officer. Mr. David Wong, Deputy Chief Executive, and Mr. Jason Yeung, Deputy Chief Executive. For today's agenda, Mr. He will start with the performance highlights, followed by Mr. Zhuo's financial results. After that, Mr. He will talk about the outlook and strategy. Then we shall open the floor for a Q&A session. Mr. He, please.
Thank you, Ronnie. Good afternoon, ladies and gentlemen. In 2012, the overall operating environment remained tough. Major economies witnessed subdued economic growth, while evolving European debt crisis continued to agitate global markets. In Hong Kong, growth was modest with sluggish external trade and domestic consumption. Banks in Hong Kong continue to face challenges from persistently low interest rates, reduced business activities, and intense competition. On the bright side, the offshore RMB market saw further regulatory relaxation in areas such as the RQFII scheme, RMB banking service to non-Hong Kong residents, and the Qianhai pilot scheme. These initiatives expanded RMB business coverage and RMB front deployment channels for banks. 2012 marked another year of record results for the group, despite all the challenges in the operating environment.
The solid performance was achieved on the back of the group's effective execution of its balanced growth strategy and enhanced capabilities to capture business opportunities. All our key business segments posted solid earning growth. Capitalizing on the group's strong RMB franchise, we swiftly captured emerging opportunities during the period with encouraging growth. The income from offshore RMB business further increased with better deployment of RMB funds. We achieved remarkable growth in offshore RMB loans, which almost tripled. In addition, we pioneered in launching new products and services to cater to the widening RMB usage in global transactions. We maintain our leading position in major RMB businesses and received various industry recognitions. Meanwhile, to better serve customers in different time zones, we upgraded our clearing systems by extending the operating hours of RMB real-time gross settlement system. We continue to enhance our service model and customer relationship management.
Our service capabilities were strengthened in 2012. A new private banking platform was launched to provide targeted affluent customers with tailor-made wealth management services. Our phone banking platform was optimized to meet the increasing demand for cross-border banking services. The network coverage of automated channels was expanded with upgraded functions. Further integration of the group's e-banking and cash management platform with those of BOC and its overseas branches has greatly stepped up the group's cross-border cash management capabilities. New business platforms set up over the past few years continue to deliver encouraging performance and better position us for future development. Capturing cross-border investment flows and RMB related developments, our custody business continued to expand its client base with better global service capabilities. Riding on our asset management platform, we further enrich our product offerings and uplifted the quality of our wealth management service. Here are the key financial highlights.
The group's profit attributable to the equity holders increased by 2.4% year- on- year to HKD 20.9 billion, a record high since our listing. Net operating income before impairment allowances rose by 15.9% to HKD 35.8 billion. Operating profit before impairments allowances increased by 6% to HKD 24.4 billion. In 2011, there was a large net recovery from the underlying collateral of the Lehman Brothers minibonds. If excluding this exceptional impact, the group's profit attributable to the equity holders would have increased by 14.9% year- on- year. ROA and ROE would have improved by 0.23 percentage point to 1.24%, and by 0.19 percentage point to 14.74% respectively. The board recommended a final dividend of HKD 0.69 per share. Including the interim dividend, our full year dividend will amount to HKD 1.238 per share, representing a growth of 4.2% year- on- year, and a payout ratio of 62.5%.
During the period, we delivered quality growth in most business areas and maintained a strong financial position, which is one of our key competitive edges. The group cautiously control its funding cost while growing deposits to support this business. Customer deposits expanded by 7.2%. Despite slow market demand, advances to customers grew healthily by 11.3% with broad-based growth in both corporate and personal loans. Loan-to-deposit ratio increased to 63% from 61% at the end of 2011.
Overall loan quality remains sound, with classified or impaired loan ratio staying at a low level of 0.26%. Throughout the year, we continued to manage our capital and liquidity prudently. Consolidated core Tier 1 capital ratio as at end of 2012 was 16.8% and 12.3% respectively. Average liquidity ratio was 41.2% versus 36.2% a year ago. That ends my performance highlights, and I'll pass you to Mr. Zhuo for detailed financial review. Mr. Zhuo, please.
Thank you, Gary. Let me walk through the income statement. In 2012, the group's profit attributable to the equity holders increased by 2.4% to HKD 20.9 billion, but would be up 14.9% if excluding the impact of the Lehman-related recovery. Net operating income before impairment analysis rose by 15.9% to HKD 35.8 billion. We saw growth in net interest income. Other operating income surged due to mark-to-market gains and growth in income from our insurance segment. Total operating expenses increased by 45%. The sharp rise was due to a lower base effect as about HKD 2.8 billion of Lehman-related recovery were included in previous year's expenses. Excluding such recovery, core operating expenses grew by 7.9%. As for overall impairment analysis, a net charge of HKD 859 million was recorded. The group's investment properties registered a revaluation gain of HKD 1.9 billion, down 14.3% from previous year.
Now let's take a closer look at our income lines. Net interest income grew by 12.4% year- on- year to over HKD 24.7 billion, driven mainly by widening net interest margin. The net interest margin was 1.6% up 28 basis points compared to 2011, with net interest spread increasing by 25 basis points and contribution from net free funds rising by 3 basis points. The expansion in net interest spread was driven by the higher return from the offshore RMB business, improved pricing of corporate and residential mortgage loans. The positive impact was, however, partially offset by rising deposit costs amid keen market competition and increase in lower-yielding investments in short-term debt securities. In past periods, the group's RMB clearing bank business had been a major drag to the overall margin.
Since the first half of 2012, its dilutive impact has already become insignificant as the balance deposit with clearing bank reduced. Our average interest-earning assets contracted by 7.2% year-on-year, mainly due to the decline of participating banks' RMB deposits with the clearing bank. Total non-interest income rose by 24.6% to HKD 11.1 billion, mainly attributable to the significant increase in net trading gain and net gain on financial instruments designated at fair value through profit and loss. Net fee and commission income increased mildly by 0.9%. Key growth drivers included fee and commission income from loans, credit cards, and funds distribution. Non-commission surged by 40.3%. Fee income from credit cards business climbed by 14.5%, driven by the 10.9% increase in cardholder spending and 14.6% increase in merchant acquiring volume.
Commission income from funds distribution rose substantially by 60.2%, attributable to our strong performance in the distribution of RQFII funds and continuous efforts in developing products to meet customers' needs. The strong growth of these businesses, however, was mostly offset by the decline of commission income from securities brokerage, fees, and insurance, reflecting the subdued investor sentiment and trade activities last year. For other operating income, net trading gains surged by 83%. The increase was mainly a result of higher net trading gain from interest rate instruments and items on a fair value hedge foreign exchange products, as well as equity instruments. The group recorded a net gain of HKD 747 million on financial instruments designated at fair value through P&L, compared to a net loss of HKD 340 million recorded in the previous year.
The net gain was mainly due to the mark-to-market change of debt securities and gain from equity investments of BOC Life. Now let's turn to our expenses. This chart shows our core operating expenses, excluding the impact of Lehman-related recovery. Our core operating expenses grew by 7.9% to HKD 11.5 billion. Core cost-to-income ratio improved to 32.2%. We continue to focus on operational efficiency and cost control while deploying resources for new business development. Staff costs increased by 6.1%, driven by annual salary increment and increased headcounts for mainland business. Premises and equipment expenses were up 4.7%, mainly because of higher rental costs in Hong Kong and the mainland. Depreciation rose by 16.9% due to larger depreciation charge on premises following the upward property revaluation in Hong Kong and on our continuous investment in IT infrastructure.
Other operating expenses was up by 9.7%, mainly due to activities to support business growth, such as marketing expenses. Loan impairment allowances recorded a net charge of HKD 854 million. Net charge of individually assessed impairment allowances increased from a low base to HKD 512 million, mainly due to the downgrade of a few corporate loans. Net charge of collective impairment allowances before recoveries decreased by 15.8% as loan growth moderated in 2012 compared to 2011. The group's loan quality remained sound, with classified or impaired loan ratio staying at a low level of 0.26%. Classified or impaired loans rose mainly due to the downgrade of a few corporate loans. The formation of new classified loans represented 0.26% of total loans outstanding. Total assets increased by 5.3% to HKD 1.83 trillion, driven by customer deposit growth. Cash and balances with banks and other Financial Institutions dropped by 28.7%.
The decline was mainly due to a decrease in IMB funds deposited by the participating banks with the clearing bank. Placements with banks and other Financial Institutions dropped by 38.8% as we redeployed these funds for advances to customers and security investments. Security investment increased by 24.9%. Advances to customers and other accounts grew by 8.5%, mainly due to the growth in customer loans. Total equity grew by 16.4%, mainly attributable to profit for the period, increase in reserves for premises revaluation, and fair value changes of available for sale securities. Customer deposits increased by 7.2% compared to last year. Demand deposits and current accounts grew by 25.6%, while savings deposits increased by 19.5%. Time call and notice deposits fell by 6.8% as part of our initiatives to carefully manage funding costs. In terms of currency, growth came mainly from Hong Kong dollar and U.S. dollar deposits.
Total customer loans increased by 11.3%. Corporate loans for use in Hong Kong grew by 6.4%, with balanced growth covering a wide range of industries. Individual loans climbed by 10.1%, mainly driven by the 9.9% growth in mortgage loans as we captured the growth opportunity arising from the revival of property market during the year. Credit card advances rose by 19.5%, with other loans to individuals surged by 20.1%. Personal finance was up 12.8%, and loans for use outside Hong Kong grew by 17.9%. The group's loan-to-deposit ratio was 63%, up from 61% at last year-end. We continued to prudently manage our banking book investments in view of the market complications and changes. Total securities investments increased by 24.9%. Portfolio mix was further optimized. We increased our investments in government-related bonds, high-quality bonds issued by Asia Pacific Financial Institutions and Corporations, as well as the IMB-denominated bonds.
In terms of issuer distribution, 41% of our investments were in government or government related papers. 46% in banks and financial institutions related to securities. 91% of our debt securities holding were rated A or above. This slide shows operating income breakdown by segments. The personal banking business delivered a satisfactory performance with solid growth in both loans and deposits. We maintained our market leadership in new mortgage loans with improved pricing. Credit cards business sustained its growth momentum in 2012. Our wealth management business posted a solid performance with further increase in customer base. We enriched our products and services and provided a more customized solution to meet the different needs of our wealth management customers. Trading volume of the stock market in Hong Kong decreased substantially, which dampened our brokerage business. Nevertheless, our other investment services performed strongly, especially in the funds distribution business.
Corporate banking business sustained its momentum and delivered broad-based growth. Total corporate loans grew by 11.6% with encouraging growth in offshore RMB loans. Pricing of our corporate loan book also improved on the back of our consistent strategy to balance growth and profitability. We strive to provide a total solution with a full range of financial services, including innovative trade related products and integrated branches for commercial business, enhanced cash management and custodial services to better serve the needs of major corporate and SME customers. Treasury segments recorded outstanding financial results in 2012. The group prudently managed its banking book investment, as I explained in previous slide. On the product development front, we introduced various innovative products to help customer better manage their exchange rate risk and financing costs, which were well received by customers. We also made good progress in expanding our offshore RMB business.
We launched three new offshore RMB bond sub-indices this year and remain an active participant in the RMB bond underwriting business. Capitalizing on our strong RMB franchise and close collaboration with BOC, we expanded business relationships with banks and Financial Institutions in different regions. Insurance business continued to enrich its products range and maintain its strong position in the RMB insurance market. We also step up efforts to strengthen the integrated capabilities of our sales team to better serve the needs of our customers. During the year, BOC Life was granted the quota to invest directly in the mainland interbank bond market, thus facilitating the expansion of its RMB assets and further development of RMB insurance products. Now let's take a look at our mainland business. Our mainland operation maintained encouraging growth amid a challenging operating environment.
Net operating income increased by 18% year-on-year, mainly driven by the higher net interest income. Responding swiftly to the interest rate cuts by PBOC, we proactively adjust asset and liability structure to enhance asset return. Customer loans and deposit grew by 21.2% and 12.8% respectively. Overall loan quality remained solid and classified or impaired loan ratio at 0.79%. Operating expenses increased by 19.1% as we continued to invest in expanding our mainland operation. In 2012, we added nine outlets to a total of 36 in the mainland. The enhancement of the group's e-banking platform proved to be successful as the number of the new accounts and transaction volume increased significantly. That concludes my financial review. I now hand you back to Gary for the outlook. Thank you.
Thank you, Mr. Zhuo. We started the year with improved sentiment in global markets, which brings along optimism to the outlook. However, some of the key fundamental issues are still unresolved and may continue to affect the stability of the global markets. Growth outlook for Hong Kong's economy will likely be modest. The overall operating environment still looks mixed. We therefore need to stay alert. Despite the still challenging environment, the groups remain focused on driving its business development and exploring new opportunities, especially in the offshore RMB business. Over the past few years, major breakthroughs have been made in the development of the offshore RMB business in Hong Kong and other places. As a result, the offshore RMB market has grown substantially in depth and breadth. We believe room for further regulatory relaxation will certainly provide even more opportunities.
Capitalizing on our strong RMB franchise, we strive to create new growth drivers by expanding our business scope, customer base, and geographic coverage. Joining forces with our parent bank, BOC, we are well-positioned to capture cross-border RMB business growth as well as provide high-quality RMB services to meet the global demands of BOC Group's customers. We will ride on our enhanced business platforms with more new products and services to diversify our income sources. Our private banking platform will focus on strengthening its differentiated service capabilities to meet the needs of our privileged customers. Our custody business is well-positioned to capture the market opportunities arising from new regulatory relaxation in areas such as RQFII. Through our asset management platform, we will broaden our product offerings and continue to develop our investment services to overseas markets by establishing strategic partnerships.
Maintaining a strong financial position will continue to be one of the management's key priorities, especially amid current market conditions. As shown in our results, all our key financial ratios were at solid levels with strong capital and liquidity profile. With Basel III implementation to be effective this year, banks need to operate on a higher capital base and efficiency. The group is well prepared to meet the new capital standards while continuing our growth plans. As uncertainties remain in the global financial markets, we have to closely monitor the market changes and take proactive measures. We will also stand firmly through our risk management principles and credit policy to safeguard the quality of our assets. Going forward, we will continue our proactive approach in managing our assets and liabilities. While pursuing income and profit growth, we will keep focusing on disciplined cost control to achieve greater efficiency.
I'm confident that the group will remain strongly positioned to capture quality growth opportunities and to create greater value for its shareholders by building on its distinct competitive edges and financial strength. That concludes our presentation. My colleagues and I will be happy to take questions from you.
Okay. Now it's time for Q&A. Please raise not more than two questions each time. Sophia, would you like to be the first?
Thank you. This is Sophia Li from Deutsche Bank. My first question is regarding your net interest margin. It's down 8 basis points half on half. Can you tell us for this year, are you seeing stable NIM compared to second half or some improvement? My second question is regarding your impaired loans, specifically for transport equipment. It increased by more than HKD 1 billion, which explains most of your impaired loans increase. Can you tell us what's happening in that sector?
[inaudible]
Okay, sure. For the interest margin of 2012, the average interest margin was 1.6%, which is higher than 2011, up 28 basis points. I think the positive factor for this increase is mainly the less dilution impact or little dilution impact from the RMB clearing bank. More importantly, we increased the expanded use of our participate bank, RMB, and also our deposit costs to then ensure the loan pricing improved. For the second half of last year, there is an 8 basis points decrease of the interest margin, and that is mainly because of the higher deposit costs of RMB. Even though we have controlled as possible the funding costs, but as the overall market interest rate going up for the deposit, the cost actually increased.
Also some of the short-term funds received from other banks with us in the bank, especially after Q4, also have that negative impact on our interest margin. Those funds are short-term. We can only use for short-term investment. So you can see some of the funding investment increased or not in the second half of last year. You also asked for 2013—
For this year, so far, compared to second half.
I think in margin, we will maintain our consistent strategies to carefully control our asset and liability to get a higher return and control the funding costs. That is a consistent operating strategy. In margin, as the market interest rate does not change much, is actually even a little bit lower than the first half of last year. So we expect the interest margin currently will largely remain, maintain stable. We also see some negative factors such as the intensifying competition in customer deposits and the competition pressure on loan pricing. Those factors may have negative impact for the interest margin of this year.
Okay. About impaired loan ratio, Mr. Gao will take that question.
Yeah. About increase in the impaired loan, that is related to the particular customer in the shipping industry. Maybe due to the shipping industry in recent years, difficult situation. This loan have undergoing restructuring. So that is why all the outstanding amount have been classified loan. But now that loan have already back to the normal repayment terms. So that is the case. Yeah.
Stephen, please.
Thank you very much. Stephen Chan, CITIC Securities. Okay, two questions. First of all, again, on asset quality. If you just look at the overdue loans that has not been impaired within three months, actually, it has increased to HKD 4.1 billion. Of course, half of that is related to mortgage. Are you worrying about that these overdue loans are likely to be dangling to NPL this year? At the same time, the special mentioned loans which has not been overdue and not been impaired, remaining high at HKD 5.4 billion. I just want to know what that is about, because it is also related to corporate sector. Second question about insurance. Indeed, we are seeing the gross insurance premium income decline over the year, although the net earned premium increased, but it is mainly because you have reduced your premium income receipt to the reinsurer.
I just want to know whether you have changed your product mix in your insurance business over the year that results in this change in insurance income receipt to reinsurer. How are you going to resume your growth in gross premium this year? Because I also noticed that your bank assurance fee income was negatively affected by these reduction in gross premium income.
David, would you take the insurance question first, and perhaps okay.
Okay. Let's talk about the insurance business. It is true that last year, the fee income from the insurance business has actually gone down. There are actually three components in the fee income. One is life insurance, the other one is the general, and the third one is, of course, the fee that is arising out of the reinsurance fee. Last year, as you recall, the expectation for the RMB appreciation actually weakened last year. As a result, there was actually less demand for the RMB-based insurance policy. So that is one reason why the reinsurance fee came down. The other reason, of course, is that last year we have been approved the domestic interbank bond market quota by the PBOC. So there is less need for us to actually do reinsurance in the RMB policy.
Looking forward this year, you look at the first couple of months this year, we have seen a very healthy growth in terms of our insurance businesses, both in terms of U.S. dollars, Hong Kong dollars, as well as RMB. It is quite a balanced growth. I think the momentum will continue, because I think overall economic situation and also because of QE3, there is still a lot of liquidity in the marketplace. We have seen a quite positive sign so far.
Okay. Chengwe n, you want to?
Okay. For the overdue loan and the special mentioned loan, I would say overall, our loan quality is still good. Even for the overdue loan, most of the overdue is within three months. Actually, most of them are within one month. That is mostly due to some of the payment technical issue, not reflecting the overall loan quality deterioration. It is true, our non-performing loan increased for the end of last year. As Mr. Gao just said, that is due to some isolated cases. Overall loan quality is still good. We did not see systematic deterioration of the loan book. For the special mentioned loan, I think the overall amount and the ratio is relatively stable. I think overall it reflect some pattern. The special mentioned loan ratio now account around 0.66%, and the absolute amount disclosed in our financial book.
For the calculated percentage actually is lower than end of 2011. On the other side, as Mr. Gao said, we will carefully, cautiously manage our loan quality, especially in the customer selection, in the loan approving. Some of the companies in some industry may have difficulty as the overall world economy is still not so strong. We will keep our consistent risk management strategy in this area.
Okay, Sally.
Sally Ng from CICC. I just have one question. I am interested in your overall profitability and the growth of the offshore RMB business in FY 2012. Specifically, if you can indicate some trends on the net interest margin of—
Can you speak a bit louder, please?
Oh, okay. Sorry. The overall profitability and the growth of the offshore RMB business in last year, specifically regarding the net interest margin trend, not exact figures, but the trend, as well as the balance sheet growth and what you see the trend year-to-date in this business. Thank you.
Sorry. Just interested in RMB?
Yes, the offshore RMB business.
Okay, not the RMB.
Thank you.
Okay. Last year we saw some very interesting development, especially in the contribution of RMB businesses. Definitely, we're seeing satisfactory growth in the contribution RMB business, but we do not disclose the specific number because, it's not I don't want to tell you, it's the fact. RMB business could be easily replaced with any other currencies because people would do Hong Kong dollar or U.S. dollar, because if they're interested in RMB, they may switch. That really doesn't tell a very clear trend or clear implication as to whether this segment of the market is going to further grow or not, because it can easily be replaced with business in other currencies. However, last year, we're definitely seeing a very encouraging and satisfactory increase in the contribution of RMB.
If you're talking about asset size of RMB, because we have seen drastic drop in the participating banks balances in the clearing account. So the overall balance sheet of RMB has shrunk. If you're talking about the NIM of RMB. The NIM of RMB, because of the shrinkage of the overall RMB balance sheet, as you may recall, the diluting effect that we usually suffer from the huge inflation of RMB assets because of the clear account balance. Because of the shrinkage, that diluting effect almost disappeared. As a result, there's an improvement in the NIM in the RMB business. In the future, of course, we're interested in what's going to happen next. I think we're seeing more competition in RMB deposit taking.
At the same time, it seems on the lending side, the pricing of lending is also facing some pressure. As a result, perhaps, I'm not too optimistic actually in the RMB NIM. As Mr. Zhuo Chengwen has mentioned, overall, we're trying to balance the business needs, our deposit taking, as well as our NIM and NII. Hopefully, with this flexible implementation of the business strategies, we'll be able to maintain our overall NIM going forward.
Hi, it's Vishal from Merrill Lynch. Thanks very much. I have two questions. The first one on asset quality, the second one on your Basel III preparedness. On asset quality, looking more into the China loan book, it looks like the impaired loans from China as well as the NPL ratio in China was up quite significantly. I understand that the overall percentages are quite small, but if you could help us understand what are the sort of problem areas that you're seeing. Is this coming from any geographical area or any specific industry? My second question on Basel III relates to your overall capacity and what the impact would be of Basel III on your capital ratios. Is there any pro forma numbers that you could share with us to help us sort of understand whether or not we'd see a meaningful or insignificant impact? Thank you.
I will ask Mr. Gao to take the first question, and then our CFO the second.
Merrill, on quality, I think there is also one case, one particular project related to the photovoltaic industry. That is, it is not very significant amount, but because as you mentioned, our total outstanding amount of NCP China is not big. That is why this one case have a big impact on our NPL ratio in commercial China. We are in that industry, I think we have just limited exposure on that.
That is the only exposure to that industry.
We already—
Luckily and unluckily.
—already we included in our impaired loan already. Yeah.
Basel III.
For the other three, as you know, we are well-capitalized. The strong capital base enable us to maintain the consistent strategy for the past several years. I think it will also give a good foundation for our future business development. Starting from this year, the first phase of Basel III will be implemented. According to our internal assessment, there might be some positive and negative side, such as the inclusion of the revaluation of property, the guarantee for corporation. Those are positive sides. The negative impact may include the higher charge for large FIs assets, and also a stricter requirement for sub-notes. But overall, I think the use of Basel III will have some positive impact on our coverage ratio. For the specific number, we cannot disclose at this moment.
I think in our interim report, we will use the Basel III to calculate and disclose in that standard.
Okay.
Thank you. This is Stephen Andrews from UBS. Actually, just a follow-on. It is actually two questions on capital. The first one is just on capital generation in the second half of the year. I mean, the reported shareholders' fund grew nicely. Ex-minorities were at about HKD 150 billion, so it went up HKD 10 billion in the second half. But your reported core Tier 1 actually fell, which suggests that actually the quality of the earnings that you had was very poor, as it was not allowed in your core Tier 1 capital. Can we just square that off? Why do you show such strong growth in shareholders' funds but no growth in core Tier 1?
I know that the HKMA reserve is not allowed in Tier 1 nor your property gains, but you would have hoped that some of your profits in the second half would have contributed to your core Tier 1. Second question comes back to Basel III again. I note your comments on some positive and some negative impacts. I think most sensible people would agree that including unrealized property revaluation reserves in core Tier 1 is not sensible. Although it will be the rules. Would you still have a positive impact if you take out property revaluation reserves out of that calculation? Thank you.
Go ahead.
It's highly technical. Our CFO can answer that question.
Firstly, the core Tier 1. For last GM, our Tier 1 capital ratio is 12.3%, which is very strong, and we are confident with that. That core Tier 1, as required by Basel III, does not include any revaluation of the property or anything. I think a core capital, strong capital base enable us not only our future business development, but also important for us to implement our strategy, especially we are going to expand to a new business platform, our further expansion in mainland China. Also, it's very important for us to maintain a stable dividend payout ratio. Starting from our listing, I think in most of the year, we maintain our dividend payout ratio at 60%-70%. Our organic growth provide our core Tier 1, and in return, we also pay dividends to our shareholders.
We believe we're comfortable with our current core Tier 1 capital, and we regard that as an advantage in our future business development. For the second question, is about S3, especially you ask whether it is good or bad to include the revaluation of property. I think there might be some discussion, but according to my personal understanding, when HKMA set up the rules for the implementation of Basel III for the treatment of property revaluation, they have been very prudent compared to other regions. Currently, they only allow 45% of the revaluation gain to be included in the true capital. The remaining 55% of the marked up only can be deducted from the RWA. It has maintained conservative as possible from my own view. Also, if you look at other regions, I think some countries may have some different treatment.
Overall, I think to my observation, banks in Hong Kong, relatively, they are well capitalized. Currently, I think the guidelines or the implementation of Basel III in Hong Kong will provide a comparable base to other regions and also can strengthen the position of Hong Kong as a financial center.
Jerry?
Thank you. It's [Jerry] Lam from Citi. Two questions regarding your net interest margin. Thank you for the additional disclosures made in page 22, which we were able to get a more detailed breakdown. Looking at that, it seems to me that the half-on-half bond portfolio investment asset yield declined quite noticeably. Wondering if this trend is continuing in 2013 since we understand typically bond yield movement is according to a moving window of your outstanding portfolio. Secondly, on the liability side, we saw some increase in time deposit mix half-on-half during the second half of 2012. Is it a purposeful deposit strategy? Can we understand whether it is primarily due to the RMB absorption strategy and your thinking behind? Thank you.
Okay. Thank you for giving me the chance to explain in depth further. Specifically for the average return on the security investment. The average return decreased half by half. That is partially because of the short-term investment of the security. As you know, after the introduction of the further quantitative easing in the market, the Hong Kong dollar and the U.S. dollar decision fund from other banks with us increased or not. Those are short-term funds. For prudent management, we normally will use those sort of short funds or other FIs for short-term investment only. The return or the spread of those funds are relatively low. For this year, I think some of the funds have been remade out, used by other banks. We will only disclose our interest margin for the interim.
As I just said, we expect largely our interest margin will maintain stable compared to the average of last year. Second question is regarding—
What is the second question?
Fixed deposits.
Oh, fixed deposits. Sorry. When we're taking the deposit, we may proactively manage the mix of the deposit. On the other side, customer may have their choices. The time deposit increased compared to the end of first half. From the full year aspect, we can still see our total deposit balance increased around 6%. That is a result of our proactive management in control the funding costs. Even though the deposit rate of the market increased, but we believe, after the implementation of our strategy in control funding costs, we're comfortable with the spread between the deposit and the loan.
Another factor actually for the increase in the term deposits in the second half, perhaps is, of course, the RMB deposit taking. As you may recall, in the first half at interim result announcement, we had a substantial drop in the RMB deposits. Then we made up most of that loss actually, in the second half. Most of RMB deposits is time deposit. Maybe that actually is one of the factors why time deposit increased half on half.
Hi, Gurpreet.
Thank you. Gurpreet Sahi with Goldman Sachs. A quick question regarding the corporate loan pricing. You mentioned that on the RMB side, you are seeing some pricing pressure. Is it true for Hong Kong dollar, U.S. dollar also?
Say it again.
Yeah.
Okay.
Loan pricing.
Loan pricing for Hong Kong dollar, U.S. dollar, right? Yeah. For this year, we think the pace of the improvement in the loan spread is limited. Yeah, because considering the loan demanding are slowing, and also because it is still very low interest rate environment, and also the competition fierce. So we feel the pressure on the loan spread even for Hong Kong dollar and the U.S. dollar on corporate loan side. Okay. Last two questions.
Hi, this is Yi Hu from HSBC Fixed Income Research. I have two questions. The first question is regarding the bank's funding strategy. If we look at the second half number, in incremental terms, the incremental funding from borrowings from other banks has been much larger than the incremental deposits from customers. I am just wondering what is the funding strategy or the rationale behind this move, and what are they still want to move going forward? The second question is regarding the bank's investment strategy. What differentiate BOCHK from other smaller Hong Kong banks is that regarding your bond portfolio. Other smaller Hong Kong banks have mainly increased their exposure to corporate bonds. But when I look at BOCHK's portfolio, it mainly increased the exposure to sovereign bond funds and with a rating of A1 to A3.
May I know the country exposure, and also given the fixed income market outlook in 2013, what will be the BOCHK's investment strategy this year and going forward? Thanks very much.
Okay. For the funding strategy from Financial Institutions, banks in particular, in fact, we do not have a strategy. We are passive mostly because we have natural accounts for many of those Financial Institutions when they want to, especially after the QE3. QE4? QE3?
It is three.
QE3. I lost count, actually. There were so many QEs. After the QE3.
Three.
This market is flooded with funds. A lot of Financial Institutions increased their deposits with us, including some of the government agencies. As a result of that, actually, partially to answer the other question for the decrease in our overall investment portfolio yield. We have to place some of those funds in the lower yield short-term government papers. On the average, actually, to pull down the overall yield of investment. Of course, with customers, we certainly do have a very clear strategy how to attract deposits sometimes, how to control the deposits, cost of funding in order to manage our NIM and NRI. In terms of investment strategy, I will ask David Wong to answer that question.
Just to supplement a little bit on what happened last year. In the second half of last year, where the security tree implementation by U.S. and actually the rest of the central bank as well, Japan and Europe, and U.K. as well. What happened was that, as CFO had mentioned, there is a surge in the liquidity in the marketplace, a lot of interbank liquidity. We took advantage of that to invest in very short-end government security. That is why you saw last year that on the sovereign and the public sector, we actually have increased by something like 23% account increase. Those are mostly placed in U.S., Hong Kong, and also some JGB, very short term JGB, about three months maturity, roughly. In terms of you look at last year, our increases in the corporate bond as well.
We also have increases there that is mostly from China and Hong Kong. In terms of bank and Financial Institution, the increase come from China, Hong Kong, U.S. and Australia. Going forward in terms of 2013 this year investment strategy, I think our strategy is also quite straightforward in the sense that looking at return, looking at risk, and also in terms of liquidity as well, how to have the balance. You look at our overall investment portfolio right now, we have 70% of exposure in Asia Pacific, around 30% in U.S. and Europe combined. I think that is geographical distribution. In terms of sector distribution, I think that is really depending on the availability of investment opportunity as well, whether it is going to be government-linked, corporates or Financial Institutions. We will look at the availability and also the risk profile of the credits that we look at.
Suffice to say that I think this year is going to be quite choppy. I think, seeing what happened in Cyprus. I think we will have a very active management process and keep everything very close to our vest.
Well, in fact, given the size of the Bank of China, our investment portfolio, there simply is not enough corporate bond supply in the market. 56% increase is really a big jump.
Sally, you would like to ask the last questions, please?
Can I just ask a follow-up question on capital? I guess now it is very adequate at more than 12%. At what point do you think you would have too much capital? The reason I am asking is that some of your larger international peers have started to reconsider the dividend policy. Can you just clarify what the dividend policy is at the moment? Also secondly, can you please talk a bit about your outlook on loan growth, both for corporate outside Hong Kong, inside Hong Kong, and also for the mortgage market? Thank you.
Okay, go ahead. Go ahead. Okay.
Overall, our dividend payout ratio, dividend policy is quite stable. It's maintained 60%-70%. It didn't change in the past 10 years, only one exception in the financial crisis. For the adequacy of capital, I think we are comfortable with our Tier 1 capital base, especially the Basel III, the regulator emphasizing more CET capital. I believe a strong core equity capital base will provide us competition edge, competition advantage over other Financial Institutions. Also at the same time, we maintain a relatively higher, strong Tier 1 capital base. At the same time, I think our return to shareholder is reasonable. We pay a relatively higher dividend ratio than other peer banks in the market. What we can do is, we try to efficiently use the capital base and maintain our strategy consistent, and maintain a reward to shareholder consistently.
Well, in terms of the question actually, when do you think is enough? What level is enough? It's very hard to say. It's a very tricky question. In fact, capital is very precious in the market on the one hand. The other hand, actually, if you look at the regulatory environment, it's sort of changing towards a tighter, higher capital requirements. Luckily, we have strong capital base for the time being. But at the same time, if there's any strategic initiatives on our side, we may have to engage more capitals in those business. So it's very hard for us to tell whether 16.8 is enough or whether we need to repay in form of special dividends back to the shareholders. I have no answer to that. But of course, when it comes to a stage where we think- There's a new strategy we need to implement.
We need to engage more capital, perhaps. We're going to do it. Hopefully, we can get reasonable return for our shareholders. But of course, if we don't really have that opportunity, then perhaps the other way, perhaps, is to increase the payback. In terms of loan growth, as you can tell, our capital position, our liquidity position, our LD ratios, all warranted good loan growth, continuous good loan growth. In the last few years, ever since 2006 or 2007, we've continuously experienced double-digit loan growth. But of course, whether we can achieve that or not depends on the market situation. But my point is that we are in the position to continue this kind of growth, and this growth is sustainable given our financial position. But whether the market will give us that opportunity or not, I hope. You see, we've experienced very strong RMB loan growth last year.
The loan size of RMB almost tripled. We think this is only the beginning of a strong RMB loan growth. If we have opportunity, we will certainly continue to grow our RMB. At the same time, we have achieved very broad-based growth in all major sectors. Of course, except mortgage. Mortgage this year seems to be very difficult. Other than that, hopefully, we will be able to grow our loans in Hong Kong, outside Hong Kong, and in various segments in an evenly way. We certainly were in a position. That is why we managed our capital very carefully. We hope we maintain the strong position for more business opportunities.
Okay. Thank you all for your coming today. See you next time, okay? Thank you.
Thank you very much.