Good afternoon, ladies and gentlemen. Thank you for attending the 2011 interim results presentation of BOC Hong Kong (Holdings) Limited. I am Yammie Tang, the Head of Investor Relations. Before we begin, may I draw your attention to our forward-looking statement disclaimer presented on this slide. Now, let me introduce our management team. With us today are Mr. Guangbei 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. Here is today's agenda. Mr. He will start with our performance highlights, followed by Mr. Zhuo's financial presentation. After that, Mr. He will talk about the outlook. Then we shall open the floor for comments and questions. Mr. He, please.
Thank you, Yammie. Good evening, ladies and gentlemen. It is getting dark, so I said good evening to you. For the first half of the year, we operated in a mixed environment where opportunities and uncertainties appeared side by side. The economies of Europe and the U.S. remained fragile, while the Asian economies in general fared better. During the period, banking industry in Hong Kong continued to see considerable business opportunities arising from surging loan demand and expansion of the offshore RMB market. The growth momentum of loans remained strong in the market, but banks still faced with the pressure of narrowing net interest margin as intensified competition for deposits drove funding costs higher. Banks raised loan pricing in view of higher funding costs. HIBOR-based mortgage rates have been raised several times during the first half, and corporate loan pricing increased.
Apart from the strong loan demand, banks in Hong Kong also benefited from the continued expansion of the offshore RMB market. Demands for RMB trade settlement grew rapidly while RMB deposits in Hong Kong saw solid growth. During the first half of the year, we continue our balanced growth strategy and delivered satisfactory results. We proactively manage our assets and liabilities and focused on maintaining our key financial ratios at healthy levels to support our business development. Our core businesses, including personal banking, corporate banking, treasury, RMB businesses, and bancassurance, registered healthy growth. We saw particularly strong growth momentum for our corporate banking business, both year-on-year and half-on-half. This was attributable to our deepened corporate relationship and enhanced business platform for total solution services. We collaborated with BOC to offer cross-border trade finance to corporate customers in both Hong Kong and the mainland.
Cross-border trade settlement volume recorded a notable growth of 138% year-on-year. As for our personal banking business, we broadened our high quality and cross-border customer base by offering differentiated services to our wealth management customers. We have formed an investment product specialist team to offer professional advice on retail funds, boosting the volume of our fund distribution business by 237%. For the bancassurance business, our financial planning model continued to expand with encouraging results. Gross premium income grew by 132% with more RMB insurance products we introduced to meet the market demand. Our offshore RMB business continued to grow with increased contribution to group's income. During the period, we continued to expand our RMB deposit base. Our trade settlement and exchange transactions recorded satisfactory growth. We diversified the use of RMB funds and increased high yielding assets to enhance profitability.
We were integrating the RMB business into our existing business as part of our total solution services to our customers. For example, by combining our competitive edges in RMB business and cash management capabilities, we have introduced a wide range of new RMB cash management service covering the RMB payments and receivable products and cross-border RMB bill payment service. As for our custody business, we extended our service to the custody of RMB investment instruments. Cash management and custody platforms did not exist in BOC HK four years ago. These examples demonstrate that our continued investment in enhancing our business capabilities is now paying off, enabling us to better capture market opportunities. Here are the key financial highlights. For the first half of 2011, we recorded the broad-based growth in income and profit. Net operating income before impairment allowances was HKD 15 billion, up 20%.
All our income streams, including net interest income, net fee and commission income, as well as other operating income, recorded satisfactory growth. Operating profit before impairment allowances was HKD 13 billion, up 64%. Profit attributable to shareholders increased by 67% to close to HKD 12 billion. The increase in profit was mainly attributable to the growth of our core businesses and the Lehman -minibond related recovery. Excluding the impact of Lehman-related recovery, net profit for our core business increased 33% to HKD 9.7 billion, setting a new high for our first half results. ROE, excluding Lehman-related impact, will be 15.75%, up 2.49 percentage points year -on -year. ROA would be 1.07%, down 0.11 percentage points due to faster expansion of the group's average assets. The board has declared an interim dividend of HKD 0.63 per share, representing an increase of 58% compared to HKD 0.40 per share for the same period last year.
On the back of our proactive strategy, we maintained the growth momentum in our lending business. We further grew our loan book by 9.7% in the first half. While capturing the growth opportunities, we strictly adhered to our credit policies and focused on customer selection to ensure quality growth. Our loan quality remains solid, with classified or impaired loan ratio staying at low level of 0.1%. In view of supporting the growth of our lending business, we took effective measures to grow our deposits by 7.5% compared to the end of 2010, amid intensified market competition for deposits. While BOCHK has a strong deposit franchise, we proceeded with diversification of our sources of funding. The development of our cash management business contributed to the strengthening of our deposit base. Average deposit balance of our cash management customers increased by 170% year -on -year.
Our loan-to-deposit ratio was at 61% compared to 60% at the end of 2010, while our liquidity position remained solid at 36.38%. Commencing 2011, we migrated to FIRB approach to quantify our credit risk. The implementation of FIRB provides an important support for the group's credit business and risk management. As of the end of June 2011, our capital adequacy ratio stood at 17.62%, and core capital ratio was at 12.87%. We have a strong capital base, which will provide us with greater flexibility to fund future business growth, support our dividend policy, and offer safeguard against the market uncertainties. Our major achievements in the first half of 2011 once again demonstrated our capabilities in delivering sustainable growth for our shareholders. The second half of the year started with tremendous market volatility, and we expect the operating environment to be more challenging.
The consistently solid performance of the group proved that we have the effective strategy and solid financial strength to be strongly positioned to capture more quality growth opportunities and to safeguard against the market uncertainties. I will stop here for now and pass you to Mr. Zhuo, our CFO, for a more detailed financial review. Mr. Zhuo, please.
Thank you, Guangbei. Good afternoon, ladies and gentlemen. Now, let's go through our financial performance in greater detail. Let's start with the group's income statement. Compared to the same period of last year, profits attributable to shareholders increased by 66.8% to HKD 11.99 billion. This included a net recovery of HKD 2.85 billion from the underlying collateral of Lehman Brothers Minibonds. If excluding the Lehman-related impact, our profit attributable to shareholders would be HKD 9.68 billion, up 33.4% year-on-year. The group's net operating income before impairment allowances increased by 20.6% to HKD 15.1 billion, mainly due to higher net interest income, net fee income, and net trading gain. Total operating expenses dropped by 56%, mainly due to the recovery of Lehman Brothers Minibond. Excluding the recovery, core operating expenses increased by 8.3%. The group's investment of property registered an increase in revaluation gain to about HKD 1.5 billion.
Now let's turn to the net interest income. Net interest income increased by 13.8% year-on-year to HKD 10.2 billion, driven by the growth in average interest earning assets. Overall NIM declined mainly due to the margin dilution by the offshore RMB business for both clearing bank function and our participated bank business. But in terms of net interest income, the RMB business continued to contribute positively. The NIM declined by 37 basis points year-on-year to 1.21%. If excluding the impact of our unique RMB clearing function, the adjusted NIM was 1.48%, down 16 basis points year-on-year. Excluding the offshore RMB business, the core NIM declined year-on-year. The pressure mainly came from the increase in HIBOR-based loans and higher funding costs amid intensified market competition for deposits.
This was partly offset by the improved pricing for new corporate loans and residential mortgages, as well as better asset mix. If compared to the second half of 2010, the core NIM decline was moderate. Total non-interest income increased by 37.6% year-on-year, mainly driven by the increase in net fee and commission income and net trading gain. Compared to the first half of 2010, net fee and commission income grew by 17.3% to HKD 3.99 billion, with growth in both traditional banking business as well as investment and insurance business. Income from investment and insurance increased, driven by fund distribution and insurance business. Contribution from stock broking business declined as market sentiment turned less favorable. Stock brokerage income was down slightly year-on-year, but saw a bigger drop from the strong second half of last year. Funds distribution picked up strongly by 163% year-on-year and 89% half-on-half.
Insurance-related fee income, which included life insurance, general insurance, and reinsurance, grew by 177% year-on-year. The strong growth was mainly due to the rise in business volume in BOC Life. Gross fee income from other traditional businesses also recorded broad-based growth, with particularly strong contribution from the credit cards and currency exchange. Other operating income increased year-on-year, mainly driven by the net trading gain of HKD 761 million versus a net loss of HKD 36 million for the same period of last year. The increase in net trading gain was mainly due to the fast-growing currency exchange activities and the change in mark-to-market values of interest rate swap contracts. Now to our expenses. This chart shows our core operating expenses, excluding the impact of Lehman-related products. Compared to the same period last year, our core operating expenses increased by 8.3% to HKD 4.83 billion.
Core cost-to-income ratio decreased to 31.9% from last year's 35.5%. The cost increase was mainly due to higher staff costs, which grew by 8% on the back of increased headcount for our business expansion, higher salaries, and performance-related remunerations. As at end of June, total headcount was 14,104. Premises and equipment expenses increased by 6% as a result of the higher rental costs for branches in Hong Kong and the mainland. As at the end of June, total number of branches was 293. Depreciation rose by 10% year-on-year due to larger depreciation charge on premises following an upward revaluation. In the first half, we recorded a net charge of HKD 30 million, arising mainly from the net charge of known impairment allowances. As the group's loan quality remained solid, we recorded a HKD 42 million net reversal of individual impairment allowances before recoveries.
Net charge of collective impairment allowances before recoveries was HKD 295 million as result of expansion of our loan book. The group's loan quality remained sound, with classified or impaired loan ratio staying at a low level of 0.1%. Classified or impaired loan decreased by 18.6%, mainly due to collections and fewer new classified loans. The formation of new classified loans remained at a low level, representing approximately 0.03% of total loans outstanding. The quality of the group's residential mortgage loans remained sound. The combined delinquency and rescheduled loan ratio was at 0.01%. With improved economic condition and cardholders' debt servicing capability, the charge-off ratio of card advances further improved from 1.56% to 1.07%. During the period, the group maintained a prudent strategy to manage the balance sheet. Total asset grew by 10.2% to HKD 1.83 trillion.
The overall asset growth was primarily driven by the expansion of the group's core banking business and the offshore RMB business. The increase in placement with banks and other financial institutions was mainly due to the growth in RMB interbank placement as we diversified the use of our RMB funds. Securities investments only increased by 2.8% as we continued to deploy our funds to quality lending opportunities. Advances in other accounts rose by 11.5%, which was mainly attributable to the growth in customer loans. Shareholders funds increased by 9.5%, mainly attributable to the profits for the period, and include premises revaluation reserve. As at the end of June, our deposits increased by 7.5% compared to last year-end, mainly driven by the growth of RMB and U.S. dollar deposits. During the period, market competition for deposits intensified. We continued to pursue proactive deposit strategy to support our business growth.
For our lending business, we continued to pursue our balanced growth strategy, and strived to optimize the mix and improve profitability. In the first half, we sustained our loan growth momentum and maintained a healthy growth pace. We grew our loan by 9.7%. The group's loan-to-deposit ratio remained relatively stable at 61%. The loan growth was mainly driven by corporate loans for use in Hong Kong and residential mortgage loans. Total corporate loans increased by 8.5%, mainly driven by the 12% increase in corporate loans for use in Hong Kong. The growth covers a wide range of industries. Trade finance increased by 12%, while loans for use outside Hong Kong grew 3%. Residential mortgage loans increased by 14% as a result of an active property market, particularly in the first quarter of the year. We continued to adopt a proactive investment strategy to optimize portfolio mix and risk-adjusted return.
Fully alert to the market uncertainty and volatility, we have been closely monitoring the market changes, and adjusted our investment allocation accordingly. As at the end of June, total securities investment increased by only 2.8%. The increase was mainly due to the new investments in RMB-denominated bonds as we continue to enhance the use of our offshore RMB funds. For the non-RMB bonds portfolio, overall balance declined compared to the end of 2010. For the exposures to five European countries affected by the debt crisis, as at the end of June, we only had debt securities issued by financial institutions of Ireland and Italy amounting to HKD 1 billion, accounting for 0.2% of our total investment book. Subsequently, the Ireland paper have already been redeemed in July. We now only have the Italian FI papers in our portfolio, and there is no sign of deterioration as of today.
Looking at our portfolio mix, we maintain a very solid portfolio with 37% in government or government-related papers, and 55% in high quality banks and financial institutions. 94 of our debt securities were rated A or above. This slide shows the operating income breakdown by segment. For personal banking business in H1 2011, taking advantage of improved property market, we recorded satisfactory growth in residential mortgages with improved pricing of new HIBOR-based loans. Credit cards business also grew where we maintain a leadership in the China UnionPay merchant acquiring business and the CUP card issuing business, with merchant acquiring and cardholder spending volume surging by 56% and 86% respectively. As for our corporate banking, we achieved solid expansion of the lending business. Capitalizing on the robust lending opportunity, we focused on loan quality control and profitability enhancement. Pricing of new corporate loans improved.
We further enhanced our service capability for our core corporate customers. We continued to make good progress for our custody business, expand the service spectrum in our cash management business. As a result, we succeeded to reach out to new clients and capture cross-selling opportunities for strong growth. Our treasury business recorded satisfactory growth with income mainly coming from net interest income of our treasury function and income generated from our customer activities. We remained vigilant in managing our investment portfolio to secure risk-adjusted return. In the meantime, we continued to strengthen our traditional products offering by improving customer service quality. Net trading income also increased due to fast-growing currency exchange activity. Our insurance business also saw good growth. Gross insurance premium income rose considerably by 132%, most of which came from sales of regular premium products.
Through optimization of product mix and service quality, the group further reinforced its market position and expanded its market share. Our mainland operation recorded a satisfactory growth. During the period, we focused on strengthening the deposit base of our mainland operation to support its long-term development. Customer deposits grew by 35%. For Nanyang Commercial Bank (China), Limited, the loan-to-deposit ratio improved further to 86% as at end of June 2011. Total operating income increased by 27% year-on-year, mainly driven by the higher net interest income. Despite the slight drop in our loan book, the increase in average interest earning assets, together with our focus to optimize asset mix, resulted in satisfactory growth in net interest income. Operating expenses increased by 32% as we continued to invest in expanding our mainland operation. As of the end of June, we had 26 outlets in the mainland. That concludes my financial presentation.
I'll now hand you back to Guangbei for the outlook. Thank you.
Thank you, Mr. Zhuo. Looking into the remaining months of the year, we're facing increasing uncertainty and volatility in the market. You must have really felt it with the rout in the global equity markets. The slow recovery of the U.S. economy, the ever-evolving European debt crisis, and the rising inflationary pressure may lead to a softening of growth in the global economies. Interest rates will stay at current low level for a longer period of time. Given the heightened market volatility and weaker than expected economic growth, we have to stay alert and be prepared for any sudden deterioration in the operating environment. It is our top priority to safeguard our strong financial position and good asset quality. We will remain focused on proactively and prudently managing our capital liquidity and risks. We'll monitor our investment portfolio very closely and make adjustments promptly.
At the same time, we will invest judiciously in key strategic areas for long-term growth. This includes upgrading our service infrastructure as well as human resources. While thriving for growth, we will manage our cost prudently. Despite difficult market conditions, we believe there will still be opportunities for growth, particularly in the RMB related business and cross-border financial services. We welcome the package of measures supporting Hong Kong economy announced by Vice Premier Li Keqiang during his recent visit to Hong Kong. In addition to strengthening Hong Kong as a major financial hub, the new initiatives will further boost Hong Kong's exposure to China's growth and provide us with new business opportunities. The demand for cross-border financing service by large mainland enterprises will continue, and the corporate loan market is expected to remain very strong.
We are well positioned to capture these opportunities given our competitive edges in RMB and China business, as well as our close collaboration with Bank of China. At the same time, we will continue to adopt stringent risk management to secure loan quality at a healthy growth pace. The local deposit market is expected to remain highly competitive, which will continue to pose pressure on deposit costs. We will focus on managing our funding costs and optimizing our risk-adjusted return on our assets to enhance overall profitability. The RMB business will become an important growth engine for the group, not only because of expanding business volume, but also the associated business and customer relationship it brings to us. We will continue to take the lead in driving the growth of RMB business into Hong Kong and capitalize on our competitive edge in offshore RMB business to create more business opportunities.
In all, I am pleased that we are making good progress in implementing our balanced growth strategy. Capitalizing on our strong franchise and solid fundamental, we will be in a good position to withstand the market challenges and to capture the growth opportunities ahead. That concludes our presentation. My colleagues and I will be pleased to take questions from you. Thank you.
Okay, to ensure that you will be heard clearly, please make sure you get the microphone before you ask the question. The gentleman in the middle, please.
Thank you. Steven Chan, MF Global. Two quick questions. First of all, Hong Kong dollar loan-to-deposit ratio increased sharply to over 75%, and U.S. dollar loan-deposit ratio remained at about 100%, mainly because the Hong Kong dollar deposits actually decline in terms of balance. Of course, you see a sharp rise in RMB deposits. My question is, in the second half and then coming years, are you going to increase your Hong Kong dollar deposit by making more competition, offering higher rates? Or the other way around, that will restrict your Hong Kong dollar loan growth? That is the first question. Second question, mainland business. The loan-to-deposit ratio, again, is still well above 75%.
Even if you maintain the run rate in the first half, I think that means that you are still far away from the 75% level. Does it imply that there will also be a sharp decline in loan balance for your mainland business in second half?
Okay. Mr. Zhuo, want to talk about the Loan-to-Deposit Ratio in Hong Kong dollars? I'll take Well, maybe I answer that mainland question first. Okay. In the first half this year, we managed to bring our Loan-to-Deposit Ratio in our mainland operation down to 86%, which actually, at the beginning of this year, was our-
113%.
113%. Of course, in the process, our loan did not grow very much, actually stayed almost flat. As you know that the 75% LTD ratio actually is mandatory, is regulatory requirement. You have to achieve it by the end of this year. That definitely have some impact on our loan growth in China, on the mainland. But I would say, generally speaking, dramatic drop in our LTD ratio in our mainland operation in the first six months is very encouraging. We are only about 10 percentage points away. With the corporation support of the group here in Hong Kong, and also Bank of China, we are quite confident that we'll be able to achieve 75% by the end of this year. Then, of course, that will depend on the balance, the growth of loans and deposits of our China operation into the future.
For the Hong Kong dollar, LTD ratio through increase, but it still way below the market average. Also, our management focus is on maintain a solid liquidity position. While the LTD ratio is a key parameter. So in the first half, our liquidity ratio maintained at around above 36%, which is way above the major peer banks in Hong Kong. For the deposit taking, is quite true. Deposit is one of our key core business. So we will take proactive strategy to take in deposit and leverage our branch network, customer base. Also, we are going to promote more product and services, including the payroll card and wealth management to absorbing the deposit.
Did you say that our U.S. dollar LTD ratio is about 100%? Did you say that?
Yeah. According to-
Is it market or our number?
your number.
No.
No.
It's on page 63 of your notes. Sorry.
Steven, as explained previously, this also include other accounts, but we have also separately disclosed our U.S. dollar loans. By that calculation, actually, our U.S. dollar loan-to-deposit ratio is quite stable at around 85%.
Hi, this is Sophia Lee from Deutsche Bank. I have two questions. First is regarding your capital ratio, which was improved by the adoption of Foundation IRB. Can you share with us how much of your credit portfolio, what percentage, is currently under Foundation IRB? Because I would like to know if there's more room for improvement in the second half. Do you plan to increase your dividend on the back of this? My second question is, you mentioned that you are able to improve the deployment of your RMB deposits into higher yielding assets. Can you provide more color on what types of assets that you're investing in? Also, how much spread pickup you're looking at? Thank you.
For the capital ratio, the rule for the HKMA is, you at least have 85% of your credit RWA using the FIRB. This is the criteria for the approval of FIRB adoption. For our percentage, we are higher than the threshold.
Well, in terms of RMB, we managed to increase our high yielding RMB assets in the first six months of this year. Most of the increase actually is from our investment in treasury, central bank bills, and also our interbank placement with the domestic Chinese banks.
Do you have figures on how much spread that has gone up?
Do you have that numbers in our book?
We do not disclose separately the RMB spread. But overall, the spread improved compared with the second half of last year for the RMB business. As Guangbei He introduced, we are expanding our investment or use of RMB funds in the bank market, in trade finance, securities investment, and other business.
RMB loans still has not increased that much yet, but we expect it actually to grow into second half.
Thanks. It is Stephen Andrews from UBS. Just a couple of questions, please. Firstly, on the margin, obviously it was down again half on half on the underlying basis. Can you give us a bit of a flavor as to whether Q2 was lower than the first half average? Because a lot of the other banks are saying that the funding pressure in terms of competition really came in in Q2 rather than Q1. Secondly, I just wanted a bit of color on the interbank balances. Obviously, they did not actually move much on the asset side half on half, but the average you disclosed for the average balance sheet was much higher. Did you move out the RMB assets into fiduciary accounts towards the end of the quarter? Or was there something that distorted those numbers, which we should be aware of going forward?
Secondly, I just think on the question on the dividend. We did not get an answer a second ago. You have had a 60%-65% payout ratio. Should we assume that you will be sticking with that in the second half, for the full year? Thank you.
I think these are all the questions for our CFO, so [okay].
I think I answer your second question first. For the interbank placement, the average balance increased. This is the increased use of the RMB funds or other kinds of funds actually based on the market need and our source of funding. RMB is one partly contribute to the increase of the average balance increase. For the dividend payout ratio, this is the third question you asked. For the annual dividend payout ratio, we are maintaining at 60%-70%. This policy has not been changed. It is usual for the interim dividend payout ratio, relatively lower than the annual rate. For the first question, sorry, I think
Margin. Want some flavor on the margin.
Okay. As you have seen, the NIMs still under pressure, mostly because of the dilution impact of RMB business. But excluding the RMB clearing function, our NIMs still decreased year-on-year and half-on-half. But the pace moderated if compared with the second half of last year. We have a higher percentage of RMB deposit, which is from our participated banking business. So if exclude all the RMB impact, including clearing bank and participated bank function, our core NIM is only declined slightly from the second half of last year. Having said that, I think there are some positive and negative factors affecting the NIM. Especially the pressure is much from the intensified competition for deposit and the relatively high proportion of high-risk loans. Some of the positive factors including the, we believe, the loan demand is still there.
We have opportunity to improving the pricing for loans. Also, we have been exploring opportunity to use RMB fund more efficiently.
Well, earlier you said the change of the balance sheet, whether the operation of a custodian account is a factor. Yes, it is. Because we started operating this custodian account for RMB for all the other participating banks in April. Then toward the end of the second quarter, some of the participating banks moved their balance out of the clearing account into the custodian account.
Perhaps one thing that I could add is in relation to the mortgage lending. As you are aware, banks have been increasing mortgage pricing since March. But the first half results have hardly reflected those increases. Because normally it would take at least three to four months time lag before the actual price increases being reflected in the financials because of time lag for drawdown and time lag for the interest payment to be reflected.
Sally.
Thank you. Sally Yuen from CICC. Just two questions, if I may. The first one quickly, I notice your RMB deposits were only up about 40% half on half. Which would be quite well below the increase of RMB deposits for the system in terms of the offshore deposits. Is this a reflection of a more proactive AUM strategy given the still limited attractiveness of RMB investments? Or is there a certain reason behind that slower growth in terms of RMB deposits? The second question, if I notice your cross-border claims to Europe as well as U.S. were added up, it is about HKD 200 billion. Which actually hardly changed half on half. And given that we had this U.S. sovereign credit rating downgrade and/or the ongoing European debt crisis, just wonder if you could give us more color on that HKD 200 billion portfolio.
We can get some gauge from your disclosure. But could you split that between sovereigns, the public sector entities, interbank lending, and the FI bonds papers, given with what is going on an ongoing basis as the crisis unfold in Europe? And what your strategy is with regard to that portion of the portfolio going forward. Thank you.
Okay. David, why don't you try to answer that question about cross-border claim? Well, about RMB deposit, there are two factors affecting our growth. First of all, of course, we face. In the second half of last year, we had very, very fast RMB deposit growth. At the same time, it was very difficult to find appropriate assets to invest RMB. Therefore, we deliberately slowed down our deposit growth. Because we were stuck there. We don't know how to use RMB. The other factor actually is this increase of the players in the RMB market. We saw more financial institutions participating in the RMB business. As the beginning of this market, of course, they try very, very hard to get as much RMB deposits as possible and paying high rate. We did not really take part in the competition in that.
I think the two factors perhaps caused, are the reasons why we had a slow RMB deposit growth.
Sally, for your question regarding the cross-border claims, you want to actually more the color for that portfolio.
Yes.
David?
Yes.
David.
On the investment portfolio, actually, you look at the chart that we have earlier on, 37% is actually on sovereign and government, 55% is on the FI and the banks, 8% on corporate. That is quite a well-diversified portfolio. Within that, half is in Asia Pacific, which is Hong Kong, China, and Australia, and the rest of Asia. The rest is actually in Europe and North America. In terms of Europe, if you look at our European exposure, about it is in the four countries, in U.K., Germany, Netherlands, and France. That actually cover almost quite a substantial, I would say even up to 90% of our exposure in Europe. So that is kind of in the very core European countries.
We talk about in U.S., going back to U.S. again, in terms of the sovereign exposure, the sovereign exposure in the U.S. is in excess of-
49%.
50%, 58%. You look at since the crisis, since the downgrade of U.S., you look at the long bonds, the 10-year, 10-year have actually gone down. At one time, even below 2%, and now it is recovered back to 2.15%. In terms of the volatility in both Europe and U.S., I think you can see that the funds actually move into safe haven status still in the U.S. bond market, because it is still the deepest and the broadest debt market in the world. In fact, the search for safety is still there. I believe that, and also with quite I guess encourage or quite a low interest environment in the U.S., I think that the bond market will continue to be very firm in the U.S. Come again.
Half of that HKD 440 billion of bond portfolio is to U.S. and Europe. Is that the number-
Roughly, I would say, yeah.
Do you provide further breakdown within that half, that U.S.-Europe portfolio, how much you have in terms of sovereigns?
We don't disclose that, right?
FI's.
No, we don't.
Yeah. Okay.
Suffice to say that I think if you look at our overall investment portfolio, it is a very well-diversified portfolio in terms of countries, in terms of also the asset category as well. So I think that is something that I can assure you. If you look at the so-called the PIIGS country, the European PIIGS country, as our CFO had mentioned earlier on, we only have a HKD 1 billion exposure in Ireland and Italy. Ireland market already matured since July. Also we only have exposure in Italy, which is less than HKD 1 billion, to two financial institution in Italy.
In short, actually, our foreign time investment portfolio, about 50% actually is here, Asia, Hong Kong, China, actually is the bulk. Then, of course, the rest of Asian countries, there are some well-diversified investments. The other half actually is roughly about evenly divided between U.S. and Europe. Out of the Europe, actually, about 90%, more than 90% of investment, it is in U.K.-
Germany.
Germany, Netherlands, and France.
Yeah.
The financial institutions that we invest in are most of them actually, what you call now, it is a very fashionable word, what they call syst-
Systemically important.
Sys-
Systemically.
Systemically important financial institutions. Yes. SIFI, SIFI, whatever. I hope that answers your question.
Thank you. Just one last small question. That decline in the PIIGS exposure to HKD 1 billion, have you taken any provision for the provision in H1 2011? What are those exposure? Are they secure exposure like repo?
I didn't quite get your question.
The exposure.
Whether we made any provision against that HKD 1 billion exposure?
Yeah.
The remaining exposure actually is to major financial institutions in Italy. We do not see any deterioration. There's no provision-
Okay. Thank you.
we made against that.
No.
Thanks so much.
Thank you and congratulations on the result. It is Gary Lam from Citi. Three questions on capitals, if I may. Firstly, I hope to confirm that whether you have made progress to increase the regulatory reserve regarding to higher and tighter the HKMA requirements. Secondly, in your detailed disclosure, page 22, there is a capital floor adjustment item total to HKD 40 billion. I am wondering if you can give us more color. And thirdly, with this 12.87% of tier one ratio is clearly higher than your peers. How do you perceive as the longer-term normalized level of tier one? Thank you.
I think it is all for you.
Gary Lam to answer your questions. For the regulatory reserve, we have accounted for the requirement from regulator in our first half. The balance of the regulatory reserve at June 30 have reflected the increased R-ratio and the increased reserve for the loan growth. For the capital floor, I think you are quite right, because after the implementation of FIRB, according to the bank capitals rule, this item in the capital return called capital floor. This is to restrict the decrease of RWA for the first several years of the adoption of FIRB. This is inject by the certain percentage of HKMA. For the third question-
I will take that one.
Okay.
Okay. 12.87% core capital seems to be high. At the same time, you have to really see. For the time being, there is still a lot of potentials, business potentials, organic growth potentials for us. At the same time, of course, our China operation may still need capital. It is very hard to say what is the normal core capital level for BOC HK, because now Basel III will come and everybody wants cushions, and everybody build cushions on top of cushions. Of course, you end up with much higher core capital and other capital adequacy ratios. For us, actually, our focus is to run our business in a balanced, sustainable way, and we try to use our capital very carefully so as to generate maximized return for our shareholders.
At the same time maintaining adequate capital to face off any potential uncertainties in the market. If you ask me what is the appropriate level, I do not know. For the time being, capital is very rare and scarce. Very rare in the market, and it is very expensive. What we want to do, the entire team wants to do, actually, is try to preserve the capital adequacy ratio at a very strong level so that we can really support the potential growth in the future.
Thank you, Anil.
Thanks. Hi, this is Anil Agarwal from Morgan Stanley. I had a couple of questions around margins. The first one is on loan pricing. When I look at your disclosures on page 14, loan yields have not moved on a half-on-half basis. On an average, they are still at 2.02%. What is happening there? Because we are hearing about loan yields potentially moving up, but when you look at the balance sheet, it is not. Is there some kind of a drag in the first half numbers? How should we look at loan yields moving ahead? My second question is on margins. Have your Hong Kong dollar margins started stabilizing? Because one of the pressures is obviously rising proportion of RMB.
If I look at only Hong Kong dollar margins, have they started stabilizing or do you see more pressure on that because of deposit competition as you move ahead? Thanks.
Do you want to talk about the loan margin yield, things like that?
Yeah.
Okay, you go ahead. Yeah.
For the average return of the loan yields, I think you are quite right. Compared to the last two half, the average return is mostly the same. I think several factors. First of all, for the new loans, both corporate and residential mortgage loans, the pricing has been improved compared to the second half of last year. If you remember, in the first half of this year, banks mostly improved three times of the residential mortgage loans. For corporate loans, the pricing also improved. But at the meantime, the percentage of higher risk loans increased. The weighted average return for the loans still keeps the same. This is the reason you are-
Quick answer to the question.
For the NIM of Hong Kong dollar, as we explained earlier, the NIM, even excluding RMB business our NIM is still under pressure. But if compared to the second half of last year, the decline is moderate. As we said, there are several factors, especially in the market competition for the deposit and also the relatively high percentage of HIBOR-based loans. All those negatively impacted the overall NIM. But still there are some positive factors, higher loan pricing opportunity. This is a trend for the Hong Kong-based loans.
Take one last question, if any. Gentleman in the middle.
There is one more there.
Hi, this is Edwin from Bank of America Merrill Lynch. Just a quick question on credit quality. Obviously very low now. You mentioned a lot of prudence and uncertain outlook. Anything that would cause for concern or anything that would make the bank vulnerable going forward?
Loan quality?
On credit quality.
I think although, because this being a circle, so we have got very good growth for past several years, and also we are very proactive control risk, so we keep very low NPL ratio. We are still very cautious on our growth. You can see for past, especially from last year, although in the market there are very strong loan demanding, and this is in Hong Kong also have a very fast growth on loan growth. We even below the market growth. That reflect we are very cautious on the future's uncertainty and also economic environment. We are very prudent, and we want to balance our growth and also we want to control our risk. That reflect we are very cautious and alert to the future change in the market.
Internally, there's a change of risk management mentality. First of all, of course now we select our customers very carefully. If there's something goes wrong with one customer, there's a special team within the corporate banking department, independent of the lending team. That team will step in immediately, try to recover the loans as early as possible. It doesn't mean that we did not experience any bad loans in the first half. The recovery, the speedy recovery of the bad loans actually really helped us reduce the net loss caused by the bad loans. While credit control and selection of customers and early involvement of the recovery team actually all help us to reduce our bad loan ratio.
As I said many times actually, 0.1%, it's unsustainable even though we want to keep a balance and sustainable growth, but not this 0.1% in NPL ratio. Sorry.
Okay. Okay, that concludes our presentation today. Thank you again for joining us.