Good afternoon, ladies and gentlemen. Thank you for attending the 2012 interim results presentation of BOC Hong Kong (Holdings) Limited. I am Yammie Tang , Head of Investor Relations. Before we begin, may I draw your attention to this slide for the forward-looking statement disclaimer. Now let me introduce our 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 Young, 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 afternoon, ladies and gentlemen. During the first half of the year, overall market environments became more challenging. Global markets experienced increased volatility as the Eurozone debt crisis intensified while economic growth in major markets was losing steam. After years of faster growth, the mainland economy was assuming a more modest pace. In Hong Kong, the momentum for GDP growth also weakened with sluggish external trade and domestic consumption. For the banking sector, overall business volume moderated in a slowing economic environment, as reflected in softer loan demand and trade activities. Stock market turnover also came down notably due to a poor market sentiment. Interest rates stayed at a very low level, but competition for deposits, particularly RMB deposits, intensified, thus adding to the cost of funding.
On the positive side, we saw new business opportunities with the further development of offshore RMB business in Hong Kong and overseas. Despite a more challenging environment, the group delivered a set of satisfactory results for the first half of 2012. Both core income and profits achieved new heights. This was attributable to the solid growth of our traditional businesses, enhanced contribution from RMB business, and disciplined cost control. We also focused on safeguarding our financial position with key financial ratios staying at healthy level. During the period, we continued to proactively manage our assets and liabilities to improve profitability and contain risks. Loan demand moderated in a slowing economic environment, but we managed to capture quality growth opportunities. Our conscious efforts to enhance the deployment of RMB funds, to improve loan pricing, and to control funding costs, resulted in a notable expansion in net interest margin.
Average yield on our loan book improved by 32 basis points year-on-year and 27 basis points half-on-half. Income contribution from RMB business increased further, driven by the improved return on our RMB assets. Global markets continued to be overshadowed by the worsening Eurozone debt crisis. We had already taken early actions last year to reduce our exposure. During the period, we further optimized our portfolio mix. We continued to trim down our European exposure and switch to high-quality bonds issued by financial institutions and corporations in Asia Pacific region. The group continued to make good progress in this business development, especially in the offshore RMB business. We maintained leading market positions and enhanced our RMB product and service capabilities in areas such as dim sum bonds, underwriting, trade finance, cash management, and custody.
Riding on the momentum achieved in 2011, the group's RMB lending business recorded respectable growth. While the sluggish market affected the stock brokerage business, we made good progress in enhancing our wealth management business platform. During the first half of 2012, we distributed 14 RQFII funds, being the largest distributor of RQFII funds in Hong Kong. We also capitalized on the opportunity and became the largest custody service provider for RQFII funds in the market. Through our asset management platform, we rolled out the new products to both high-end and mass ratio customers. in January this year, we have launched the private placement service for bonds in the secondary market, offering bonds to targeted high-end customers. Meanwhile, we further expanded our investment product specialist team to provide customers with comprehensive professional service in connection with wealth management products. Here are the key financial highlights.
For the first half of 2012, we recorded the broad-based growth in income and profits. Net operating income before impairments allowances was HKD 18 billion, up 20% year-on-year, with net interest income being the major driver, while non-interest income also delivered satisfactory growth. Compared to the same period last year, operating profit before impairments allowances decreased by 2.7% to HKD 12.8 billion, while profit attributable to the equity holders declined by 6.3% to HKD 11.2 billion. Profits were lower because there was a one-off Lehman-related recovery in the first half of last year. Excluding such impact, operating profit before impairments allowances and profit attributable to the equity holders registered encouraging increase of 24% and 16% respectively. ROE and ROA were improved by 0.74 percentage points to 16.5% and 0.28 percentage points to 1.38% respectively. The board has declared an interim dividend of HKD 0.545 per share.
The dividend per share was lower year-on-year as last year's payout included the impact of Lehman-related recovery. On the back of our proactive strategy, we maintained the growth momentum in our lending business. Loans grew by 6.8% in the first half, with broad-based growth in corporate loans, trade finance, and mortgages. We continued to manage the loan portfolio prudently. Loan quality was benign, with classified or impaired loan ratio staying at a low level of 0.1%. The loan growth was supported by our solid deposit base, which increased by 3.4%.
Loan-to-deposit ratio increased moderately to 63%, which reflected the higher loan-to-deposit ratio of our offshore RMB business. Our capital and liquidity positions remained strong, with capital adequacy ratio of 17.4% and average liquidity ratio of 39.9%. I will stop here for now and pass you to Mr. Zhuo, our Chief Financial Officer, for a more detailed financial review. Mr. Zhuo, please.
Thank you, Gary. Now start with the group's income statement. Compared to the same period last year, profits attributable to the equity holders amounted to HKD 11.2 billion, down 6.3%, but would be up 16.2% if excluding Lehman-related recovery in the first half of 2011. The increase was driven by the solid growth of net operating income before impairment analysis, which grew by 20.1% to HKD 18.2 billion. The increase in total operating expenses by 171% was again due to the Lehman-related impact in the first half last year. Excluding the recovery, total operating expenses increased by 11.7%.
Overall impairment allowances recorded a net charge of HKD 108 million. The group's investment properties registered a revaluation gain of HKD 1 billion, down 31% year-on-year. Now let's turn to the net interest income. Net interest income increased by 23.7% year-on-year to HKD 12.6 billion, driven by the expansion of net interest margin.
Average interest-earning assets decreased by 9.1%, mainly due to the decrease of participating banks RMB deposits with the clearing bank. NIM increased by 43 basis points year-on-year to 1.64%, mainly driven by the offshore RMB business and the eased dilution by the clearing bank business. In the first half, return on offshore RMB business continued to improve as we actively enhanced the deployment of our RMB funds. In the past periods, the group's RMB clearing bank business has been a major drag to the overall margin. In the first half of 2012, its dilution impact has already become insignificant as the balance deposited with the clearing bank reduced while the ex-clearing bank business was expanding. Compared to the ex-clearing bank NIM in the two halves of last year, NIM would have improved by 17 basis points year-on-year and 14 basis points half-on-half.
The improvement was mainly driven by the RMB business of our participating bank, while NIM of non-offshore RMB business also improved slightly. Total non-interest income increased by 12.7% year-on-year. Net fee and commission income grew by 2.9% to HKD 4.1 billion, primarily driven by the growth of fee and commission income from loans, credit card business, and funds distribution. Contribution from stockbroking business declined by 29% in a sluggish market. Commission from funds distribution rose by 32%, with strong performance in the distribution of RQFII funds. Insurance-related income decreased by 2%, mainly due to lower reinsurance income from BOC Life. Other operating income increased by 54%, mainly driven by the net trading gain, which was up 85%. The increase in net trading gain was mainly due to the mark-to-market gains on certain interest rate instruments and lower loss of foreign exchange swap contracts. Now to our expenses.
This chart shows our core operating expenses, excluding the impact of Lehman-related products. Our core operating expenses increased by 11.7% year-on-year to HKD 5.4 billion. Core cost income ratio improved to 29.7% from last year's 31.9%. In the first half of this year, staff costs grew by 10.5% due to annual salary increment and increased headcount for business expansion. Premises and equipment expenses increased by 11.6% with higher rental costs for branches, particularly in the China Mainland, as well as higher IT costs. Depreciation rose by 17.6% due to larger depreciation charge on premises following the upward revaluation in Hong Kong and on our continuous investment in IT infrastructure. Other operating expenses were up by 11.1%, mainly due to higher marketing and promotional expenses, as well as other business expansion.
Net charge on impairment analysis amounted to HKD 108 million in the first half, arising mainly from the net charge of loan impairment analysis. Loan impairment analysis recorded a net charge of HKD 87 million. It was HKD 50 million more than in the same period of last year, mainly due to lower recoveries. Individual impairment analysis recorded a modest net charge of HKD 5 million. The net charge of collective impairment analysis was HKD 238 million. The group's loan quality remained sound with classified or impaired loan ratio of 0.1%. The formation of new classified loans remained at low level and represent 0.05% of total loans outstanding. During the period, the group continued to strengthen its asset and liability management. Total assets decreased by 3.1% to HKD 1.68 trillion.
The decline was mainly due to the decrease in RMB funds deposited by participating banks with the clearing bank, which is in line with the new developments in the offshore RMB market. Securities investments increased by 3.3%. Advances and other accounts rose by 4.1%, mainly due to the growth in customer loans. Total equity increased by 8.4%, mainly attributable to profits for the period and increase in reserves for premises revaluation and fair value changes available for sale securities. The group adopted a flexible deposit strategy to support business growth while maintaining a cautious control on funding costs. At end of June, our deposits increased by 3.4% from last year-end, driven by the increase in both savings and time deposits. In terms of currency, growth came mainly from Hong Kong dollar and US dollar deposits. In the first half, total customer loans grew by 6.8%.
The growth was broad-based across all key categories. Corporate loans for use in Hong Kong increased by 3.4%, covering a wide range of industries. Residential mortgages loans increased by 4.6% as we captured the opportunities arising from the revival of the property market during the period. Trade finance increased by 14%, while loans for use outside Hong Kong grew 11.8%. The group's loan-to-deposit ratio was 63%, slightly up from 61% of last year-end. Total securities investments increased by 3.3% during period. We continued to adopt a proactive investment strategy to optimize the portfolio mix. European exposure was further reduced by 24%, while we increased investment in high quality bonds issued by banks, financial institutions, and corporates in the Asia Pacific region. Part of the increase was in RMB-denominated bonds, which increased by 22%.
Looking at our portfolio mix, 38% of our investments were in government or government-related papers, and 49% in high quality banks and financial institutions. 91% of our debt securities were rated A or above. This slide shows the operating income breakdown by segments. Personal banking business recorded a solid growth in net interest income, contributed by the growth in average loans and deposits, coupled with higher deposit spread. The increase was, however, largely offset by lower stock brokerage fee income. Personal loans and customer deposits increased by 4.2% and 3.2% respectively from last year-end. Mortgages, funds distribution, and credit card business delivered solid results. We continued to enhance our wealth management business platform with more new product roll-outs. Credit card business continued to do well. Total number of credit cards issued grew by 5% from last year-end.
Cardholder spending and merchant acquiring volumes grew by 10.8% and 16.8% year-on-year respectively. Corporate banking business continued to make good progress and delivered broad-based income growth. Despite a slower loan demand in the market, corporate loan book sustained growth of 7.9%, with notable improvement in average year on the back of our consistent strategy to balance growth and profitability. Corporate deposits increased by 3.6% with improved average deposit spread. Taking advantage of our strong cross-border service capabilities, groups sustained their growth momentum in trade finance. Innovative trade related products were introduced to corporate clients in view of the fast expansion of the offshore RMB business. Our treasury business posted strong growth with increase in income, mainly coming from net interest income and net trading gain. The group continued with a proactive investment strategy in view of the increased volatilities in the global financial markets.
We also made good progress in expanding our offshore RMB business. We bundled offshore RMB exchange rate related and interest rate related products with deposits, loans, trade finance to help customer lower their exchange rate risks and financing costs. Our treasury product innovation were well received by customers. This presented us with business opportunities, even in challenging operating environment. We continued to cooperate with Bank of China's overseas branches in extending the oversea RMB bank notes business with substantial increase in transaction turnover from the same period in 2011. As for the insurance business, during the period, we continued to optimize product mix and solidified our leading position in the RMB insurance market. During the first half of 2012, BOC Life was granted the approval to invest directly in the mainland's interbank bond market, supporting the further development of its RMB insurance products. Now to our mainland business.
Total operating income increased by 33% year-on-year, mainly driven by higher net interest income. Overall loan demand in the market weakened during the period. We continued to optimize the loan structure and improve loan pricing. Our customer loan increased by 1.2% from last year-end. Overall loan quality remained healthy with classified loan ratio of 0.48%. Deposit base was further strengthened, which increased by 9.8%. For Nanyang Commercial Bank China, the loan-to-deposit ratio stood at 72.9% at end of June. Operating expenses increased by 29% as we continued to invest in expanding our mainland operation. As at end of June, we had 31 outlets in the mainland. That concludes my financial presentation. I will now hand you back to Gary for the outlook. Thank you.
Thank you, Mr. Zhuo. Looking into the remaining months of the year, the overall market environment will remain challenging and difficulties may persist longer than expected. Recent macro trends suggest that global economies may face further downward pressure. The global financial markets will be subject to volatilities and risks coming from unresolved European debt crisis. For the local banking sector, the slowdown of the mainland and Hong Kong economies might mean softer loan demand ahead. At the same time, banks margins may face pressure given the persistently low interest rates and increasingly fierce competition. The local deposit market is expected to remain highly competitive, which will continue to pose pressure on deposit costs. All these inevitably imply a tough operating environment. Further growth for the sector will be confined by the slower economic activities in general.
Despite the slowdown in overall market, investing in our franchise remains as a key priority for us to enhance the group's long-term competitiveness. Over the past years, we have never stopped investing in our business, even during the tough times of the financial crisis in 2008 and 2009. This strategy proved to be prescient as today they have enabled us to capture many new business opportunities. A new platform such as cash management, custody, asset management, have enhanced our services and product capabilities. We have also set up a new private banking platform to provide unique and tailor-made services to targeted affluent customers. Given the prevailing market conditions and the more stringent regulatory requirements, having a robust financial position will be a distinct competitive advantage for financial institutions. In this respect, the group is strongly positioned.
As shown in our first half results, our key financial ratios were at solid levels with strong CAR, sound liquidity, healthy loan-to-deposit ratio, and benign loan quality. This will put us in a unique position to withstand the market challenges and to capture emerging opportunities. Although the near-term outlook may not look exciting, we still see a lot of opportunities in the mid-term to long-term. To celebrate the 15th anniversary for Hong Kong's return to Chinese sovereignty, the central government has further deepened the economic cooperation between Hong Kong and the mainland. These new measures and policies will give rise to more business opportunities for Hong Kong. Offshore RMB business is a key strategic focus of the group, and we have made great progress in enhancing our business platform. We are well-positioned to capture the opportunities arising from the further relaxation of the offshore RMB market.
The HKMA's new regulations on RMB liquidity management allow banks to have greater flexibility on RMB asset allocation, which will be conducive to the management of our RMB assets and liabilities. The recently announced extension of RMB banking services to non-Hong Kong residents have opened a new window to expand our business coverage. Since its launch in August, we have really made a good start by offering an array of RMB services to global customers. In all, I am pleased with the solid first half results and continuous progress in our business development. We will continue to upscale our capabilities to better serve our customers and create new growth drives. In view of the uncertain market environment, it will remain our top priority to proactively and vigilantly manage our capital liquidity and risks. While making investments in our business will remain cost-conscious and seek to enhance our cost efficiency.
Capitalizing on our strong financial position and franchise, I am confident and optimistic about the group's long-term sustainable growth. That concludes our presentation, and my colleagues and I will be pleased to take questions from you.
Okay. Each time, please raise no more than two questions. Stephen.
Thank you. This is Stephen Andrews from UBS. I have got one question. It relates to page 14 in your management discussion and analysis, which shows the average balance sheet and the yields on different parts of the balance sheet. I think, first of all, congratulations. I think you are the only bank I have ever seen that has a higher yield on their interbank assets than you do on your loan book. It is 2.42%, and it is the highest yielding part of your book. I just want to explore that a little bit more because obviously this is predominantly RMB assets, and the vast majority of this is your offshore RMB liquidity. If we back out, I think 70%-80% of it is RMB denominated. We know in interbank markets in Hong Kong and U.S., you cannot get anything like a 2.4% yield.
So it looks like on your offshore RMB liquidity, you are already making probably well north of the 3% yield. So you have got almost none of it sat with the People's Bank of China now. Is that a fair assertation to make? If not, how do you explain the 2.4% yield there?
Zhuo, explain.
These are very good questions. As you know, in the first half, our interest margin increased as expected. I think RMB made a good contribution on the improvement. At the meantime, actually, we have taken a lot of efforts in improve the loan pricing to control the funding cost, and we optimize our asset and liability structure. For the RMB business, this is a policy driven business. There for further relaxation in the first half of this year. BOC Hong Kong has been in the leading position in the major area of RMB business. So we fully comply with the liquidity requirement set by HKMA. At the same time, we capture the business opportunity in RMB business, especially in the RMB loan. We over doubled the RMB loan balance for the offshore RMB loan. We over doubled the RMB customer loan balance.
We also increased the RMB investment. As we disclosed, the balance increased more than 20% from the end of last year. All those measures, I think, make a comprehensive improvement to our overall interest income and the gross yield of our asset. At the same time, our balance sheet increased.
I don't know whether that answers your question or not, because your question is very complicated. We're trying to figure out how to answer it. You're talking about page 14.
Yeah, it's page 14. What I'm curious about is just what you're doing with your offshore RMB liquidity, because historically, that interbank line was made up of three components. It was your onshore RMB liquidity, which NCB has. It was the third-party funds, and then it was your own offshore RMB liquidity, which you have gathered yourself in terms of where it's invested.
Well, let me put it this way. In RMB business, there are two types of liquidities. One is our participating bank liquidity, which is customer deposits we attracted from the market. The other one actually is the other participating bank's deposits. For that part, actually, majority of that actually was or had been placed with PBOC in Shenzhen, earning minimum.
That is exactly my point. We know that is making 60 basis points. We know the offshore your US dollar-
No, not even 60.
Yeah.
Overall interest we get from PBOC is what? 9 basis points, 12 basis points or something like that, to share it with the other participating banks, and net actually for us is very minimal. The other part actually is the customer's deposits. The allocation of the customer deposits, we started very early. You may notice, this first half of this year, we have seen tremendous growth in our loans, and also an increase in our securities investment. We also placed some of that partner funds with the other banks in the domestic markets, even though the overall interest environment in China, the overall interest rate level in China has gone down because of the early placement of the funds. We are still enjoying sort of a reasonable return on this part of our assets.
For my second question, can I come at it a different way, which might be easier to explain? Of your own RMB deposits you have, is it fair to say that almost none of them now are placed with the PBOC earning that minimum return for you?
We try to do that. Try to place as less as possible deposits with PBOC. But on the other hand, HKMA also have specific requirements on clearing banks of liquidity management. So within that limit, the excess funds, we try not to place with PBOC.
Okay. Nothing further. Thank you.
Okay. Gentleman in the middle, please.
Thank you. Steven [inaudible], CITIC Securities. Two questions. First one about insurance. Why did you see a slight decline in gross earned premium in the first half? Whereas your peers actually report quite a good growth in insurance premium in the first half. What will be your strategy to revive the growth of your insurance premium in second half or maybe next year? Second question is about the amount of special mention loans in June, because we actually have seen a sharp rise in special mention loans in second half last year. Just want to know whether these special mention loans has already been removed from your balance sheet.
Can I ask David to answer the first question, and then the Chief Financial Officer the second?
You look at the gross earned premium actually, compared to the first half 2011. Actually, it is flat. The reason is quite simple, because if you remember the first half last year, there was a big surge in terms of the RMB life insurance policy in the whole market, not only ourself, I guess, because of the expectation of further appreciation of the RMB and so on and so forth. Whereas this year, I think the expectation of appreciation of the RMB is kind of dampened. That is one reason why the gross premium didn't actually grow. The other thing, it is all from a very high base compared to a normalized market this first half, so we see a little bit of a flat movement.
In terms of product offerings and in terms of what are we going to do going forward, in fact, we already started doing it the first half of this year, is to really diversify in terms of rather than just being a market leader in RMB product and services. We also move into the US dollar side and the Hong Kong dollar side. Of course, it all depends on the customer's needs and requirements. So we have a broad range of product, from the saving products into the protection product into investment product. Also, the other thing to remember is that, I guess over the last one year now, the avenue for the usage RMB have also grown, in the terms of now you have RQFII. They have other alternatives as well. Compared to last year, which is quite a narrow window in term of asset deployment.
Now, asset deployment alternatives are quite broad and wide. So there are more choices for the client as well. To answer your question about second half, I think we are trying our best to broaden our product base, our product range, and also in currency offering as well.
Okay. The special mention.
For the special mention, no. Normally, we did not disclose the balance or ratio in the interim report. From just a trend, both the special mention loan balance and the ratio improved in the first half compared with the last year end. As you know, our asset quality is still quite sound, quite healthy. Non-performing ratio is only 10 basis points.
Please pass the mic on to Sally, the lady in the middle.
Sally [inaudible] from CLSA. Congratulations on a good set of results. I just have two questions. Firstly, on your dividend, I understand last year was an exceptional year where you paid out the Lehman-related products write-back. When you look at just the cut in dividend, it was down 13%, but the profit was only down 4% or 6% on reported. Which means your payout ratio is now closer to 50%. I was just kind of wondering, has there been any sort of Is this a reflection of more reserve outlook for second half? Or what's sort of the reasoning behind that? If I look at the previous halves, there's not any one half yearly that actually has a payout ratio closer to 50%. On the second question is, you very kindly provided in this year's final results presentations, the offshore RMB net interest income increase was five times increase.
If you could share that same information for your interim, that would be really helpful. Thank you.
I'll ask our Chief Executive Officer, the Chief Financial Officer, if he's willing to share that information with you or not.
Yeah.
Can you? Okay.
Firstly is for the dividend payout ratio, especially the dividend amount. It's lower than last year. That's true. But, as you know, last year's dividend included the recovery of Lehman. So that is a one-off item. As a dividend policy for the whole year, we maintain the 60%-70% for the whole year dividend policy. For the second half, as you know, there's a lot of uncertainties in the market. And also HKMA is going to give the detailed guidelines in Basel III requirements. So, we should be prudent. And given our CAR ratio or the quality of our capital, we have the confidence in maintaining a constant dividend policy. For the interest income of RMB, right? You're talking about that. That is quite important portion or contribution of our income growth.
Over the past several years, even in some periods, the RMB business may be a drag for our overall interest margin. Still, if you look at the income itself, it's a contribution. In recent years, it has become a more important factor for the growth of our overall income. I think, for the RMB business, interest income is one thing, and actually RMB is bringing us more other comprehensive income, such as the RMB fund, RQFII fund distribution, credit card, insurance, and also loan commitment fees, settlement fees, et cetera. We are going to leverage our strengths or our leading position in the comprehensive banking business and capture the RMB business to maintain our competitiveness going forward.
I would say generally, widening of RMB NIM actually is an important factor, the most important factor in the overall widening of the NIM. An increase in RMB's interest revenue is also a very important factor in an increase of our overall interest revenue. Okay. You want to know the numbers? You didn't say it, so I wouldn't.
Okay.
Hi, this is Edwin from Merrill Lynch. I guess building on Sally's question, can you give us some color on your RMB deposit growth half on half this year? Even around, we saw a bit of a spike off a small base in terms of structured deposits. What was the rationale for that?
I'll take that question. Okay.
Answer the structured deposit.
Who's going to answer? No, I'm trying to-
Structured deposit. RMB deposit.
Well, just to answer the question on the structured deposit side, really. What happened this year is we actually have put a lot of emphasis in terms of gathering the liabilities side of the balance sheet. And one of the things that we did quite well this year is on the equity, not equity, interest link and foreign exchange link deposits. And that's why you see a surge in the structured deposits, admittedly from a very low base, yeah? Because of the overall demand for liability this year.
Well, in fact, RMB deposit decreased in the period. Ever since the beginning of the first half this year, we saw very fierce competition in RMB deposits. As a clearing bank and also main market player in the local market, we certainly have substantial RMB deposits and certainly a sizable market share. We look at the situation, we think, if we increase the deposit rates just like the other competitors do, then it will do more harm in our overall RMB interest revenue. So we actually adopted very proactive and prudent strategy. On one hand, of course, trying to look at the size and the market share of RMB deposits, whether that be enough to support our assets, RMB assets business.
On the other hand, also trying to also look at the revenue and NIM, things like that, and try to strike the balance between the two. So as a result, we've seen some decrease in RMB deposits, but at the same time, the NIM and revenue both increased significantly.
Next question.
Thank you. It's Gary Lam from Citi. Congratulations for the solid results. Two questions on the loan book if I may. Firstly, with regards to the RMB loan demand and loan growth. With the slowing macro backdrop here, are you seeing the sustainable demand on that front? In the first half, could you also share colors as for these RMB loans, whether these are trade related or more long-term capital investment related? The second question is on the loans for use outside of Hong Kong. That category, we are aware that it's the category that grows relatively fast. However, in terms of collateral level, it is around 25%, seems lower than the general domestic Hong Kong corporate collateral level. What kind of confidence would we have given this macro backdrop in terms of asset quality outlook? Thank you.
Yes. For your first question, I think the first half of this year, I think most banks in Hong Kong, they expect very strong RMB growth. From the second quarter of this year actually, because one is due to the regulatory change on the lending rate in China. That means actually the rate cut in RMB lending in China and also the funding costs increase in Hong Kong. That leads to narrowing the gap between the onshore and offshore market rate. Due to the fierce competition, actually, and also compare with last year, expectation of RMB appreciation is also not so strong as last year. So that leads to the Actually we can see the weak RMB demanding in this market. So we expect the second half of this year, the trend will continue. So I think that's for your first question.
For your second question, if the long course for RMB loan, we expect there will be the RMB loan instead of trade related financing because I think for trade related RMB products, the demand is decreased much more substantially. Because the new policy on FDI and that kind of policy, so they are more demanding the RMB direct loan. So we as BOC Hong Kong for first half of this year, we are major increase in the RMB is also in the direct loan. Yeah, so.
Well, in terms of loan quality in the future, I would say we're not seeing widespread deterioration of loan quality in our loan portfolio. And we're confident with the current management, risk management control measures in place. I think our loan quality will remain sound. At the same time, we actually last quite few years, we try to make our RMs to focus on the customers themselves, the quality of the customers themselves rather than the collaterals. Collateral is good. Collateral is loan quality enhancement. But the key thing is to know your customers. With a better knowledge of your customers, then you're in a better position to control the quality. So we actually, in the last few years, we focus on the state-owned enterprises, the major corporations in China, and the good quality local blue chip companies.
So we extend the loans to them, and we think the loan quality is excellent so far. So we're not seeing any significant deterioration even for those SMEs that we lend to. So, that actually is part of the In the last, in terms of our quality, asset quality management, that's part of the measures that we adopted. And we think it's going to pay off in the future.
Okay. Over here.
Good evening. It's [Vishal Mittal] from Merrill Lynch. Two very quick questions for you. Firstly, I recognize it's off an extremely low base, but on page 51, if you look at the overdue advances from Mainland China, again, it's off a very low base, but it did more than double. I'm just wondering, is there any particular area of stress that you're seeing? Is it coming from any particular geography or any borrower type? My second question surrounds Basel III. If you'd be so kind, can you share with us what the pro forma impacts of Basel III implementation would be on your capital ratios given the higher deductions but also the higher risk weighting for trade finance and other types of loans that you do quite a lot of business in? If you could share that would be fantastic. Thank you.
Okay. The first is the NPL change in China?
Overdue loans.
Okay. Overdue balance. Mr. Gao, can you consider?
Those overdue loans are in line of China Mainland, is mostly from our China operation. If you look at the amount itself, it's only HKD 405 million and HKD 400 million compared with our total balance of our China operation or the bank as a whole. It's still a small base.
With that said, I will say, giving the operating environment is quite challenging. The economic growth is slowing down. We are quite cautious in monitoring the asset quality. Those overdue are from individual cases. We didn't see the sign of substantial deterioration. All those trend, I think, is still manageable.
Well, in fact, in China, most of the concern should be placed to local government borrowing and property lending. In those two areas, Nanyang China has very minimum exposure. In that regard, I would say even though there are certain individual cases, deterioration of asset quality, we're not too concerned about the overall quality in this lending portfolio. The Basel III.
Yeah. For the Basel III, we are still awaiting the specific or the final guidelines from HKMA. From the assessment in the past several years, and also communication with HKMA, I think given our capital base and the quality of our capital, we are confident to meet the current requirement of Basel III. At the meantime, Basel III also required some of the operating strategy or the customer strategy or the business model to be refined. I think that is a long term. Every bank in such industry should put much effort on that, especially put much effort on establishing the customer relationship or maintain the long-term business opportunity with the customers. That is the area we will explore more in going forward.
Hi, Sharnie Wong from Barclays. Gary mentioned that on margins you expect some pressure going forward in your outlook statements. I'd just like to clarify the extent of the pressure, because if I look at your offshore RMB margins, the deposit competition in Hong Kong really picked up towards June. Now deposit rates are similar to onshore rates. How significant would that be in terms of your offshore RMB margin going forward into the second half? Moreover, given that China's cut interest rates, how does that affect your interbank return going forward into the second half as well, in terms of placements?
You want to go ahead.
Yeah. Our interest margin increased remarkably from last year and the second half of last year. But even under the current operating environment, it's quite difficult to further improve that in the short term. Also, as you said, there are many uncertainty or pressures on the interest margin, especially on the competition of the deposit or the easing policy or interest rate cut on the market interest rate. But we have the confidence to say that our overall interest margin for the whole year of 2012 should be higher, better than 2011. And we will take all the measures, especially in proactively manage our asset liability, improve the overall return or the spread of our asset and liability. Such as increase the loan pricing, cautiously control the funding cost, and also adjust the asset liability structure.
Well, actually, if you look at RMB, especially what you mentioned, RMB NIM and interest revenue has made big contributions to our overall improvement in NOI and NIM. Well, actually, we got squeezed on both sides, both end, on the use of funds and source of funds. When we say use of funds, the deposit side, of course, the increase of deposit rates in the first half of this year, certainly, we managed to control it well in order to contain the negative impact on the cost of fund. On the other hand, of course, China's lowering interest rates. Now interbank market placement interest rate is getting lower. We don't know whether our lending rates will be able to maintain the same level in the first half this year. Yes, that is a very, I would say, clear situation that we have to face.
The question is, whether you have the right customer base, whether you have the right products that you can do things with your customers with a decent return. So in order to control our cost of funding, of course, as I said, we lost some RMB deposit base. Into the second half this year, especially after easing the interest rates in the mainland, I don't know whether you realize or not, the competition in RMB deposits have eased a lot. So I think our competitors also realize just grabbing RMB deposits by increasing rates, perhaps. I don't know. They're not achieving the benefits they really want. So I think the NIM RMB and NII RMB is the relationship between the cost and return. What we try to do, actually, we have very close look on the RMB asset liability management.
In our ALCO management, actually, RMB is a specific item. We don't look at it actually as overall asset liability. We just single out RMB to look at this particular currency, because this particular currency's asset and liability is very much subject to policy changes and market environment changes. Of course, the other currencies too, but policy changes actually, it's a very important factor in the control and management of your asset liability. For instance, the quotas you're allowed to make investment in local, in RMB domestic bond market, whether that's increased or decreased, things like that.
The quotas you're allowed to make deposits in the domestic interbank placement market. We're expecting the PBOC, in order to further expand RMB business to support Hong Kong as an offshore market of RMB, will gradually increase those quotas to allow banks to be able to allocate more assets in various markets.
It's already happening, actually. So as a result of that, even though we're seeing downward pressure on our RMB NIM, we still expect we'll be able to control it in a good manner so that the negative impact on our NII will not be as much.
Okay.
Thanks. Stephen Andrews from UBS. Hopefully this question is a little bit simpler. It is just to do with property. Just looking at the rough maths in the notes to your accounts, you revalued your investment book, investment property book, about 8% in the first half, and your own property through the revaluation gained by about 12%- 13%. The reason I ask is your group shareholders fund grew in total about HKD 11 billion in the first six months, and HKD 5 billion- HKD 5.5 billion of that was these property revaluation gains.
So it has been a very big driver of your book value growth. Can you perhaps just outline to us the mechanics of how you revalue these properties? Do you literally get one of the local real estate agents to look at your portfolio as of June 30? They give you a value, that is what you use.
It is up to date as of June 30 and using cap rates, observable market values. How are you doing that so we know how we can expect to see that move going forward?
Revaluation of property.
Yeah. Actually, we have disclosed in our annual report. For the revaluation of property, we engaged third party independent agency to give us the information. Also, I think the method has been consistent over the past several years.
Okay. We will take the last few questions.
Actually, I think in the past, we disclosed the methodology for our property valuation. Can you give a frequency of valuation?
Every reporting period.
Say it again.
If it's in the annual file, I'll dig it out. That's fine.
Okay.
Okay. If there's any other questions? If not, then we'll end the presentation. Thanks for joining us.