滙豐控股 (HSBC) 2004 Q2 法說會逐字稿

Well, good morning, ladies and gentlemen, and welcome to this briefing on the 2004 Interim results at HSBC Holdings. I’d also like to welcome those investors who are joining us via the internet. My name is Stephen Green, I’m the Group Chief Executive of HSBC. To my right over there is Douglas Flint, Group Finance Director. In the front row we have Alan Jebson, Chief Operating Officer, Michael Geoghegan, Chief Executive of HSBC Bank Plc, and a number of other senior HSBC colleagues.

We’re also joined this morning by two of our non-executive directors, Sharon Hintze and Sir Brian Moffatt, and Sir Brian Williamson -- three of our non-executive directors.

Before we start the presentation, I’d like to draw your attention to the cautionary words on forward-looking statements showing on the screen. This is, of course, to comply with the regulatory environment. And can I ask that you please turn off mobile phones, or blackberries, during the briefing.

Can I also remind you that at HSBC.com you can find the news release, the slide presentation, and our interim report, which includes the information which will be filed on Form 6-K.

Let me now run through the headline figures. As we judge ourselves on cash, return on cash invested, we focus internally on profitability, excluding goodwill amortization. On this basis, operating profit before provisions was up 41% to $12.685b. Pre-tax profits are up 49% to $10.25b. Profit attributable to shareholders is up 48% to $7.229b, and earnings per share increased 40% to $0.57.

The Board has declared a second interim dividend of $0.13, in line with the program announced with our 2003 results, bringing the total declared dividend to date to $0.26, an increase of 8% against the dividend declared at the same stage last year. Our capital ratio has strengthened, with a Tier 1 ratio at 9.3%, up from 8.9% at the end of 2003.

This slide illustrates the movement in pre-tax profits, over the first half of 2004, and highlights the contribution of organic growth. Pre-tax profit increased by almost $3.4b. Of this, $294m arose from foreign exchange translation effects. The Bank of Bermuda and other acquisitions and disposals contributed $85m.

Households’ first quarter contribution this year added $1.113b, and our existing businesses, including Household second quarter, added $1.880b, of which $966m arose from lower provision requirements.

The key achievements for the period can be summarized as follows – a solid performance across all our businesses, which generated a record level of earnings. There was strong organic growth in many of our established markets, against a backdrop of improving economic conditions, especially in the US and in Hong Kong.

[There was] continued investment in the future of HSBC, combined with costs discipline in our existing businesses. At the same time, we have maintained a consistent profile in both credit and market risk. Improving economic conditions also allowed us to recover historic bad debt charges. We have improved our financial strength, and recent additions to the Group have extended the HSBC franchise.

And we continue to develop our brand. In a report by [Interbrand], published last week, HSBC improved to the 33rd most valuable brand in the world, and the most valuable in Britain. According to [Interbrand], we are the fastest growing major financial services brand in the world.

As you can see from this slide, there has been profit growth across all of our customer groups. The Personal Customer base, including Consumer Finance, now contributes 46.2% of profits, up from 39.7% at the interim stage last year.

Let me take you now briefly through each line of business. In Personal Financial Services, pre-tax profit, including goodwill amortization, increased by 26% to $2.615b. In constant currency terms, and excluding acquisitions, the increase was 19%.

In the UK, where we were rated by Moneyfacts as the country’s best value mortgage lender, and the only high street bank in the top 20, we grew mortgage balances by 18%. Overall in Europe, our efficiency improved as our revenues grew 14% and our costs at 3% on a constant currency basis.

In Hong Kong, we generated record sales of unit trusts, and capital protected investment products, and established a market leading position in the sale of new, regular, premium life insurance. Net fees and commission income grew by 36%, which helped compensate for the reduction in net interest margin.

Profits in the rest of Asia Pacific for the six month period were higher than for the whole of 2003, generated by strong growth in mortgages and cards. It’s pleasing to note that the roll-out of our Customer Relationship Management Systems was influential in improving sales growth and efficiency in the period.

As I turn to Consumer Finance, pre-tax profit, excluding goodwill amortization, and with a full six month contribution from Household, was $2.117b, an increase of 226%. On a constant currency basis, and adjusting for the additional quarter from Household, the increase was 53%.

The integration of Household is now virtually complete. Household achieved annualized customer loan growth of 13% on a like-for-like, primarily in real estate secured lending, enabled by access to competitive funding.

Towards the end of the half, we saw encouraging growth in branch-based consumer finance lending, driven by rising consumer confidence. Funding and operational synergies were in line with expectations. A strong improvement in credit quality was driven by the economic upturn, tighter credit scoring and improved collection activity, and credit trends were positive.

We continue to export Household best practice to the rest of the Group, sharing technology and marketing skills, and experience in consumer credit management and retail services. Mexico and Brazil are our priorities at present, as prime beneficiaries of Household’s model.

We continue to derive other benefits. Following on from our agreement with the John Lewis Partnership last year, to manage jointly their own brand card, last month we reached an agreement with Marks & Spencer to acquire their Retail Financial Services business. I think it’s fair to say that neither of these deals could have been done by either HSBC or Household alone.

Turning now to Commercial Banking, pre-tax profits, excluding goodwill amortization, was $2.191b, an increase of 33%. Again, in constant currency terms, and excluding acquisitions, the increase was 26%.

Revenues grew over twice as much as costs, driven by strong growth in fee and commission income, as we expanded sales of trade finance, credit and insurance services to this sector.

Cross-border business referrals into Mainland China, and between the US and Canada grew strongly. We opened specialist business banking centers in Hong Kong, and we serviced more Top Tier customers in our corporate banking centers in the UK, France and Canada.

Our business internet banking customer base has grown by over 50% since June of last year, and we’ve seen a significant increase in revenues through this channel. And our market share of business start-ups in the UK was a record 20%. In Hong Kong, momentum returned to lending to commercial customers, as the economy grew, and trade services increased.

I turn now to Corporate Investment Banking and markets, where our pre-tax profit, excluding goodwill amortization was $2.764b, an increase of 24%. On a constant currency basis, and excluding acquisitions, the increase was 17%.

As part of the planned investment in upgrading our product and service capabilities, we recruited around 700 people in the period, and a similar number departed. Some 90% of the planned senior hires into this business have now been made.

Growing revenues have helped offset the cost of this investment. Global markets and record revenues reflected in part, strong trading volumes in derivatives and foreign exchange, due to US dollar volatility. We also grew revenues from custody, funds administration, payments and cash management, and trade services.

There was encouraging growth in the number and size of debt and advisory mandates in global investment banking. Worldwide, our share of international bond issuance rose to 4.5%, from 3.8% in the same period in 2003. Within an expanding pipeline of future revenue potential, there are encouraging signs that our investment in talent is being successful.

Improvement in the economic environment led to restructuring activity, which enabled us to achieve a net release of provisions, and credit quality has remained stable.

Turning now to Private Banking, pre-tax profit, excluding goodwill and amortization, grew to $345m, an increase of 29%. On a constant currency basis, and excluding acquisitions and business transfers, this increase was also 29%.

Income grew almost twice as fast as costs, following the successful restructuring of the business, and its re-branding, as HSBC Private Bank. In constant currency terms, we grew fee and commission income by 13%, and lending to clients grew by 30% since June of last year.

The Bank of Bermuda’s Private Client Services business has added considerable product and service strength to our existing trust capabilities, making HSBC one of the largest private trust banks in the world.

This slide shows the unique balance of HSBC by geography. As you can see, with a full contribution from Household, North America now contributes one third of pre-tax profit. I’m now going to hand over to Douglas, who will take you through some more of the detail. Douglas.

Thank you, Stephen. This slide shows the underlying growth for the Group. Reading from the left, we have adjusted for the impact of the additional quarter from Household, by taking out the first quarter 2004 figures and then adjusted to the impact of other acquisitions which are principally Bank of Bermuda and Losango.

After reassessing the first half of last year on a constant currency basis, you can see that underlying profit growth is 8%, and this is double the underlying growth of 4% that we showed both at the half year, and at the full year stages in 2003.

This has been achieved substantially through strong growth and fee and commission income following investments in our businesses, and this has encouraged us to continue this investment, which is reflected in cost growth of 8%.

This chart shows the rate of income growth and costs growth for the Group. Income grew at 8% for the Group, and costs at the same rate. Income is growing faster than costs, in all our customer groups, except for Corporate Investment Banking in markets, where, as you know, we have embarked upon a program of investment.

Looking at Personal Financial Services, we can see that in Europe, we grew revenues by 14%, and costs growth was held to 3%. In Hong Kong, other operating income, which represented 44% of total revenues, grew by 33%. The costs growth of 12% was in line with that. Total revenues were, however, flat, as margin compression offset the growth in other income.

For the rest of Asia Pacific, income growth was a robust 12%, as the mortgage and fee income businesses grew, following investment in recent years. Our costs increased by 18%, principally from sales-related staff costs, and increased marketing activity.

In North America, the cost growth was substantially attributable to Mexico, where staffing was increased to improve service in the branches, and performance related pay rose in line with new business. There were integration costs in Canada related to the acquisition of [Entessa] Bank Canada.

Turning to Commercial Banking, income growth in Europe reflected good progress in expanding fee income, particularly loan fee income, through building more deposits from [indiscernible], and from building more deposits from our commercial customer base.

In Hong Kong, other operating income, which represented 45% of total revenues, grew by 19%. There was a notable increase in trade finance activity. The cost growth at 12% reflected this expansion activity, on top of which there were some costs for moving credit support and trade service back-office operations to Shanghai.

Net interest income was flat, as margin compression offset the growth in lending. In the rest of Asia Pacific, strong growth in international trade contributed to strong growth in other operating income. Finally, in North America, the reduction in costs related to the sale of businesses in the United States last year, the revenue gone from those businesses was replaced by good growth across all businesses, in Canada, Mexico, and the United States.

Turning to our operating margin on a risk adjusted basis, the Group’s profitability improved from 2.55% for 2003 to 3.2% for the first half of 2004, reflecting the impact of a full half year from household, and the improving credit environment.

This slide shows the composition of our loan mix. Total personal lending is now 55% of all customer lending. Over the last year, lending within our principal asset categories grew by 13%. Residential mortgage growth was strong at 26%, and other personal lending growth was 10%. By contrast, commercial lending remained muted at 5% growth, although it has picked up against the second half of last year.

Dealing profits continued to account for an acceptable proportion of income, at 5.5%. Foreign exchange profits accounted for well over half of dealing profits. And this familiar slide of the daily distribution of market risk revenues, show that revenues remained concentrated in a very similar range to previous half years.

The Group charge for bad and doubtful debts was 96 basis points down from 153 basis points. Household’s bad debt charge fell by over 100 basis points, reflecting economic recovery in the United States. Excluding the impact of Household, the charge was only 9 basis points, which is clearly extremely low in historical terms, and indicative of the improved economic climate.

Looking at HSBC excluding Household, the rate of new provisioning improved, compared to the corresponding period last year. Corporate credit experienced remained highly favorable, compared with historic trends. Improved sentiment afforded further restructuring opportunities, and these allowed us to recover provisions as companies refinanced.

Releases of specific and general provisions were $939m, which was $480m higher than in the first half of 2003. Recoveries were $202m, which were $89m higher, and the combined effect was to reduce the net charge by $619m.

One important aspect of the improved economic climate has been a favorable impact in credit quality as reflected in Delinquency and Loss statistics, particularly in the United States and in Hong Kong.

Improving levels of employment, rising property prices, resilient consumer confidence, and lower bankruptcy filings were all key factors in our evaluation of portfolio provisioning requirements, and as a result of this assessment of the impact of the improving economic outlook, as it impacts credit delinquency, $245m of general provisions were released in North America and Hong Kong.

There were at the end of the first half of 2004, no concentrations of industry or geographic exposure, which were of significance in terms of credit risk exposure.

Turning to the circumstances which drove the release of general provision, they are set out clearly in this chart. Personal lending has been growing as a proportion of our book, particularly, obviously, as a result of the acquisition of Household. Household’s provisioning is on a strict roll-rate methodology, and for the rest of HSBC, over the last three and a half years, as economic conditions have improved, the incidence of new specific provisions has fallen, and this trend, particularly in the last half year, explains the lower general provision requirement.

Turning to credit quality in Household, driven by the strengthening economy, both the charge-off rate and the delinquency rate have shown improving trends. The decline in risk adjusted revenue margin reflects a combination of the lagged impact of charge-offs related to business written some time ago, and the lower margin loan growth that is currently being put on the books.

In Household, the business mix is changing, as we expand our presence in prime and near prime space, and this is particularly evident in the strong growth in real estate secured lending. There has been a reduction in delinquency rates in the first half of the year across nearly all products and maturities.

Let me update you on our progress with Group Service Centers, which are a major part of our strategy for serving our customers more efficiently. At the end of June, we had just over 9,000 staff employed in these centers, and we’re on course to reach 13,000 staff by the end of this year, serving customers around the world.

You can see that these centers engage in a wide variety of back-office and processing functions. Around 70% of this is to do with mortgages, payments, insurance and finance back-office work, and customer account administration, address changes and the like. The remaining 30% is call center work.

It’s worth returning to our business in Hong Kong to reflect on its progress in what has been a difficult five year period of deflation. Over that period, when loan growth has inevitably been modest, and there has been significant pressure on net interest margins, we have reconfigured this business to emphasize sales of insurance and investment services, thereby increasing other operating income. Non-interest income now accounts for almost half of all operating income, which is a substantial change from the 29% contribution in 1999.

Let me now hand you back to Stephen.

We’ve talked about our progress in our existing businesses. I’d like now to update you on some recent strategic developments in the Group, first, the Bank of Bermuda, where the integration of the bank, which joined the Group in February of this year is proceeding very well.

We’re delighted with the reaction of customers, who see our investment as building a platform for a major development of funds administration and trusts services, as well as bringing additional products to an important Commercial Banking presence in Bermuda itself.

Our combined strengths have already been successful in attracting sizeable new mandates. Similarly, in supporting Bermuda’s reinsurance industry, HSBC’s capital strength is allowing the Bank of Bermuda to expand its coverage of this important sector.

We’re achieving revenue synergies beyond those identified in our acquisition business case, and we expect the integration process to be completed by the end of this year.

And on June 24, we confirmed that the Hong Kong and Shanghai Banking Corporation is in discussions to acquire 19.9% of the Bank of Communications in China. I can report that those discussions have gone very well, and are at an advanced stage, and we expect to make a further announcement on this shortly.

As our results for the first half of this year demonstrate, my colleagues have found opportunities within this challenging environment to deliver our strongest ever performance in a six month period.

The current operating environment remains broadly favorable. There are no obvious signs of significant adjustment. Although trading conditions in our markets business in the second quarter were less buoyant than in the first, there are no obvious signs of significant deterioration.

China is exercising increasing influence on the global economy, and after five years of deflation, the Hong Kong SAR is recovering well. However, global imbalances remain, and it will be unwise to relax, particularly when the last eighteen months have seen a significant build-up of capital reserves within the financial services industry, and whilst capital investment in the west remains muted.

The risk of market distribution rises as financial institutions use increasingly similar technology to manage risk, and the possibility of volatility also increases as the investment sector becomes more highly geared, in search of better returns.

We remain focused on these, and other issues. Our strength lies in the broad diversification of our revenues by geography, and by customer group. It also rests on delivering the revenue growth, and improved productivity objectives of our current strategic plans.

This is the challenge that lies before us now. I know that my colleagues, talented and industrious as they are, are committed to meeting it, and to serving more than 110 million customers around the world, as effectively as possible.

Now, we’d be very happy to answer any questions you may have. Can I ask you to wait until the roving microphone reaches you, so that we can hear the question, and it would be helpful if you could identify yourself, and if time permits, we will also take some questions by email.

Hi, it’s Alex Stern from Goldman Sachs. Could I turn to the operating profit level, and focus on the income up 8%, costs up 8%, operating profits up 8%? On Page 20 of your release, you mentioned that if you strip out the impact of CIBM, the underlying cost growth would have been up 6%, which suggests that there is a positive [jaws] of 2.

Looking further into Hong Kong, cost growth was up 12%, and you mentioned that, I think, that this was in line with income growth. Could you give us a little bit more color on that?

And then looking further into dealing profits and fees, the run-rate of revenues, looking at Q2 on Q1, had there been any change in either of those two line items? And I’m sure it will help Simon and myself on our numbers a little bit more if you could give us a little bit of color on the run-rate of earnings and costs, revenues and costs, that you’re seeing in the business going into the second half of this year.

Right, let me start answering. Yes, there is a positive jaws, to use that rather inelegant phrase, in all of the other businesses except CIBM, and even CIBM, of course, profits were up. And the CIBM numbers reflect our commitment to invest, that you’re well aware of.

In the other businesses, really, around the world and across the customer groups, we’ve got it the right way around, and that’s what we’re committed to. So far as Hong Kong’s PFS is concerned, you’ve got a situation where net interest margin has declined, and indeed, there is a negative performance in net interest income in the PFS business, offset almost, essentially, almost exactly by non-funds income.

But the decline in the net interest income, of course, did not lead you to save any costs, whereas the growth in this non-funds income, which is very substantial, over 30%, does carry with it a cost implication, and so that’s why you see that zero on the revenue, and 12% on the costs.

I think that business is going the right way in all of the circumstances, and indeed we, as we showed in a later slide, I think the transformation of our Hong Kong business in circumstances which were deflationary all of the time, and recessionary for quite a lot of the time, is nothing short of remarkable. Q2 on Q1?

Yes, I mean there’s no – with the exception of the markets business which we commented upon, and I guess you all know from your own environments, where Q2 was not as powerful as Q1 in trading businesses, the other businesses in terms of generation of net interest income, and fees and commissions, made progress, so there were no Q1/Q2 impacts on those businesses, steady progress in really all of them.

I think the other thing to say in relation to, and this is speculation as to what the shape of the yield curve might be, but you know, it has been one of the dramatic impacts on our costs/income ratio over a period of falling interest rates, that as the value of deposits falls, you get no benefit to your cost/income ratio because you lose 100% of the margin, and there’s no impact on the cost/income ratio because you don’t lose costs for a smaller margin.

The foot side is true when rates begin to rise, where your margin begins to, or the value of the deposits begins to rise, and it should have no impact on your costs. If we’re at that point, then it’s potentially quite helpful.

Hi, it’s Richard Stake from SG. Can I ask you a couple of questions on Household, on the sustainability of the bad debt charge? I know the asset mix is changing rapidly in the Group, but on a sort of product by product basis, has it fallen to an unsustainably low level, or should we look at this as a more normalized charge?

Secondly, just on the funding synergies, can you just clarify where we are with those, and as you restructure the balance sheet, do you expect further synergies coming through?

If I may on the bad debt charge, this is the reflection in a change in product mix in part, as well, of course, as improved economic conditions. I think it would be unwise for us to make predictions. Clearly, if the American economy got into severe difficulties, that’s going to have a flow-through in terms of bad debt performance.

I can only say that at the moment, as you will be well aware, the US economy is pretty robust, and even if it slows somewhat, as I think is the consensus expectation, and even if interest rates continue to gently rise, which again, I think is the consensus expectation, we are comfortable with the performance of that business in terms of bad debt.

But I wouldn’t want to say that in any environment, we’ve reached a norm. It clearly is going to be influenced by the performance of the overall economy. On funding synergies?

Let me come to that. The other thing on the sustainability of the bad debt charge is that, remember always that what Household seeks to do is manage risk adjusted revenues, so one of the reasons why the margin is falling is that they’re doing higher quality business with lower credit costs.

One of the reasons for doing that is that the demand on the cards base, and the consumer finance base and the branches has been relatively muted in the first six months of this year, and indeed, in the second half of last year, as the economy was weaker, and people were paying down credit.

To the extent that they were profitable opportunities as the economy gets more resilient and there’s more consumer confidence, that we can build higher margin businesses with higher credit losses but higher margins, we’ll be delighted to do so, and therefore, what we’ll be focused on is the margin, rather than the absolute level of bad debt.

In terms of funding synergies, the Household, if you haven’t got enough to read, there’s another couple of hundred pages coming out at lunchtime from Household’s filing. We’ll say that the $1b is still the number that we talk about.

In relation to the first half of this year, if you like, what they call the cash funding synergies, i.e. what has actually been achieved on the revolving of credit as facilities roll over, is $140m in the Consumer Finance business so that’s not accounting, it’s actual cash, and on top of that, there’s probably about $20m of fees and other spreads that were paid internally that would historically have been paid outside, so it’s $140m or $160m, whatever you want to do, on a cash basis.

As we do more, again, Household’s filing will say we will look, probably to migrate the private level card business from Household into the Bank in the second half of this year, and that will move a business that’s funded exclusively wholesale at the moment, to a business that will be funded through a mix of wholesale, and retail, and therefore, to the extent that that funding mix improves the cost of funds, then there will be further benefit.

Good morning, it’s John-Paul Crutcher from Merrill Lynch. I wanted to ask two questions, one on strategy, and one on the detailed numbers. The first, from the strategic perspective, you’ve outlined clearly in your [Bank of Bermuda] and your Bank Communications issue. I was wondering if you can just maybe broaden that out a bit.

Apparently, there may be a dogfight starting to brew in the UK right now over one of the smaller banks out there. I just wondered if you can comment on Bermuda as I’m interested in the development of that.

Secondly, and more importantly, you were linked with some Japanese consumer finance names earlier in the year, and I just wondered, you know, clearly, the Household model could play there. I wondered if you could comment on that as well?

A further strategy point – I had a question on margins too. Shall I give you that now, or come back to that?

If you can give us that now.

Yes, it’s really a question just on the evolution of the Hong Kong margin in particular, where, clearly, it’s come off substantially in the first half. We all know that there was excess liquidity in the [high-ball] issues which had been prevailing there. Clearly as we move into an upward moving US rate environment, I just wondered if you can comment on how you see that evolving over time, whether you expect to have reached a plateau, and you expect some improvement going forward? Thank you.

Thanks, John. On strategy, I’ve no specific comment to make on any local issues in the UK, other than to say, I think, that we’re very pleased with the agreement that we have reached with Marks & Spencer to extend our presence in the UK through buying their Financial Services business, and working with them on a co-branded offering to what is a very exciting customer base.

So we certainly see the UK as a general matter as being a market which we are keen to develop, but I’ve no specific comment to make on any particular issues that are attracting some comment at the moment.

So far as Japan is concerned, Japan is the world’s second largest economy. It spent the 90s in the doldrums. It’s beginning to recover. Growth is quite strong, and there obviously questions in the public domain about how much real restructuring has taken place.

It’s been a market which has historically been very difficult for foreign banks to find anything sensible to do that at all makes sense from the point of view of their shareholders.

I’m not sure that that’s fundamentally changed, but we have an existing business there. It’s a Commercial Banking business. We have some Private Banking activity, and we have some Corporate and Investment Banking activity, and we feel that there are quite a lot of things that we can do organically in the Japanese market, as it recovers.

One of the obvious opportunities for us is the interest that so many Japanese companies have in the Chinese market. We can be on both ends of that, so there’s plenty of work for us to be doing in what is, as I say, the world’s second largest, and a very wealthy market, and strategically, it’s bound to be on our radar screen.

You asked about margins in Hong Kong. You’re quite right, they’ve fallen off, both in the Hong Kong Shanghai Bank, and in Hang Seng Bank, and there are really two factors at work in that. There’s continued pressure on the asset side, on net interest margin in mortgages, and there is of course the high levels of liquidity, and low levels of interest rate, reducing the value of deposits towards that zero.

I guess it’s difficult to see that deteriorating further, certainly on the deposit side. I’d be more chary of making predictions as to what happens on the asset side, but on the deposit side, it’s difficult to see that getting any worse, and as US rates have started a drift upwards, and I think drift is the right word, rather than any form of short spike, you would have thought that that would help improve matters on the terms of value of deposits in Hong Kong dollars.

It’s Simon Simonson (ph). I’m sitting next to Tom Rayner, and he’s trying to steal the microphone from me! I’ve got two questions actually. The first is the risk adjusted margin analysis on Household. Douglas, this is a topic we’ve discussed previously.

It feels like it’s down about – well, I’m trying to work out the chart ahead of the lunchtime release. It’s down about 100 basis points or so, from its kind of peak, sort of 7.5% to 6.5% region. It seems to be what the risk adjusted margin’s doing in Household, and I guess that’s after the benefit of funding synergies as well, so it would suggest that excluding those, it would have come down further.

I hear what you say, Douglas, about you’ve got [lagged] effective charges of previously written business in the current mix, which is towards thinner margins [still]. The question is, where do you see that settling?

I think that, as we said last time, it’s what our colleagues in Asia call the pig and the python, that you’ve got the charge-off impact of a different business mix flowing through the risk adjusted margin, and not being compensated for additional higher margin business throughout the Consumer Finance branches, getting taken on at the moment. Therefore, there’s a reduction in the risk adjusted margin.

I think it will begin to creep back up again. There is evidence that in the cards business and the Consumer Finance businesses, towards the end of the second quarter, that some of the higher margin products are available again, as consumers, with greater confidence, are using debt service capability to take on more credit, rather than pay down credit, and you know, one swallow doesn’t make a summer, but I think the mix will improve in margin terms, probably in the second half of the year.

But I think that the historical band of risk adjusted margin is likely to be a little bit lower than it was historically, because of increased competition in the sector, and a different product mix.

Okay, the second question was, just really as a reminder, I know in the past you’ve spoken about what you think of as a normal level of bad debt for the Group, excluding Household. From memory, I think you were talking about 60 to 70 bits, but I honestly can’t remember what the number that you’ve floated previously was, so I was wondering if you could just update us on that?

I think it was lower than that. I think it was 45-55, as the last thing we said. I don’t think we would move terribly far away from that kind of range at the moment. All one can say is that clearly, the first half of this year, the number is abnormally low, and clearly not sustainable.

It’s difficult to see 9 basis points going any lower, that’s for sure.

But it’s, you know, with a low interest rate environment, and strong employment, the small business sector has done very well, and the corporate sector has been restructured, so I would still say 45-55, 40-60 range.

It’s Robert Law of Lehman. I’ve two unrelated questions. Firstly, could I follow on the bad debt trend, please? Looking at Page 119 of your Interim Statement, which gives the stock of bad debt provisioning and obviously, because of the level of releases during the first half, that’s fallen substantially. It’s down about $1.2b, while your loan book has gone up by about 10% in the first half of the year.

Now, the reason I’m exploring is, we all make our assumptions about long-term, normalized provisioning charges, but in terms of our short-term models, I wonder if you could help us by indicating whether you think there is still scope to reduce the stock of provisions further, or whether you’ve really utilized the benefit of improved conditions at the moment? That’s the first question.

The second question was on UK strategy, ignoring your little quote, little local difficulty at the moment. Could you comment on the strategy of the organic business in the UK? Obviously you’re taking costs down at the moment. Is that the focus? There’s been some speculation that you may be more competitive, in terms of pricing and market share, of the other side of that, and I’d like some comment on the UK strategy. Thank you.

Well, if I may talk about the UK strategy first, and then we’ll come back to the bad debt point. We are undergoing an important restructuring program at the moment. It’s the first time for ten years that we have reorganized the bank as extensively as we’re in the process of doing. It’s led by Mike Geoghegan, who’s in the front row here, as CEO of the UK Bank.

This is about making sure that we devote our resources to serving the customer. We are reducing the number of administrative positions by 3,000. We are increasing the number of front-office positions by 1,000. Why is this happening?

It’s happening for essentially two important reasons. One is that this is a furiously competitive market, and as indeed in all banking markets, competitive, and it’s our job to make sure that our business is managed as efficiently and competitively as possible, but we are not serving our customers and our shareholders, or indeed our colleagues, well over the long-term if we don’t do that.

Secondly, of course, we have to take account of the fact that technology is changing. If you take First Direct by way of an example, well over half of its business, actually nearly 70% of its business now, is done over the internet. This is a harbinger of the way the market is evolving. Internet and telephone business is rising, quarter by quarter, and we have to acknowledge the effect of that on the way we do business with customers.

There’s a lot that we can do. We have a platform which is under-geared in some senses. It’s under-geared in terms of non-funds income. It’s under-geared in terms of mortgages. Our share of the basic banking market current accounts and savings accounts is 11% or 12%. Our share of the mortgage market is still around 4%, or slightly less than that, actually.

So there’s plenty that we can do to increase the amount of products that we bring to the customer, and I’m optimistic, and I know that Mike Geoghegan, you would share this feeling. I’m going to get Mike to say a word in a second, but there’s a lot we can do with our network.

This is not about contraction, it is not about going into entrenchment mode. This is about making sure that our resources are lined up the way that we need to be to efficiently service the customer.

I’m very conscious, of course, that this creates upheaval in the lives of individuals, but actually, we have reason to believe that the amount of compulsory redundancy will be a pretty minor share proportion of the total positions made redundant, and we will do all that is appropriate for us to do, or you’d expect us to do, to responsibly make sure that those who are affected are taken care of appropriately.

Mike, do you want to add anything to that?

Thanks, Stephen. I think it’s clear that really what we’re after is that we build the platform, [by business model of platform] by service. We are by far the best service bank in the country, and now we’re just taking that up, up the hill to selling to our customers, understanding our customers’ needs and giving them value. I think there was a question asked about value.

Obviously our brand, being the number one brand in the country, we’re going to use that to attract customers to come through. As Stephen also has said, a lot more of our customers, and quite rightly so, are using alternative [delivery] channels. We want to be able to provide a service to them, at any time, day or night, in any place. We do that through our branch network, our direct channels, and obviously now, through M&S as well, so it’s a continuation of giving our customers what they need.

Through our MI, we believe we probably know more about our customers today than we certainly did a year ago, and we’re using that information to assist our relationship managers to understand our customers and sell to our customers’ needs. Thank you.

Robert, just turning to the credit quality. I mean, put the retail business, including Household, to one side, which is really all our methodology. I think that from an accounting perspective, and probably, correctly, from a risk perspective too, provisioning is going to be more sensitive to underlying economic circumstances than certainly it was historically, as the accounting model, certainly with International Accounting Standards leaves less room for judgmental areas of general provisioning.

I think the slide that’s interesting is Slide 22, in a sense that new specific provisions, excluding Household, have fallen from 75 basis points to 60, by 59 basis points, so a 20% improvement in the incidence of new provisions. If you look at the first half of 2003 and the first half of 2004, you’ve got somewhere between, let’s say, net of recoveries and releases, 20 to 45 basis points of provisioning.

I guess your general provision would be covering somewhere in that range, times whether you’ve got six or twelve month coverage. So, today, our general provisions are around 45 basis points of lending. I think that if the economic activities improve globally, there may be some modest scope – modest scope – to adjust them, but I think we’ve probably got fairly close to our base level. But I think that figure will be more sensitive to economics than perhaps historically.

Thank you, it’s Ray Siver (ph). Turning to CIBM, your comment that 90% of the senior hires have been made, what implication does that have for the level of investment spend going forward, and also, more broadly, when the build-out has largely been accomplished, where do you see CIBM positioned competitively versus the other major factors in the sector?

Thank you, Ray. The 90% of the senior hires done – not, of course 90% of all of the hires done, but a huge program. As we mentioned, 700 people have joined, and about the same number have left, so we’ve been very busy just on the hiring front, never mind on the business getting front, which is also going apace.

We said last year that we would be prepared to invest up to $400m worth of incremental costs base. We’ve expected to come in within that number. We will make sure that we come in within that number. I wouldn’t want to put a number on exactly where we are in relation to that at the moment, but we will definitely hold. That’s the commitment we have made.

We think it’s going well. We’ve got a good flow of business. Where do we expect to be? We’ve got some pretty specific goals of where we think we need to be in terms of league tables, and I should say that league tables, in my view, and I know that in the view of John and Stuart, who are in the front row here, they would echo this, they are a means to an end, and not an end in themselves.

You need league table position to the extent that you need credibility with clients, but it is not our goal in life to become number one in everything, everywhere for the hell of it. But we do want to see ourselves at certain specific levels in league tables. We’ve said we want to be one of the top three banks in foreign exchange, one of the top five banks in derivatives, top five in all international bonds, top three in euro and GDP bond issues.

In M&A terms, we’ve said that we want to be in the top five as far as Asia is concerned, a top seven position in Europe, and within the top ten as far as the US is concerned. So I hope that you would take from that we are serious about this. We want to be one of the largest businesses in this highly competitive world, and we say that because we believe that we have the fundamental competitive strength to do it, and to do it well, and because our clients are telling us that they want to see us do it.

We have the relationships with over 1,000 of the world’s highest quality corporates and institutions. We start with the client base. We start with lending relationships with many of them. We start with payments and cash management relationships with many of them. We think that there’s plenty to build on.

In other words, we’re not doing this on a clean canvas. We start with obvious competitive strength in this business, and we’re pleased with the way it’s going.

Good morning, it’s Ian Smiley from UBS. Your underlying non-interest income, I think, was up 15% versus the balance sheet of 11%. Could you tell us if further improvement in that ratio is something that you will target over the next, say, three years?

Could you really give us a bit more disclosure on how you view the balance between what proportion of the non-interest income is recurring, versus what proportion would be more flow-dependent?

Yes, I expect we do expect to see non-written income increase as a proportion of our total income. You’ve seen it dramatically so in Hong Kong, but you would have seen it even if the trends had not been in place, that were in place on net interest income.

You’ve seen it in the UK as well. We would expect, as we broaden out our service range, as we build in those franchises where we’ve got basic banking relationships with a large consumer franchise, we expect to build that out in the direction of the kinds of products that inevitably bring non-funds income into the accounts.

Do we have a specific metric for that? No. We have a strategy of growth for those businesses, and you can see it, both from the Hong Kong Personal Financial Services performance, and from the UK Personal Financial Services performance – which I think is dramatic, by the way – there we showed costs up 3%.

Actually, that included, essentially, the property provisions and the redundancy provisions related to the restructuring we’ve talked about, and basically, those costs were flat. It shows what substantial gearing there is in the Personal Financial Services business, and it is non-funds income that we should expect to be the principal beneficiary.

Thank you, it’s Mark Thomas of Keith Flett. Just following up on non-funds income, obviously fees and commissions were very strong. Just to look to the trend going forward, could you give an indication as to how much the increase is, because you’re better capturing fees you should have caught? How much of that is actually due to re-pricing, and how much is actually due to new business?

I specifically note, for example, that sort of funds under management and unit trusts are up enormously.

A specific breakdown under those three headings, I’m not – as you gather – I’m not sure that you can. I mean, in some sense, it’s kind of all of the above. Getting ourselves into gear, the marketing investment, cross-sell ratios, I mean, it’s a Curate’s Egg actually. As we look around the world, we think we have come on in terms of cross-sell ratios, but we recognize that we’ve got quite a long way to go, and some businesses are stronger than others in that.

When you look at our premier customer base, that’s a very important sub-segment of Personal Financial Services, we have over 3% of our Personal Financial Services customer base now classified as premier. We’d like to see that rise up to about 5%, and the cross-sell ratios there are markedly higher.

So that as we are successful in rolling out the premier offering, this should lead to improved cross-sell ratios, as well as leading to further work on cross-sell ratios within the other 95%. I’d find it – Douglas, unless you have something?

No, I think it’s quite difficult, Stephen, to say, that are you just counting fees you should have got. I think one of the things – and clearly, unit trusts and investment products are dominated by the significant growth again in Hong Kong, where those businesses are competing against a savings rate which is very difficult not to beat in a sense, because there’s no real value for deposits in the savings accounts, and therefore, structure for such investment products are very, and increasingly attractive.

I think that the power of that [low] is that over the last five years, what has happened in Hong Kong is that the bank channel for the distribution of investment funds has been clearly established as the channel, as opposed to it not really existing five years ago, and I think that the branding strength that we’re beginning to see with HSBC on top of the customer bases that we’ve got, the premier segment globally, the CCF customer base, we’ve got some very high net worth customer bases that have not been investing very much over the last few years because of the markets. To the extent that those market conditions become better, I think there’s a lot of leverage to come off of the existing distribution structure.

I think the other thing that’s happening is that credit fees are rising, not just because of growth in credit, but I think we’re all focusing more on describing a fee as a fee, as opposed to building it into the margin, and I think you’ll see a trend in lending to consumers, splitting out what is a fee element of the relationship, to what is a spread element of the relationship to the benefit of transparency, and I think to the benefit of stability in those revenues.

The insurance is actually another example. Insurance in Hong Kong, we have, from a very small position, become the leading supplier of insurance services to the Personal Financial Services market in Hong Kong.

Thank you, and good morning. It’s Michael Lever (ph) at CSFB. I’ve got a couple of questions, if I may. The first is, I wonder if you could give us some update on your current thoughts on the impact of International Financial Reporting Standards on the Group?

The second question concerns the pattern of costs. Historically, HSBC has tended to see accelerating costs growth in the second half of the year. I was just wondering whether we should continue to expect to see that.

The final question, really, is on Household. I apologize in advance for this but I seem to recall that Household made something in the region of about $850m post-tax, UK GAAP for the first quarter. I may be a little bit out there, but it seems to me that the profit contribution is probably fairly flat, Q2 and Q1, and I just wonder if you could confirm that for me please?

Can I take the middle question first on costs. IFRS is definitely one for Douglas! Costs, you’re right, have in the last two or three years been higher in the second half than in the first. There are some structural reasons why there’s a tendency that way. Obviously, pay rises where they are kind of systemic, kick in during April, which means that there’s a full impact in the second half, and not a full impact in the first half.

In the specifics of last year, we were heavily investing in the marketing side of the Personal Financial Services in Asia, both Hong Kong itself, and the rest of Asia, in the second half to catch the bounce, post SARS, and so there were some specific things going on, and there were also one or two other specific things, voluntary separation schemes in two or three different countries in the world.

So there were various one-offs around in last year’s second half, which on the face of it, there’s no reason to see why they should be repeated this second half. So I don’t want to say what the pattern will be, but I don’t think there’s any good reason to believe that there are certain specific things that were driving the costs level last year will be around this year, to the extent, of course, that income grows faster than you might expect, then costs are going to grow up, because some of the costs are bonus and compensation related to profit performance.

Okay, just on that point, can we assume that you are expecting income to grow faster than the costs, at least at the Group level, and this is your strategic objective on costs?

Well, that’s certainly our strategic objective.

In the second half of the year?

We’ve made a forecast about the second half of the year, but clearly, our strategy is to grow the business, and you can’t do that with a declining cost income. Well, you shouldn’t be doing that with a decline in cost/income ratio. Our strategy is to make the business as efficient as possible, and that carries an implication of the strategic objective, to make the cost/income ratio trend downwards.

IFRS – this is the quick version, no more than an hour. I don’t think there’s a significant impact from it. Obviously, there will be some big number changes, i.e. you don’t amortize goodwill, and all sorts of things. In terms of whether IFRS will expose any different profitabilities or risks that are not well exposed in what we report at the moment, no.

There may be some differences in accounting, which I don’t actually think will be significant in terms of the timing of recognition of certain revenues and costs, but on a cash basis, there will be no difference at all, and therefore, I don’t see it as a big issue.

What we will do, and it’s set out in this, again, just updating, is we will set out in the second half of this year, sort of the in principle differences, and then towards the end of the first quarter of next year, we will actually give you re-stated figures so that you can build your historical pattern of IFRS numbers and then obviously give you 2005 numbers in IFRS real. I don’t think it’s a big issue.

Household Q1 on Q2, it’s picking up.

Yes, I mean, if you look at the business drivers, the business drivers were picking up towards the end of the second quarter, and particularly in cards and in Consumer Finance. You’re absolutely right that first quarter in UK GAAP was higher than the second quarter. There are two reasons for that, principally.

One, in the first quarter, provisions were lower than charge-offs and that reversed in the second quarter, so there was, if you like, a draw-down of provision in the first quarter which was not the case, in fact. Provisions were about $30m higher than charge-offs in the second quarter.

The other thing is that there is a seasonal business in Q1, which is the refund anticipation lending business, so there are a big chunk of revenues in Q1 that are one-off seasonal business. The second quarter would tend to be a weak quarter for Household, and again, relatively, and again this year, what we saw was on the back of further tax rebates, people paying down credit. So there’s a seasonal impact, and there was an accounting impact in relation to the reserves. These are the big impacts.

But underlying, obviously –

Underlying, it’s getting stronger.

Thank you very much.

It’s the same for Commercial Banking, by the way.

It’s John-Paul Crutcher again from Merrills. I wonder if I could ask another question? Just on capital, actually, I mean, during the half you paid out, or proposed to pay out, $2.8b by way of dividends, of which $1.6b came straight back to you in terms of the [script]. The Tier 1’s up to 9.3% against the backdrop of an improving risk profile in the Group. It’s almost starting to look like a surfeit in riches, that you’re starting to have.

I just wonder if a) you’re going to have to start thinking about other ways of returning money to shareholders at some point, or reviewing the script alternative, given the direction the Tier 1 ratio’s starting to move in, and I just wonder if you can comment on capital during that context, please?

John-Paul, we always review the position, of course. But we don’t feel that we’ve got excess capital. We’d like to be strongly capitalized. We think that’s the right way to be, but we think we’ve got plenty of growth opportunities and believe that the capital position is the right level to support that for business growth.

It’s Richard Stake from SG again. Can I just clarify what you think the impact of – well, the realistic impact of rising interest rates would be on the Group, because you’ve obviously got the table on Page 108, which gives a simplified scenario which never seemed very helpful in the past, and that is negative for Hong Kong if interest rates go up.

So, you know, under a more realistic situation, what do you think is going to happen? Will the benefit in Hong Kong offset the [horrible] negative in the US?

I think – I mean, we’ve worked hard on the wording of that, and we tried to explain that the calculation is essentially an artificial one. If you assume 100 basis points across the curve, in all currencies, or in the currencies that are important to us, this is what happens.

The fact is, of course, that life isn’t like that, and not all assets and liabilities re-price contractually in the commercial book, and of course, global markets don’t sit on their hands as interest rates move. I think it’s hard to envisage the net effect of rising interest rates being – of gently rising interest rates – being bad for us. I mean, a short spike, you know, a sharp spike in short-term rates would be less amusing.

I mean, we took on board the fact that this table is very static and unhelpful, and we’ve put some description not only as to what drives the table, but what has accounted for the principal movements between December and June, to see the actions that are taken, and I think the thing to kind of go away with is that there’s a natural offset in the businesses between the deposit-taking businesses that benefit from rising rates and the Household business, that as margins fall, although they would see a benefit in the bad debt line, but those two, if you like, structural positions, kind of offset each other.

You then have the rest of the interest rate risk of the Group, largely handed, exclusively handled, in the markets business which has got enormous flexibility to manage that, and it’s certainly a great deal easier to manage that in a rising rate environment within the markets business, because in a falling interest environment, you’ve got the structural problem of the deposit base.

So essentially, the risk is being actively managed within that markets business, so I think that gives us confidence that we can be flexible, whereas this is a very static, old currency derived, parallel shift of the yield curve 100 basis points, and we do nothing about it. It’s the best way of articulating it, but we’re all agreed that a predictably rising rate environment is probably good for us.

Any more questions? If there are no other questions from the floor, I’ve got one question from the email, from David Ray of CSFB. Why have we highlighted systemic risk now, and do we have something specific in mind?

I think the answer is, we don’t have anything specific in mind. It’s kind of adding to the concern we expressed at year end. We talked then about global imbalances. We talked then about an expectation of slower economic growth next year. The oil price, and all that lies behind that, of course, is one of the factors creating some uncertainty in world markets, and the leverage in the financial system add up to a cocktail of things.

But it is far from apocalyptic. That’s not what we meant at all, but it just means that you can’t afford to be complacent. It means that a company such as ourselves, with a strong capital base, and widely diversified activities, both in terms of customer groups, and products, and geographies, feels like a good place to be.

Are there any other questions from anybody? Well, thank you very much for coming here this morning. Thank you for the attention that you pay to the business. Thank you.