Hang Seng Is Scaling The Wall -- Gingerly

The bank's foray into China is structured for minimal risk

Vincent H. Cheng spends a lot of time on the road these days. The road to China, that is. The CEO of Hang Seng Bank of Hong Kong Ltd. (HSMGY ) spent more than 80 days on the mainland last year, with impressive results: He acquired a 16% stake in one of China's leading commercial banks, Industrial Bank in Fuzhou, signed an agreement with Industrial Bank to launch a credit-card joint venture, and received approval from regulators in Beijing to deal in Chinese equities, or A-shares, which trade on the Shenzhen and Shanghai exchanges.

Sounds as if Cheng has caught China fever -- an affliction that can prove catastrophic, given China's murky rules, casino stock markets, and sick financial institutions. Hang Seng has invested $385 million in China, including $205 million it paid in April for its stake in Industrial Bank. Look a little closer, though, and Hang Seng is playing it about as safe as you can in China -- while still staking out a substantial position. The conservative, 71-year-old bank is backed by HSBC Group (HBC ), which owns a majority stake. It has never had more than one branch outside Hong Kong -- in nearby Macau. "We are cautious," says Cheng. "This has always been the hallmark of our bank."

Hang Seng is determined to establish itself in mainland China before Beijing opens up banking in December, 2006. Establish itself -- not make a fool of itself. It's staying close to home -- in China's southern region and southeast coast, with branches in five industrial cities where it serves trusted Hong Kong-based corporate clients. And it's further minimizing risk by forming a partnership with well-regarded Industrial Bank.

It could take years before this patient strategy pays off. Beijing has made token gestures at liberalization, such as allowing foreign banks to open new branches. But officials say they won't open the banking sector until China mops up the tide of bad debt swamping the four largest state-owned banks, which are awash in bad debt. That could take a decade. "I would be concerned if Hang Seng was looking for a big return in the near term," says Alistair Scarff, an analyst at Merrill Lynch & Co. (MER ) in Hong Kong.


Yet the consensus is that Hang Seng is making progress. Although it's small and concentrated in the south, its branches are in export-oriented industrial centers that attract about 60% of the more than $50 billion in foreign direct investment that flows into China yearly. The branches reported a 62% increase in loans, to $800 million, in the first half of this year, mostly to Hong Kong manufacturers. "We're a regional bank," says Cheng. "We don't have aspirations of covering the whole of China."

Hang Seng's investment in Industrial Bank will give it a head start in consumer banking on the mainland. The deal includes agreements to set up joint ventures in the credit-card and personal loan businesses when consumer finance is just taking shape in China. Analysts say that Industrial Bank is one of China's best and that Hang Seng paid a fair price for its stake. With 240 branches nationwide, Industrial Bank reported an aftertax profit of $172 million last year -- and a comfortable nonperforming-loan ratio of less than 3% on $18.8 billion in loans. Even though Hang Seng is a minority shareholder, Cheng says he was allowed to inspect Industrial Bank's books and install his CFO on the bank's board.

Analysts agree Hang Seng is placing the right bets. "The strategy makes sense," says Andrew Salton, a fund manager at Standard Life Investments Ltd. in Hong Kong. It's smart, he says, "to prepare for entry into consumer banking when the Chinese government relaxes restrictions." And when that day comes, Cheng could find his bank even better positioned than it is today.

By Simon Cartledge in Hong Kong

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