Seng Heng Bank: History and Acquisition by Industrial and Commercial Bank of China 9811603979, 9789811603976

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Seng Heng Bank History and Acquisition by Industrial and Commercial Bank of China Patrick W.M. Huen Jean Jinghan Chen Ming-Hua Liu

Seng Heng Bank

Patrick W. M. Huen • Jean Jinghan Chen Ming-Hua Liu

Seng Heng Bank History and Acquisition by Industrial and Commercial Bank of China

Patrick W. M. Huen Industrial and Commercial Bank of China (Macau) Limited Macao, China

Jean Jinghan Chen University of Macau Macao, China

Ming-Hua Liu University of Macau Macao, China

ISBN 978-981-16-0397-6    ISBN 978-981-16-0398-3 (eBook) https://doi.org/10.1007/978-981-16-0398-3 © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Singapore Pte Ltd. 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the ­publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and ­institutional affiliations. Cover pattern © Harvey Loake This Palgrave Macmillan imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-­01/04 Gateway East, Singapore 189721, Singapore

Foreword

It is my great pleasure to read the most interesting book, Seng Heng Bank: History and Acquisition by ICBC, written by Patrick W. M. HUEN, Jean Jinghan CHEN and Minghua LIU. The book presents the history of Seng Heng Bank, a commercial bank in Macau, from its establishment in 1972, through its subsequent development and growth, to its eventual evolution into today’s ICBC (Macau). In between, from 1989 to 2007, it was owned by the legendary Dr. Stanley HO, who put Macau on the world’s gaming map, through his holding company Sociedade de Turismo e Diversões de Macau (STDM), and managed by Patrick HUEN, one of his most trusted lieutenants, first as Executive Director and then as CEO. Under Patrick’s stewardship, Seng Heng Bank made great strides. Between 1989 and 2007, when Patrick was fully in charge of the Bank, its assets grew from MOP758 million (approximately US$94 million) to MOP29,365 million (approximately US$3700 million), at an average annual compound rate of growth of more than 22.5 percent, based on purely organic growth. It was a most impressive performance! For STDM (and Dr. HO), this also turned out to be an excellent investment, with an average annual compound rate of return of more than 21 percent over this period. However, the success of Patrick and the Bank was not accidental. Dr. HO had the great judgment of entrusting the management of the Bank to Patrick. With the total trust of Dr. HO, Patrick had a completely free hand to run Seng Hang Bank. He earned this trust not only because of his seasoned professional expertise but also because of his unquestionable personal integrity. Patrick is also a person who believes in science and the v

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value of applying knowledge and technology to the Bank’s operations. As the history of Seng Heng Bank showed, both Dr. HO and Patrick earned their just returns. Today, Patrick continues to be a substantial and the only outside shareholder of ICBC (Macau), affirming his continuing confidence in his Bank and in the future of China and Macau. I congratulate Patrick, Jean and Minghua on the publication of this most interesting book. It is essential reading for anyone interested in banking, in the history of Macau and in the legendary Dr. Stanley HO. Lawrence J. Lau Ralph and Claire Landau Professor of Economics, The Chinese Univerity of Hong Kong

Foreword

Macroeconomic theory as well as applied macroeconomics tend to favor the explanation of reality through the interaction of general categories and the monitoring of their evolution over time and in different economic spaces through aggregated statistical indicators. They provide us with a grid to read and understand the reality, based on the identification of the working of the interdependence of the different conceptual entities over time and on the comparison of their pace in different countries or regions. However, this framework has revealed to be insufficient to capture the specificities and the differences over time and among different economic spaces. First, the understanding of the different economic dynamics of different social and economic realities ended up imposing the respective institutional framework and the values ​​and behavior patterns that frame and command the decisions of social and economic agents. Second, the aggregate statistics conceal the heterogeneity, the diversity, and the dispersion of the trajectories of economic agents and their relation to different endowments, different preferences and strategies. As a result, the explanation of the economic and social dynamics started to go beyond the analysis of the macroeconomic statistical aggregates to the granular information to understand the underlying diversity and the interdependence between the pace of each individual entity and its social and institutional framework and the economic policy incentives or obstacles faced with. This was a remarkable improvement in the analytical field, as it reinforced the accuracy of theoretical explanations as well as the capacity to verify the adequacy of those explanations. A qualitative leap vii

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that was largely due, on the one hand, to the quality and comprehensiveness of the collection of statistical information and, on the other hand, to the exponential increase in the capacity for automatic processing of information, not only quantitative but also qualitative. However, this is not enough. It remains to be understood how the social agent and the economic agent creates, innovates or destroys but also influences the institutional framework that determines his behavior and strategies. The aggregate hides individual histories, successes, and failures. These stories are not a mechanical predestination of the socio-institutional framework. Even in cases where the environment tends to greatly limit or to support the individual capacity for action and reaction, the outcome is always dependent of the individual perception of the environment, the willingness, and the knowledge to act and the strategy chosen. Thus, economic policy needs to understand these individual factors in order to define and to align incentives consistent with the pursued objectives as well as to mitigate or remove the factors that condition the economic agents’ response to those same incentives. Economic analysis and policy need to understand as widely and deeply as possible the behaviors and motivations of the economic and social agents that they intend to influence. So, understanding individual success and failure stories is essential to give economic theory the ability to deal with the uncertainty inherent to the fact that economic agents have sentiments, motivations, expectations, and social strategies that are dependent on their perceptions about the economic and political environment. And that perceptions are volatile. The knowledge or the understanding of each agent and each organization’s story and how frequent they are in the community are decisive factors of the explanatory power of an economic theory; and, therefore, are decisive factors of the accuracy and success of economic policy. The understanding of the working of the financial systems and their evolution is one of the fields that most needs an integrated analysis of aggregated data with the regulatory and institutional framework and the strategies and behaviors of each of the financial entities, as it is there that the interdependence is extreme. The evolution of the environment determines the evolution of the financial system, which in turn determines the evolution of each institution; and, in the opposite sense, the evolution of each one of the entities that make up the system may jeopardize the stability of the whole, jeopardizing the public’s confidence in the institutions and, therefore, the stability of the financial system.

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The nature, the role and the response of the financial system depends on a common intangible asset: TRUST. Trust is an intangible asset that determines the intermediation intensity and costs and, as a result, the dynamics, and operating costs of the economy. It is trust that allows banks to collect deposits and to grant credit. It is trust that determines the amount and the nature of resources available for investment. It is trust that ensures a national as well as a cross border efficient payments system. Lacking trust, trade will suffer, especially international trade. Trust is critical for the working of the economy and the interpersonal transactions. Trust is a public intangible asset that needs to be institutionally embedded to be preserved and improved. It is a public good that needs to be delivered across the institutional framework. The financial sector is part of this institutional framework that ensures social and economic trust in the areas of deposit collection, credit, maturity transformation, and payments. But their ability to ensure that is not a standalone task. Trust is inherent on the existence of a financial system and, therefore is a shared asset. Each financial institution benefits from this common intangible asset, but this does not prevent one of them from seeking to take advantage of that asset to maximize its profits. There is a need for a specific and broader institutional framework, comprising a regulatory framework, a supervisory authority, and a rescue authority to preserve trust when it will be at risk. The fact that the financial system shares and benefits from this common intangible asset implies that it is even more important to know individual stories in order to understand how they dealt with this risk in practice: how they improved the trust of the regulatory and supervisory authorities when they were at risk; how did the public authorities acted in the different phases of their lives; how the supervisory authorities acted to preserve trust at the individual level and at the level of the banking system. Each case is different but it is the collection of all stories that will give us the ability to have a broader understanding of all factors that are at play in the financial sector, that can put at risk the robustness of each institution and the stability of the whole system. I very much welcome all the academic work to go deeper in the understating of the interplay between individual institutions, banks, and the financial system and the economy as a whole. I also believe the fact that Seng Heng Bank did a remarkable turnaround under the supervision of Autoridade Monetaria de Macau, which had paid a lot of attention to matters concerning the impact of governance in the financial soundness and

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public trust, deserves a special mention. As a result, Seng Heng Bank became a trusted partner of Portuguese banks and a meaningful platform for the improvement of economic and financial ties between Portugal, Macao and China Carlos Costa Former central bank governor (Banco de Portugal), Former voting member of the European Supervisory Risk Board (ESRB), Member of the International Advisory Board of the Osservatorio Permanente Giovani Editori

Acknowledgements

The authors would like to thank Mr. F.L.  Loi for providing excellent research support. We would also like to thank Mr. Stephen Frost, Mr. H. H. Law, Mr. Alex Li, Mr. K. T. Poon, Mr. Michael Ching, and Ms. Cecilia Wong for providing us with detailed information on SHB and useful comments and suggestions on the book. Professor Jean Chen is grateful for the financial support of University of Macau: SRG2019-00146-FBA and CPG2020-00018-FBA. September 2020

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Contents

1 Introduction  1 2 Macao’s Economy and Banking Industry  9 3 Seng Heng Bank (1972–2007) 23 4 ICBC 57 5 Acquisition of Seng Heng Bank by ICBC 71 6 Conclusions 91 References99 Index

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Dr. Jorge Sampaio, former President of Portugal and Dr. Edmund Ho, former Chief Executive of the Macao SAR, witnessing the signing of MOU between Seng Heng Bank and Caixa Geral de Depósitos in 2005

Mr Hu Jintao, former President of China, witnessing the signing of MOU between Industrial and Commercial Bank of China and Banco Comercial Português in 2010

List of Figures

Fig. 2.1 Fig. 3.1 Fig. 3.2 Fig. 3.3 Fig. 3.4 Fig. 3.5 Fig. 3.6 Fig. 3.7 Fig. 3.8 Fig. 3.9 Fig. 3.10 Fig. 3.11 Fig. 3.12

Gold price, 1968–2019. (Source: Refinitiv Eikon) 16 SHB’s sustainable competitive advantage. (Source: Seng Heng Bank 2001) 34 SHB net interest income and as % of operating income (1993–2007). (Source: Seng Heng Bank Annual Reports) 40 SHB: loans, deposits and LDRs (1989–2007). (Source: Seng Heng Bank Annual Reports) 41 SHB loans as % of assets and Asset yields (1989–2007). (Source: Seng Heng Bank Annual Reports) 42 SHB funding costs and net interest spread (1993–2007). (Source: Seng Heng Bank Annual Reports) 42 SHB other income and as % of operating incomes (1993–2007). (Source: Seng Heng Bank Annual Reports) 43 SHB operating expenses and cost-income ratios (1993–2007). (Source: Seng Heng Bank Annual Reports) 44 SHB provision charges and write-backs (1993–2007). (Source: Seng Heng Bank Annual Reports and AMCM) 45 SHB provision charges and write-backs (1993–2007). (Source: Seng Heng Bank Annual Report) 45 SHB’s ROAA, asset-equity leverage and ROAE (1989–2007). (Source: Seng Heng Bank Annual Reports) 46 SHB vs sector ROAA, asset-equity leverage and ROAE (2000–2007). (Source: Seng Heng Bank Annual Reports and AMCM)48 ROAA and ROAE of SHB (1989–2007). (Source: Seng Heng Bank annual reports) 51

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LIST OF FIGURES

Fig. 3.13 Fig. 4.1 Fig. 4.2 Fig. 4.3 Fig. 5.1 Fig. 5.2 Fig. 5.3

Total assets and equity of SHB (1989–2007). (Source: Seng Heng Bank annual reports) 52 Holding-period returns of ICBC, CCB, BoC and Shanghai Composite Index (A-Share, 2006–2020). (Source: Datastream) 59 Holding-period returns of ICBC, CCB, BoC and Hang Seng China Enterprise Index (H-Share, 2006–2020). (Source: Datastream)60 ICBC corporate governance structure prior to IPO. (Source: ICBC Annual Report in 2005) 69 ICBC (Macau) loans, deposits and LDRs (2007–2018). (Source: Seng Heng Bank and ICBC (Macau) annual reports) 85 ICBC (Macau) net interest margin and ROAE (2007–2018). (Source: Seng Heng Bank and ICBC (Macau) annual reports) 87 ICBC (Macau) asset-equity gearing and ROAE (2007–2018). (Source: Seng Heng Bank and ICBC (Macau) annual reports) 88

List of Tables

Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 2.5 Table 2.6 Table 3.1 Table 3.2 Table 3.3 Table 3.4 Table 3.5 Table 3.6 Table 3.7 Table 3.8 Table 3.9 Table 3.10 Table 3.11 Table 3.12 Table 3.13 Table 3.14 Table 4.1

Macao’s real GDP, real GDP growth rate, and real GDP per capita10 Gross gaming revenue and tourist arrivals 12 Number of banks and employees in Macao 14 Banks operating in Macao 2019 15 Basic statistics of the banking industry in Macao 18 Profitability, leverage and bad debts of Macao banks 19 Key balance sheet items 1989–1996 (MOP million) 29 Profits of SHB, 1989–96 (MOP million) 30 ROAE and loans as a % of total assets 1989–1996 30 Return-on-average-equity and assets/equity multiplier 1989–199631 Key balance sheet items 1996–2000 (MOP million) 32 Profits (MOP million) and return metrics (1996–2000) 32 Profitability and leverage (1996–2000) 33 STDM investment in SHB and accounting returns (MOP million)33 SHB key balance sheet items 2000–2007 (MOP million) 36 SHB profits (MOP million) (2000–2007) 37 SHB profitability metrics and leverage (2000–2007) 37 SHB compounded annual growth rates: assets, deposits, and loans40 Statement of financial position, income statement and performance metrics 49 Selected financial data (MOP million) for SHB 1989–2007 53 ICBC total loans and NPLs (RMB 100 million) 58

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LIST OF TABLES

Table 4.2 Table 4.3 Table 4.4 Table 5.1 Table 5.2 Table 5.3 Table 5.4 Table 5.5 Table 5.6 Table 5.7 Table 5.8

ICBC composition of net fee and commission income, 2004–200762 Financial performance of ICBC 66 Top 25 banks in the world by assets 67 Ownership and control of the 8 largest banks in Macao (2007) 75 Market shares and branches of the 8 largest banks in Macao (2007)76 STDM investment in SHB and accounting returns (MOP million)81 Market shares and branches for top 8 banks in Macao (2007–2019)84 Loans and deposits of SHB and ICBC (Macau) 2007–2009 85 ICBC (Macau) balance sheet growth (2007–2018) 86 Selected financial data (MOP million) ICBC (Macau) 2009–201988 Net interest margin, gearing and returns for ICBC (Macau) 2009–201989

CHAPTER 1

Introduction

1.1   History of Macao Macao is located on the Pearl River estuary, and its history dates back over 5000 years. Macao was leased to the Portuguese as a trading post during the Ming Dynasty in the sixteenth century and later became a Portuguese colony. The city played a vital role in the international trade among China, Europe and Japan until the middle of the nineteenth century when the British arrived in Hong Kong. Macao was finally returned to Chinese sovereignty on 20 December 1999, becoming a Special Administrative Region (SAR) of China under the “one country, two systems” arrangement. The terms of this agreement were similar to those agreed to between the UK and China for the handover of Hong Kong in July 1997. Under agreement, Macao will keep its current economic and legal system until 2049. With a population of over 670,000, as at the end of 2019, living in an area of just 33 square kilometres, Macao has one of the highest population densities in the world.

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3_1

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1.2   About Seng Heng Bank and ICBC Seng Heng Bank: A Macao Success Story Established in 1972, Seng Heng Bank (SHB) had long been regarded as one of the best banks in Macao despite being a relatively small local bank. It had won many accolades including the following awards from The Banker, and Global Finance. • The Banker: From 2001 to 2008 it received the “Bank of the Year, Macao” award from The Banker. • Global Finance: From 2004 to 2008, it received the “Best Bank in Macao” award from Global Finance. ICBC: Largest Commercial Bank in the World Established in 1984, Industrial and Commercial Bank of China (ICBC) is the largest commercial bank in the world based in terms of total assets, though its focus has historically been on mainland China, and it has only had a very limited presence internationally until recently. Over the past two decades, that has been changing, and ICBC has gradually been expanding its overseas operations. ICBC Acquiring Seng Heng Bank  enerous Offer to Buy Seng Heng Bank Accepted G In 2007, ICBC made an offer to buy a stake of approximately 80% of SHB at a price equivalent to more than three times SHB’s net asset value (NAV). This offer, which was regarded by many as high by industry norms for bank acquisitions, was accepted by SHB’s board and shareholders. In comparison, in 2005, Dah Sing Bank in Hong Kong paid about 2.6 times NAV when acquiring 100% of Banco Comercial de Macau (BCM) and 96% of BCM’s general and life insurance subsidiaries. In 2006, China Construction Bank paid 1.32 times NAV when it bought Bank of America Hong Kong. In 2014 OCBC Bank of Singapore paid 1.77 times NAV to acquire listed Wing Hang Bank in Hong Kong. After the acquisition was completed in 2009, ICBC’s sole Macao branch was merged into the newly acquired Seng Heng Bank, and the

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bank’s name was changed to ICBC (Macau). It remained a locally incorporated bank. On 11 July 2019, ICBC (Macau) celebrated its 10th anniversary. Post-Acquisition Successes Since the acquisition, ICBC (Macau) has become the largest locally incorporated bank in Macao in terms of total assets. The bank’s total assets in Macao increased from approximately MOP29.4 billion (about US$3.675 billion, 1 USD = 8 MOP) at the end of 2007 to more than MOP351 billion (about US$ 43.875 billion) by the end of 2019). The number of people employed has also increased from approximately 320 before the acquisition to more than 1000 staff by the end of 2019. It has also brought in higher service standards of services to the local banking industry. This has been recognised by Global Finance: with ICBC (Macau) being awarded “Best Bank in Macao” for the past 10 years. The bank’s financial strength has also been acknowledged. In 2015, it was ranked as the 3rd strongest bank in terms of capital adequacy in the Asia-­ Pacific region by Singapore-based Asian Banker Research.

1.3   Why Banking Industry Is of Interest in a Gaming and Tourism Dominated Society of Macao Strength and Resilience Commercial banks take deposits, make loans and operate payment systems. They play a vital role in the economic development and well-being of any country. This is even more the case in countries where capital markets are not especially well developed and the financial system is dominated by banks. The 2008 Global Financial Crisis (GFC) highlighted the dangers associated with excessive risk taking by banks. It also revealed the importance of the strength and soundness of the entire banking system, including the individual banks that make it up and regulatory and supervisory regimes.

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Closely Intertwined The real sector of the economy and the financial sector are closely related. The health of the economy can have a significant impact on the stability of the financial system. A strong economy generates demand for various financial products and services and allows both corporate and individual borrowers to repay their loans on time without much difficulty. Demand for property remains strong and real estate prices tend to increase. Defaults on loans from banks remain low, and the level of collateral on loans secured by property increases. The level of bad debts and credit losses that banks have is very low. By contrast, when the economy is in recession, unemployment tends to increase, consumer spending goes down even further and corporate cash flows deteriorates. Real estate prices tend to stagnate or decrease and activities slow to a standstill. As a result, defaults on bank loan increase while the value of collateral on loans secured by property decrease. The level of bad debts and credit losses that banks have to cope with increases, often quite sharply. Role of Banks in the Smooth Running and Development of an Economy A well-developed financial system can promote economic development in various ways.  ole of Banks as Intermediaries R One of the major functions of banking is financial intermediation, where banks channel surplus funds from the government, companies and individual into productive uses. Most business-to-business (B2B) transactions for trading goods are conducted on credit terms, and bank credit is widely regarded as the lubricant that keeps the engine of economic growth running smoothly. Banks provide mortgages to individuals to allow them to buy their own homes. This in turn helps drive real estate development. In countries where bond markets are non-existent or lack of depth, bank lending is the primary source of medium-term financing for corporations and real estate developers.

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Banks provide three key transformations: • Credit risk—They shield depositors from the credit risk that banks take when they lend funds provided to borrowers. Banks are regarded as “delegated monitors”, screening potential borrowers and monitoring and reviewing loan performance. • Maturity or liquidity risk—Most depositors require immediate access to their funds, while most borrowers are looking for stable medium or long-term funding and interest rates. Banks take short-­ term deposits and use them to make loans with a longer term (in the case of residential mortgages terms of 25–30 years are common). • Interest rate risk—Most depositors want some level of protection against inflation and generally prefer adjustable rate deposits. Most borrowers want to know how much their loans will cost and prefer fixed rate returns. Banks are able to transform liabilities with floating rates and transform them into fixed rate loans.  ayment and Clearing Services, Foreign Exchange and Liquidity P The financial sector can contribute to economic development in other ways. For example, the provision of a safe and secure payment system is essential for the running of a modern economy. The letters of credit that banks provide are essential for trade, and especially international trade, to be conducted. Finally, financial markets and institutions can provide liquidity to market participants and allow them to diversify their portfolios and reduce risks (Levine 2005). Credit Monitoring Banks monitor the performance of bank loans and this can enhance corporate governance. Bank lending and loan reviews can provide investors and creditors with information about the financial health of bank borrowers. In the presence of information asymmetry where investors and creditors know less about the financial state of companies than management of these companies these reviews and lending decisions can provide useful signalling information (James 1987).

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Problems in the Financial Systems Can Spill Over into the Real Economy It is clear that the financial system is highly dependent on conditions in the real economy, while it can also cause the real economy to be adversely affected by problems in the financial system. During the Global Financial Crisis (GFC), problems in the interbank market were first evident in August 2007, and when Lehman Brothers collapsed in September 2008, it effectively froze. Individual banks became highly risk-averse and unwilling to extend credit to financial counterparties from fear that other banks would follow Lehman. Companies, even ones of the highest quality, found it extremely difficult to refinance short and longer-term financing as it rolled over or obtained new loans regardless of term and collateral. Companies responded by tightening their payment terms for their own business customers, which created a death spiral as these companies followed suit. This example shows how disruption in the financial system can easily spread to the real economy. A safe and sound banking system is thus vital to economic growth and development in any country. Role in “One Centre, One Platform” in Macao ICBC (Macau) and its predecessor, Seng Heng Bank, emerged from the 2008 Global Financial Crisis unscathed, and also succeeded in weathering the Asian Financial Crisis of 1997–1998 and dealt with the 1999 Macao handover. The impact that ICBC (Macau) has had on local companies and industries in the years since the acquisition goes far beyond the numbers. As the largest locally incorporated bank in Macao, ICBC (Macau) has been playing a critical role in helping Macao expanding its business internationally and diversifying its economy by offering a wide range of financial services and also being an intermediary between China and the Portuguese-speaking countries (PSCs). It is particularly important to boost Macao’s twin strategic goals of becoming the international centre for leisure and tourism (hence, the “one centre”) and the platform for international trade and other economic co-operation between China and Portuguese-speaking countries (hence, the “one platform”). Since the beginning of its establishment, ICBC (Macau) has adopted a strategy that is “based upon Macau, radiating to the Mainland, expanding into neighbouring regions and extending to

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Portuguese-speaking Countries (PSCs)”. It has been lending to a large number of projects in the Greater Bay Area of China and playing an important role in the development of the bond market in Macao as well as financial leasing. To leverage Macao’s strong connections with Portuguese-­ speaking countries, ICBC headquarters in Beijing has appointed ICBC (Macau) to manage the entire bank’s loan portfolio in those countries (Kuo 2019).

1.4   About This Book In this book, we examine the success story of Seng Heng Bank, its subsequent acquisition by ICBC and its continuing post-acquisition success as ICBC (Macau). We identify the main contributing factors behind these successes and the lessons for bank managers and owners, in Greater China and beyond. The following key issues are addressed herein: • Why was SHB so successful prior to the acquisition? • What made Seng Heng Bank an attractive candidate for acquisition by ICBC? • What made the deal possible? Given Seng Heng Bank’s success over many years, we believe governments, businessmen and academics should be interested in learning about the factors that were key to these lasting achievements. The rest of this book is organized as follows: Chapter 2 describes the economic environment in Macao as well as the structure of the Macao banking industry. Chapter 3 provides a brief history of Seng Heng Bank, its business model, expansion strategy, and its corporate governance. We examine its past financial performance and consider its strengths, weaknesses, opportunities and threats prior to the acquisition. Chapter 4 chapter provides a brief history of ICBC and examines its business model, expansion strategy, corporate governance, as well as its financial performance. In Chap. 5, we examine what made the acquisition of SHB by ICBC possible and how the deal was made. We also analyse the post-­acquisition financial performance of ICBC (Macau). In Chap. 6, the acquisition is considered in the context of the developments in the Macao banking industry since the acquisition and try to identify the principal factors behind the enduring success of SHB and the lessons we can learn from it.

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References James, C. (1987). Some evidence on the uniqueness of bank loans. Journal of Financial Economics, 19, 217–235. Kuo, M. (2019). Banking on Macao. Macao Business, July 5, 2019. Levine, R. (2005). Finance and growth: Theory and evidence. In P.  Aghion & S. Durlauf (Eds.), Handbook of economic growth (Vol. 1, pp. 865–934). Elsevier.

CHAPTER 2

Macao’s Economy and Banking Industry

2.1   Macao’s Economy Macao’s economy is dominated by gaming and the related tourism industry. Its annual gaming revenue in 2018 was nearly MOP304 (about US$38 billion) and was more than six times that of Las Vegas. At the end of 2019, Macao’s real Gross Domestic Product (GDP) was roughly MOP409 billion (about US$51.1 billion), and its GDP per capita was over MOP680,000 (about US$85,000), which was the second highest in the world. Table 2.1 shows the real GDP, real GDP growth rate, real GDP per capita and population in Macao. Over the last two decades, the economy has been growing rapidly, especially after Macao’s return to Chinese sovereignty. From 2000 to 2019, Macao’s GDP grew at a simple average rate of over 8.1% per year and a geometric average of 7% a year. Its population has increased by more than 50% and real GDP per capita increased from just over MOP259,000 to about MOP680,000 (Table 2.1). However, Macao’s economic growth is highly volatile and is strongly affected by external conditions and forces due to its heavy reliance on the gaming and tourism industries, which in turn relies on mainland China. For example, during the period around the 1997–1998 Asian Financial Crisis, its economy was in recession. GDP growth slowed down dramatically during the Global Financial Crisis during the period from 2008 to 2009. In 2015, its economy contracted by over 21.6% and remained

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3_2

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Table 2.1  Macao’s real GDP, real GDP growth rate, and real GDP per capita Year

Real GDP (MOP million)

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

110,518 114,160 113,682 113,364 108,182 105,631 111,701 114,928 125,210 139,802 177,206 191,488 216,984 248,332 256,760 260,152 325,877 396,503 433,128 481,639 475,854 373,096 369,895 405,790 424,895 409,264

Real GDP growth rate (%) 3.3 −0.4 −0.3 −4.6 −2.4 5.7 2.9 8.9 11.7 26.8 8.1 13.3 14.4 3.4 1.3 25.3 21.7 9.2 11.2 −1.2 −21.6 −0.9 9.7 4.7 −3.7

Real GDP per capita (MOP)

Population

278,538 278,916 273,865 271,665 256,172 247,141 259,427 264,869 285,602 315,153 389,754 404,447 436,499 476,778 477,750 483,401 606,938 722,264 760,297 809,818 765,224 581,599 572,726 625,254 643,537 679,600

396,779 409,299 415,102 417,293 422,302 427,412 430,568 433,905 438,407 443,600 454,661 473,456 497,101 520,855 537,436 538,170 536,920 548,972 569,683 594,750 621,849 641,500 645,850 649,000 660,250 602,213

Source: Statistics and Census Service, Macao; Datastream

stagnant in 2016 due to the anti-corruption crackdown in mainland China, which seriously affected the VIP gaming business in Macao (see Table 2.1). The anti-corruption campaign was targeted at officials from the government, state-owned companies and the military who were suspected of corruption. It discouraged VIPs and other high rollers from mainland China to visit Macao.

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2.2   The Gaming and Tourism Industry Origins and Liberalisation The gaming industry in Macao dates back to the sixteenth century. From 1962 to 2001, the gaming sector was operated by Sociedade de Turismo e Diversões de Macau (STDM) under the government-issued monopoly license. In 2001, the gaming sector was liberalized, and in 2002, three initial concession contracts were issued to Sociedade de Jogos de Macau (a subsidiary of STDM), Galaxy Entertainment Group and Wynn Resorts, while three sub-concession contracts were issued to Las Vegas Sands, MGM Mirage and Melco-Crown. Soon after, billions of dollars of foreign direct investments in gaming and related industry flooded into Macao. A construction and public expenditure boom followed and the arrival of tourist from Mainland China increased sharply after China eased travel restrictions to Macao in 2003. Tourists from mainland China accounted for more than 50% of total tourist arrivals in Macao. Tourist arrivals from other regions also soared. For example, in 2004, tourist arrival increased by over 40% a year. As a result, its GDP increased by as much as 30% per annum (see Table 2.2). Macao’s over-Reliance on Gaming Gaming’s dominance in the local economy increased over time. In the 1990s, Gaming accounted for about 20% to 25% of Macao’s GDP. In 2005, the Multi-Fiber Agreement, which provided a guaranteed export destination for textile and clothing, was terminated and Macao’s traditional manufacturing sector, the textile industry in particular, went into a steady decline. Much of the textile industry shifted to mainland China, and Macao became even more dependent on gaming and the related industry. By 2009, tax revenue from gaming accounted for over 70% of the government’s fiscal revenue. Gaming accounts for about 50% of Macao’s GDP, 80% of its exports, and 25% of employment (IMF 2014, 2019). The over-reliance on the gaming and tourism industries is and always has been risky, which can be seen from the sharp decrease of GDP growth in Table  2.1 during the Asian Financial Crisis of 1997/1998 and the Global Financial Crisis of 2008/2009. For many years, the Macao government has been struggling to find ways to diversify its economy.

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Table 2.2  Gross gaming revenue and tourist arrivals Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Gross gaming revenue (MOP million)

47,133 57,521 83,847 109,826 120,383 189,588 269,058 305,235 361,866 352,714 231,811 224,128 266,607 303,879 292,455

Growth rate (%)

Tourist arrivals

Growth rate (%)

22.0 45.8 31.0 9.6 57.5 41.9 13.4 18.6 −2.5 −34.3 −3.3 19.0 14.0 −3.7

7,443,924 9,162,212 10,278,973 11,530,841 11,887,876 16,672,556 18,711,187 21,998,122 26,992,995 22,933,185 21,752,751 24,965,411 28,002,279 28,082,292 29,324,822 31,525,632 30,714,628 30,950,336 32,610,506 35,803,663 39,406,181

23.1 12.2 12.2 3.1 40.2 12.2 17.6 22.7 −15.0 −5.1 14.8 12.2 0.3 4.4 7.5 −2.6 0.8 5.4 9.8 10.1

Source: Statistics and Census Service, Macao

Diversification and Development of Financial Services Over the last few years, the Macao government has decided that certain financial services where Macao has comparative advantages can be developed into another major pillar of the local economy. These financial services include global wealth management, financial leasing, trading of RMB denominated bonds, green financing and RMB settlement of international trade transactions between China and Portuguese speaking countries. This strategic move has received the support of the central government in Beijing. A few non-bank financial institutions have been established, though they face shortages of skilled professionals such as accountants, lawyers, investment bankers as well as office space.

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2.3   Macao’s Financial Sector and Banking Industry The financial sector accounts for less than 10% of Macao’s GDP. As there is no capital market in Macao, banks dominate the financial services industry. Bank assets account for 94% of the city’s financial assets (IMF 2019). Furthermore, the banking sector of Macao is mostly foreign owned. As at the end of 2019, there were 25 insurance companies operating in Macao, 12 of which were life insurance companies, and the remaining 13 were non-life insurance companies. Ten of the 25 insurance companies were locally incorporated, and the remaining 15 were branches of overseas companies. Other non-bank financial institutions operating in Macao include 11 money changers, six exchange counters, two payment service institutions, two cash remittance companies, and two financial intermediaries. Emergence of Banking Industry in 1970s The development of Macao’s banking industry dates back to the 1970s when exports from Macao enjoyed tax exemption in the European market. In particular, Macao has been listed as one of the beneficiaries under the generalized system of preference (GSP). Given the comparative trade advantages and the quota system, this attracted foreign companies to establish companies in Macao, and boosted the economy in terms of net exports during the 1970s. In addition, the rapid growth of the gaming industry positioned Macao to become a premier tourist destination. At the same time, several banks were then established to provide financial services in order to bolster the economic growth in Macao. As at the end of 2019, there were 30 banks in Macao, 11 of which were locally incorporated and the remaining 19 were branches of overseas banks (see Tables 2.3 and 2.4). Among the 30 banks in Macao, there were 26 commercial banks, one post office savings bank, and two offshore banks. Bank of China Macao Branch and BNU are the two note-issuing banks in Macao and the parent banks of both, namely, Bank of China and Caixa Geral de Depósitos S.A., are state-owned banks in China and Portugal, respectively.

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Table 2.3  Number of banks and employees in Macao

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

No. of banks

No. of local banks

No. of foreign banks

No. of banking outlets

No. of employees

22 22 22 23 23 26 26 27 27 26 28 27 28 28 28 28 28 29 29 30

11 11 11 10 10 11 11 11 11 11 11 11 11 10 9 9 9 9 11 11

11 11 11 13 13 15 15 16 16 15 17 16 17 18 19 19 19 20 18 19

135 132 131 132 133 137 149 154 160 165 168 175 179 186 194 199 200 210 213 221

3,574 3,660 3,650 4,047 4,433 4,728 4,599 4,843 5,202 5,326 5,553 5,726 6,042 6,096 6,210 6,456 6,835

Source: AMCM Annual Reports

Most “Local” Banks Are Subsidiaries of Overseas Banks Most of the 11 local banks are subsidiaries of overseas banks. Banco Nacional Ultramarino (BNU) is the earliest bank established in Macao in 1902. On August 26, 1970, Macao government passed the banking law. Soon after, local banks such as SHB, Tai Fung and BCM were established. Foreign banks, such as the Hong Kong Shanghai Banking Corporation (HSBC) and the Overseas Trust Bank (OTB), also set up branches and operations in Macao. Major Gold Trading Centre: 1940s–1970s During the period from the 1940s to the early 1970s, Macao was the unofficial gold trading centre of the world, and the only one in the Far East. In July 1944, over 700 delegates from 44 countries attended the United Nations Monetary and Financial Conference held in Bretton

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Table 2.4  Banks operating in Macao 2019 Banks incorporated in Macao

Branches of banks incorporated overseas

 1. Tai Fung Bank  2. OCBC Wing Hang Bank  3. Delta Asia Bank  4. ICBC (Macau)  5. Luso International Banking  6. Banco Comercial de Macao, S.A.  7. The Macao Chinese Bank  8. Banco Well Link, S.A.  9. Banco Nacional Ultramarino, S.A.  10. Ant Bank (Macau)  11. Macao Development Bank

 1. HSBC  2. DBS Bank (Hong Kong)  3. Bank of China  4. Citibank, N.A.  5. Standard Chartered Bank  6. China Guangfa Bank Co.  7. Bank SinoPac Company  8. Chong Hing Bank  9. The Bank of East Asia  10. Hang Seng Bank  11. China CITIC Bank International  12. Bank of Communications Co.  13. Banco Comercial Portugues, S.A.  14. First Commercial Bank  15. CMB Wing Lung Bank  16. Hua Nan Commercial Bank  17. China Construction Bank Corporation  18. Agricultural Bank of China  19. Industrial and Commercial Bank of China

Source: AMCM 2019 Annual Report

Woods, New Hampshire, United States. The 1944 Bretton Woods Agreement created two international organizations, namely the World Bank and the International Monetary Fund. It also fixed gold price at US$35 per ounce, but importation of gold for private use and trading of gold within and between member countries was not allowed. Notably, the restrictions did not apply to Macao because Portugal did not sign the agreement, and Macao was not a part of the fixed exchange rate system. Many businessmen carried gold and large sum of money between Hong Kong and Macao, making the route a major target for piracy and other crimes. The world’s first commercial aircraft hijacking occurred in the Pearl River estuary near Macao in 1948 and it involved one of the two Catalina seaplanes or “flying boats” chartered from Cathay Pacific by the Macao Air Transport Company. The Bretton Woods system collapsed in 1971 when President Nixon terminated the peg of U.S. dollar to gold. Most countries abandoned the fixed exchange rate system and allowed their currencies to float against U.S. dollar. Figure  2.1 shows that gold

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2000 1800 1600 1400 1200 1000 800 600 400 200 0 11-06-1968 28-09-1974 14-01-1981 03-05-1987 19-08-1993 06-12-1999 24-03-2006 10-07-2012 27-10-2018

Fig. 2.1  Gold price, 1968–2019. (Source: Refinitiv Eikon)

price over the period from 1968 to 2019, revealing the significant increase in gold prices over the years. Banks Operating in Macao There are pros and cons associated with establishing a bank branch vs a bank subsidiary. Generally speaking, bank branches give better control to the parent bank and require less capital. Bank branches are primarily governed by laws in the parent bank’s home country although they are also subject to local banking regulations. It may offer more tax benefits, and it is cheaper because it does not require minimum equity capital level nor the minimum risk-adjusted capital adequacy ratio. The advantages of establishing a subsidiary include it is easier to identify profitability of the business (e.g., return on equity). It has limited liability and can be sold separately. Most of the banks in Macao have the full banking licenses required to conduct banking business. Table 2.4 shows the names of the 11 local banks and the 19 branches of foreign banks operating in Macao at end-2019. Together, they operated 221 bank branches (about one branch for every 2900 people in Macao) and employed about 6800 people (about one percent of the total population in Macao). In addition, there was a finance company with restrictive banking license and a non-bank credit union. With a total number of over 1700 ATMs, Macao has the highest

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ATM density in the world, with 313 ATMs per 100,000 adults, based on data from the World Bank. Based on estimates by the International Monetary Fund (IMF), the number of ATMs in Macao has more than quadrupled since the liberalization of the gaming industry in 2001. In 2004, the number of ATMs per 100,000 adults in Macao was only 56. From 2010 to 2015, the number of ATMs per 100,000 adults in Macao increased from 139 to 254. By way of comparison, the equivalent number in Hong Kong increased by only 3 from 46 to 49 (Fraser 2017). According to the South China Morning Post, the amount of cash withdrawals from ATM machines in Macao was over HKD10 billion a month, or HKD15,000 per person in Macao, raising concern about their possible role in money laundering. Three major banks, namely, Bank of China Macau Branch, Industrial and Commercial Bank of China (Macau) and Tai Fung Bank (which is 50.3% owned by Bank of China), account for over 50% of total deposits in the local market. In addition, Bank of China Macau Branch and Tai Fung Bank together control about 40% of the market. Nevertheless, the banking industry in Macao seems competitive (IMF 2011). The spread between interest charged on loans and interest paid on deposits is within the reasonable range. Bank capital adequacy is heavily regulated all over the world. Regulatory authorities impose the minimum amount of capital banks must have in order to maintain public confidence and preserve the safety and soundness of the entire banking system. It is also worth noting that the banks in Macao are relatively well capitalized. The average Basel total capital adequacy ratio (CAR), defined as regulatory capital as a percentage of risk-­ adjusted assets, during the period 2000 to 2019 was about 15.2%, ranging from 14.0% to 17.2%. (see Table  2.5). The minimum CAR banks are required by regulators to maintain is 8%. From 2005 to 2019, bank deposits increased by an average of about 13% per year, bank loans increased by about 20% a year and bank assets increased by about 15% a year. The strong deposit growth reflects the favourable economic conditions and the fiscal surplus of the Macao government. The savings rate of the private sector in Macao has been consistently over 50% of its GDP and there is no public debt. Loan-to-deposit ratios increased from 35.2% to 90.1%, and loans to total assets ratio increased from 30.1% to 56.6% over the period from 2005 to 2019, reflecting increased opportunities in bank lending to companies and individuals.

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Table 2.5  Basic statistics of the banking industry in Macao Year

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Bank deposits (MOPbn) 103.3 110.5 119.6 129.7 142.8 185.1 231.0 268.2 275.0 306.8 340.0 414.0 540.6 680.1 791.1 860.0 942.1 1,022.6 1,114.1 1,163.6

Bank loans (MOPbn) 50.9 49.4 51.3 48.7 52.6 65.2 76.4 108.6 150.6 186.6 245.7 322.4 407.0 534.7 689.7 760.7 784.3 896.0 1,007.2 1,072.9

Bank assets (MOPbn) 142.7 142.3 151.9 155.8 171.0 216.8 273.5 327.7 359.5 426.8 540.2 658.2 796.2 990.1 1,174.4 1,340.8 1,390.8 1,526.7 1,788.2 2,015.2

Loan-to-­ deposit ratio (%)

Loans/ assets (%)

Total CAR (%)

49.3 44.7 42.9 37.6 36.8 35.2 33.1 40.5 54.8 60.8 72.3 77.9 75.3 78.6 87.2 88.4 83.3 87.6 90.7 92.2

35.7 34.7 33.8 31.3 30.8 30.1 27.9 33.1 41.9 43.7 45.5 49.0 51.1 54.0 58.7 56.7 56.4 58.7 56.6 53.2

17.2 15.8 15.2 17.1 15.7 14.6 14.7 14.0 15.0 15.6 15.4 14.1 14.6 14.8 14.2 15.1 16.1 15.7 14.8 14.7

Source: AMCM Annual Reports

Excess deposits are either placed with parent banks overseas or in the interbank market in Hong Kong. Like many other countries, barriers to entering into the banking sector have been historically high but have been falling. Bank product and service differentiation in Macao is relatively low. As Macao has no capital markets, banking in Macao is rather homogeneous and traditional, with taking deposits, making loans and managing excess liquidity being their major business. Banks’ balance sheets are simple and off-balance sheet activities are quite limited. Stock trading and currency transactions are carried out on behalf of clients and there is little proprietary trading. Market risk is limited (IMF 2011). In the early 2000s, Macao banks’ ROA was quite low, financial leverage was high, and non-performing loans ratio was very high (over 20% in 1999 and 2000), due to the impact of the Asian Financial Crisis from 1997 to 1998. Performance of banks improved dramatically after 2003.

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ROA had increased to 1.48% in 2006 and eased to 0.9% in 2018, with a range from 0.41% to 1.48% over the past 19 years. The average return on equity (ROE) over the same period was 19%, with a range from 12% to 27% (see Table 2.6). The high ROE after 2005 was achieved by using relative high leverage ranging from 17.9 to 28.1 times with an average of 22.4 times. This is relatively high by international standards and probably reflects the simple nature of the balance sheet of Macao banks, the relative low risk profiles of Macao banks, and the favourable economic environment. For example, banks have very little proprietary trading. The impact of the Global Financial Crisis on bank performance in Macao was also quite limited, Table 2.6  Profitability, leverage and bad debts of Macao banks Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Bank profits (MOP bn)

0.8 0.6 0.9 1.0 1.4 3.0 4.0 4.0 3.3 3.5 3.9 5.1 6.3 8.5 11.0 12.8 14.2 14.8 16.1 17.1

Return on assets (ROAA) (%)

0.53 0.41 0.60 0.62 0.82 1.40 1.48 1.22 0.93 0.82 0.72 0.77 0.79 0.86 0.94 0.96 1.02 0.97 0.90 0.85

Source: AMCM Annual Reports; IMF (2019); CEIC

Assets/ equity (x)

27.3 29.0 20.8 20.2 17.3 17.9 18.4 20.4 20.8 22.2 22.5 23.1 24.4 25.1 28.1 25.8 21.7 21.9 21.2 N.A.

Return on equity (ROAE) (%)

NPLs (%)

15 12 12 13 14 25 27 25 19 18 16 18 19 21 26 25 22 21 19 N.A.

1.7 4.2 3.6 9.0 20.0 22.0 20.2 16.7 11.6 3.5 1.8 1.1 0.6 1.1 0.6 0.4 0.4 0.2 0.1 0.1 0.1 0.2 0.2 0.2 0.3

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which can be seen from Table 2.6. Macao’s property prices have increased over ten times over the past 15 years or so and default rate on mortgages and other real estate loans has consequently been exceptionally low. Macao did not have a deposit insurance or guarantee until October 2008, shortly after the collapse of Lehman Brothers and the outbreak of the 2008 Global Financial Crisis. Like many other countries, on 14 October, the government announced that it would provide 100% protection for customer deposits held with banks in Macao, and the measure remained in place until the end of 2010 to maintain public confidence in banks and prevent contagious bank runs. On 1 January 2011, an explicit protection measure was extended but the maximum amount was reduced to MOP500,000 per customer. On 7 October 2012, a formal deposit insurance scheme was established in Macao, with a coverage of MOP500,000 per depositor per bank. The primary objectives of deposit insurance are to protect small depositors, maintain public confidence in the banking system and preserve the stability and soundness of the banking system. The amount covered is similar to that in Hong Kong which is HKD500,000 per depositor per bank. In general, banks are exposed to, and are in the business of pricing risks including credit risk, interest rate risk, foreign exchange risk, market risk, and operational risk. • Credit risk refers to the potential loss due to default on interest and principal payments by borrowers. It is determined by the probability of default of the borrowers, the loss given default, the amount of loan exposure to the borrowers and the degree of the diversification of the loan portfolio. • Interest rate risk is the risk that banks are exposed to arising from changing interests on their portfolio of assets and liabilities. They are also called structural interest rate risks. • Foreign exchange risk is the risk that banks are potentially exposed due to changing adverse changes in exchange rates (e.g., as a result of currency mismatch of banks’ assets and liabilities in the banking book and/or currency trading positions in the trading book). • Market risk refers to the potential loss in the trading and investment portfolios of banks due to adverse changes in market prices, such as interest rates, exchange rates, and stock prices. • Operational risk refers to the potential loss to the banks due to failures caused by various other factors such as internal process,

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­ eople, and systems of banks and/or external events such as fire, terp rorist attacks, natural disasters, and other similar events. Banks are highly exposed to credit risk in Macao. Credit risk is a “tail” risk—losses may be very low for many years but this can disguise the presence of these risk. Banks in other countries seek to diversify credit risk but in Macao, with its small and very narrow economy, banks cannot diversify this risk. It is especially concentrated in real estate based lending and on loans that are secured with real estate. Banks are routinely exposed to interest rate risk arising from differences between the levels of their fixed and floating rate assets and liabilities and from repricing timing differences. The presence of the currency board for the Hong Kong dollar and the peg with the Macao Pataca introduces a certain type of risk, as speculative attacks on the Hong Kong dollar can create volatility in interbank rates which are then passed on to Macao. Banks that rely on the interbank market for funding are particularly exposed. Banks in Macao are not large players in the foreign exchange (FX) market, but they are exposed to the risks arising from the peg with the Hong Kong dollar and its currency board. While they have very little market risk in their trading book, operational risk exposure in Macao can be quite high, in particular, when it comes to the issue of anti-money laundering and counter-terrorist financing (AML/CTF). It is also important to note that risk of terrorist financing in Macao is considered to be low, though risk of money laundering is quite high due to the vast number of visitors each year and the cash-intensive nature of the gaming business. According to IMF (2017), Macao’s AML/CTF measures were sound, though it lacked details to comply with the international best practices. Certain areas, such as customer due diligence, confiscation/freezing of criminal assets measures and international cooperation needed improvement.

References Fraser, N. (2017). ATM withdrawals in Macao top HK$10 billion a month, as authorities ensure machines never run dry, source says. South China Morning Post, May 5. IMF. (2011). Macao special administrative region of the People’s Republic of China: Financial sector stability assessment. IMF Country Report, No. 11/264.

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IMF. (2014). Macao special administrative region of the People’s Republic of China: 2014 Article IV consultation Discussion Staff Report. IMF Country Report, No. 14/294. IMF. (2017). People’s Republic of China - Macao Sepeical Administration Region: Staff report for the 2016 Article IV consultation discussions. January 18, 2017. IMF. (2019). Macao special administrative region of the People’s Republic of China: 2019 Article IV consultation Discussion Staff Report. IMF Country Report, No. 19/123.

CHAPTER 3

Seng Heng Bank (1972–2007)

An account of the development and performance of Seng Heng Bank before its sale by STDM to ICBC in 2007 is examined in this chapter. This period of the bank’s history has had four distinct phases: • Establishment and sale to STDM (1972–1989)—SHB was established in 1972 and went through one change in ownership before STDM acquired the bank in 1989. The bank at that time was very small, had no computerisation and was losing money. • Rapid expansion (1989–1996)—Following the acquisition of SHB by STDM, the bank (under the direction of new CEO Mr. Patrick Huen) enjoyed rapid expansion that was made possible by investments in both computerisation and staff skills. • Weathering the storm (1997–2000)—The Asian Financial Crisis erupted in 1997, and its effects were still being felt in Macao in 2000. This was a period of consolidation for the bank, which was characterized by stagnation of balance sheets and profits. SHB coped with these challenges better than its peers and still managed to achieve healthy returns on equity. • Diversification and managed growth (2001–2007)—SHB returned to growth in 2001, though this growth was carefully managed. SHB took measures to improve the bank’s corporate governance and strengthen its risk control functions. Mr. Huen developed a vision for how the bank could achieve a sustainable competitive © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3_3

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advantage. Additional investments in IT and staff training were made. The bank continued to diversify its business lines. Each of these phases are examined here in turn and a detailed appraisal of its performance over this period is presented.

3.1   Bank Origins and Acquisition by STDM Seng Heng Bank was established in June 1972. It was founded by prominent Macao businessman, Mr. LOU Tou Vo, with a registered capital of MOP5m, subsequently increased to MOP50m. Mr. Lou owned 50% of the bank and the rest was owned by Mr. HO Yin, Mr. CHENG Yu Tung and Mr. Rogue Choi. The bank was sold to Mochtar Riady and Jackson Stephens in 1983. Mochtar Riady, was and remains, a Chinese Indonesian tycoon. He was the founder and former chairman of the Lippo Group, one of the largest conglomerates in Asia with wide ranging business interests in finance, real estate, tourism, media, retailing, healthcare, education, IT and telecommunication. Jackson Stephens was an oil man and investment banker from Little Rock, Arkansas. He was the CEO of an independent investment bank Stephens Inc. In 1976, Riady and Stephens together formed Stephens Finance Ltd. in Hong Kong. STDM (Sociedade de Turismo e Diversões de Macao, S.A.) entered into the picture in 1989. STDM was, and continues to be, Macao’s leading conglomerate. It was founded by Dr. Stanley Ho and his business partners in 1962 when it was granted the gaming monopoly in Macao which it held until 2001 when the gaming industry was liberalized. It currently owns and manages about 20 casinos in Macao through Sociedade de Jogos de Macao (SJM Holdings). Dr. Stanley Ho was known as the “king of gambling” and was regarded as the one who turned Macao into the world’s capital of gaming. In addition to gaming, STDM has substantial investments in many other industries including airlines, ferry services, hotels, horse racing, department stores and real estate. Most of these are based in or have a connection with Macao. It is the largest commercial employer in Macao. STDM had never had any banking interests or much need to engage with banks more generally. The casinos generated excellent cash flows and it had never needed to borrow money from banks to finance its operations or to meet its working capital requirements. It had, however, explored the

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possibility of acquiring a bank, in part to help manage the free funds generated from its gaming activities. None of the candidates it had considered appeared suitable until the opportunity to acquire Seng Heng Bank arose in 1989. In 1989, STDM bought SHB from Riady and Stephens for MOP124m. Mr. Patrick Huen was assigned to carry out due diligence of the bank and reviewed all the bank’s outstanding loans one-by-one. Before joining Dr. Stanley Ho’s group in 1979, Mr. Huen had worked in Hong Kong and Shanghai Banking Corporation (HSBC) and Banque Nationale de Paris in Hong Kong for more than 15 years. He was responsible for major projects including the financing of the Shun Tak Centre in Hong Kong and building of the Macau International Airport. An agreement was reached between STDM and Lippo to exclude a number of non-performing loans from the final deal.After the acquisition, Dr. Stanley Ho became the chairman of the Board of Directors of the bank and Mr. Patrick Huen was appointed Executive Director in March 1991. He was given the title of CEO in 2001 and had remained in this position until ICBC acquired Seng Heng Bank in 2008. The purchase of SHB was not part of a strategic move by STDM into financial services but Dr. Ho recognised that with the Zhuhai Special Economic Zone next door and given the vast market in mainland China, SHB should, nevertheless, have excellent long-term potential. Mr. Huen was given a free hand to develop the bank’s strategy and manage its business. In 1989 when SHB was purchased, it was very a small bank by any measure. Prior to the purchase of SHB by STDM, SHB had only 60 employees and three managers (all of whom had Hong Kong banking experiences), including himself. In addition to its headquarters in central Macao, it had only three branches which were located at Avenida da Praia Grande (Nam Wan Branch), Avenida de Almeida Ribeiro (Sa Ma Lo Branch) and Rua de Sao Lourenço (Ha Wan Branch). Total deposits from customers were approximately MOP600m and its business was limited to mortgage lending, some other retail banking services, and trade finance. The bank had no computer system and most business decisions had to be sent to Jakarta, Indonesia by Telex for review and approval before its sale to STDM.

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3.2   Business Model and Expansion Strategy To turn the bank around and make it a major local bank in Macao, Mr. Huen realized that the bank had to be computerized and an internal staff training function had to be established. Computerisation Inspired by Bill Gates’ book Business @ the Speed of Thought, Mr. Huen engaged information technology experts from academia (from Stanford University and University of California, Berkeley) as well as veterans practitioners (from Morgan Stanley and HSBC) to help build a Digital Nervous System to facilitate the flow of information within the bank. Mr. Huen believed, with a functional Digital Nervous System, it would be possible to make decisions at all levels of the bank much faster. Mr. Huen saw speed of decision making as a key sustainable competitive advantage to enable the bank to respond rapidly to changes in consumer demands and in its operating environment. SHB became an early adopter and pioneer of IT and Internet banking in Macao by harnessing the very latest developments. These investments in IT also paved way for the successful integration of the bank’s systems with ICBC’s own computer system after its acquisition of SHB and laid the foundations to support SHB’s rapid expansion post-acquisition. Diversification of Business Lines Having STDM as the bank’s owner brought with it the free cash flows from its gaming operations but it also had a downside. Immediately after the purchase, Mr. Huen realized that many individuals and companies were reluctant to bank with SHB because they did not wish to disclose information about their financial affairs to Dr. Stanley Ho, who was Chairman of both STDM and SHB. Many of SHB’s directors were also from the gaming industry. At the time when STDM bought SHB, the bank’s business was mainly in retail mortgage lending. Mr. Huen recognised that SHB needed to diversify into other services and markets. Diversification is very important for banks and especially so for banks operating in small, single markets like Macao, Singapore, and Hong Kong. Macao is a tiny place geographically

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(with an area of about 30 square kilometers) with an economy highly dependent on gaming, tourism, and real estate. Over-exposure to a single borrower, a particular industry or a particular geographical location can be disastrous for financial institutions. This was illustrated by the collapse of Peregrine Investment Holding Ltd. in Hong Kong in 1998. The bank lent too much to a company in Indonesia which was severely hit by the Asian Financial Crisis. A strategy of diversifying from retail banking into other areas such as the credit card business, wholesale banking, loan syndication, fund management, and developing banking links with other countries made complete sense. Mr. Huen also saw that SHB could play a role in connecting businesses between mainland China and Portugal and other Portuguese-­ speaking countries. As the Chinese economy rapidly expanded, foreign trade and investments by Chinese companies flourished. Macao’s role as the bridge between mainland China and Portuguese-speaking countries would become increasingly important. SHB was one of the pioneers in offering credit card services in Macao. Preparation started in 1990 and in 1992, the bank launched its credit card business. While the use of credit cards has a much longer history in Western countries, it did not appear in Mainland China until March 1985 when Bank of China Zhuhai Branch launched its “Bank of China Card” in Zhuhai, bordering Macao, in March 1985. In September 1992, the Great Wall card issued by Bank of China became the first credit card issued nationwide in Mainland China. Even today, some merchants in this region are still reluctant to accept credit cards for payment due to the fees charged by banks. In 1995, it established its own fully-fledged credit card centre. Equipped with an advanced data processing system, the centre was responsible for issuing credit cards and processing payments and settlements of cardholders. Later, it started to issue its own credit cards such as “Seng Heng Bank Visa”, “Seng Heng Bank MasterCard”. By 1998, it had a 65% market share for merchant sales in Macao. The outstanding number of credit card issued was 13,800, slightly lower than that of Bank of China and Wing Hang Bank. SHB has subsequently received many awards from Visa International and MasterCard International, including those for “Outstanding Merchant Volume Growth”, “Highest Market Share in Merchant Purchase Volume”, and “Highest Market Share in Merchant Acquisition”.

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In March 1993, SHB launched its phone banking service, “Easiphone”. Easiphone allowed customers to transfer funds, pay bills, handle credit card transactions, and make other enquiries by phone. In the mid-1990s, SHB set up 17 ATMs (automated teller machine) in its branches and other strategic locations in Macao. SHB joined the shared JETCO ATM network, owned jointly by banks in Macao and Hong Kong, to expand its banking business and provide a better and more convenient services to customers. This also proved to be a financial success, SHB invested approximately HK$6.2 million and made a profit of HK$490,000 during the first year of operation from transactions with a value of over HK$343 million. With the tourism industry booming in Macao, SHB set up a foreign exchange centre in the outer harbour in 1994, and in the Macau International Airport in 1995 to cater to the demands of the increasing number of tourists visiting the territory. Thereafter, SHB moved to its new headquarter located at Macao Landmark complex in 1998, occupying five floors of its office tower inside, which was renamed Seng Heng Bank Tower. The top floor of the tower, called “The Summit”, was used as the administrative centre and the other four for business operations and as offices by other departments of the bank. Seng Heng Bank continued with its gradual development of its branch network. • In 1991, a fourth branch was opened at Hotel Lisboa, home to one of STDM’s most iconic casinos. • In 1993, the bank opened another branch at the Yaohan Department Store (where the Oceanus Macao casino is currently situated) in order to serve customers at the Hong Kong-Macao Ferry Terminal area. • In 1996, the bank moved its Ha Wan Branch to a much bigger and better equipped premises at Areia Preta. Expansion of Business and Improved Profitability (1989–1996) SHB’s performance began to improve soon after the acquisition from Mr. Riady in 1989. The period 1989–1996 was one of rapid expansion. The bank’s balance sheet enjoyed a rapid expansion between 1989 and 1996. Deposits and loans increased at annualised rates close to 50% over this period.

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• Deposits from customers increased from MOP628 million at the end of 1989 to reach nearly MOP9.3 billion by the end of 1996 (nearly 15 times larger, compounded annual growth rate (CAGR) of 47%). • Loans grew from MOP277 million to nearly MOP4.8 billion (more than 17 times larger, CAGR of 50%). • Total assets grew from MOP758 million to reach slightly more than MOP10 billion (more than 13 times larger, CAGR of 45%). • Equity increased from MOP56 million at the end of 1989 to nearly MOP600 million by the end of 1996 (nearly 11 times larger). The bank needed to increase its equity base to support such rapid growth and to allow for future expansion and turned to its owners (Table 3.1). In what amounted to continuing votes of confidence in Mr. Huen from both the board and the owner, the board agreed to enlarge the bank’s equity base twice over this period: first an injection from STDM of MOP25 million in 1991 and a further MOP75 million in 1995. In March 1991, Mr. Huen was appointed as Executive Director of the bank. Despite the big increase in investments in new equipment, computer system, and human resources, the bank was able to return to profitability in 1989 and reported a profit for every year from 1989 to 1996 with profit after tax reaching nearly MOP124 million in 1996 (nearly 16 times higher than in 1989 and CAGR of 48%) (Table 3.2). Return on assets (ROA) is a key measure of bank operating profitability and is driven by operating profit per unit of assets. A bank can increase its ROA by increasing the proportion of its assets that are loans. Loans have higher yields than other financial assets, but this is at the expense of higher credit risk. Table 3.1  Key balance sheet items 1989–1996 (MOP million)

Deposits Loans Assets Equity

1989

1990

1991

1992

1993

1994

1995

1996

628 277 758 56

1,399 316 1,524 68

2,174 763 2,323 112

3,431 1,488 3,642 150

4,659 3,051 4,946 212

5,493 3,400 6,062 369

8,156 3,602 8,829 472

9,258 4,773 10,046 596

Source: Seng Heng Bank Annual Reports

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Table 3.2  Profits of SHB, 1989–96 (MOP million)

Profits (MOP)

1989

1990

1991

1992

1993

1994

1995

1996

7.9

11.5

19.3

37.5

61.9

82.5

102.7

123.8

Source: Seng Heng Bank Annual Reports

Table 3.3  ROAE and loans as a % of total assets 1989–1996

ROAA Loans/ assets

1989 (%)

1990 (%)

1991 (%)

1992 (%)

1993 (%)

1994 (%)

1995 (%)

1996 (%)

1.04 36.6

1.01 20.8

1.00 32.9

1.26 40.8

1.44 61.7

1.50 56.1

1.38 40.8

1.31 47.5

Source: Seng Heng Bank Annual Reports

• Return on average assets (ROAA): ROAA increased from just 1.04% for 1989 to 1.50% for 1994 before falling back to 1.31% for 1996, still 26% higher than in 1989. • Credit risk: A large part of the changes in ROA can be attributed to changes in the bank’s willingness to take on credit risk. Loans as a percentage of assets increased from 36.6% at the end of 1989 to reach 61.7%, at the end of 1993. This was nearly 70% higher than in 1989 and meant the bank was far more exposed to credit risk. Asian economies generally were overheating, mindful of the risks of a downturn, management took action to reduce this level of exposure and loans as a percentage of assets had fallen back to 47.5% by the end of 1996. This proved to be timely given that the Asian Financial Crisis arrived the following year, and there would be a sharp deterioration in credit quality generally (Table 3.3). Return on equity (ROE) is the key profitability measure for the owners of any company. ROE for a bank is driven by ROA and the level of leverage (asset-equity). The higher the leverage generally the higher the ROE but higher leverage also produces higher risk. • Return on average equity (ROAE): ROAE increased from just 14% for 1989 to reach a very impressive 34.3% for 1993 before falling back to 23.2% for 1996 (still 66% higher than for 1989).

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Table 3.4  Return-on-average-equity and assets/equity multiplier 1989–1996 1989

1990

1991

1992

1993

1994

1995

1996

ROAA 1.04% 1.01% 1.00% 1.26% 1.44% 1.50% 1.38% 1.31% Assets/equity 13.4x 22.4x 20.7x 24.3x 23.4x 16.4x 18.7x 16.9x ROAE 14.0% 18.5% 21.5% 28.6% 34.3% 28.4% 24.4% 23.2% Source: Seng Heng Bank Annual Reports

• Leverage: The increases in ROE for 1989–1992 were due to a combination of higher ROA and higher asset-equity leverage. After 1992 management took action to reduce its leverage and asset-equity fell from a high of 23.4 times at the end of 1992 to 16.9 times at the end of 1996 (22% higher than in 1989). About half of the increase in ROAE for 1996 compared with 1989 came from a better operating performance and half from increased leverage (Table 3.4).

3.3   Asian Financial Crisis (1997–2000) Rapid expansion, collateral based lending and fixed exchange rate systems were at the heart of the Asian Financial Crisis that lasted from 1997 to 2000. Macao had all three. No Asian economies escaped entirely unscathed from its effects and Macao was no exception. In Macao, manufacturing and real estate were amongst the sectors that were worst hit. Tourism was also badly affected from the downturn in the economies of neighbouring Hong Kong and mainland China. This was a period of consolidation; the rapid expansion of the balance sheet came to an abrupt halt. Deposits grew by 4% from the end of 1997 to 2000, loans by just 3% (Table 3.5). Most banks in Macao saw sharp drops in their profits in 1997 and 1998. Specifically, HSBC (Macau) profits were down 79%, Bank of China Macao Branch’s profits fell by 31%, and Luso Bank dropped by 4%. Seng Heng Bank profits were also hit by rising credit losses, though it succeeded in performing much better than its peers. It was one of the few who were still able to report profit growth, albeit only modest growth, at 5% and 3% for 1997 and 1998, respectively. Profits were weighed down by credit losses, provision charges as a % of operating profits rose from zero

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Table 3.5  Key balance sheet items 1996–2000 (MOP million)

Deposits Loans Assets Equity

1996

1997

1998

1999

2000

9,258 4,773 10,046 596

10,211 5,256 11,126 726

9,387 5,004 10,485 560

8,659 5,589 9,722 665

10,667 5,414 11,785 782

Source: Seng Heng Bank Annual Reports

Table 3.6  Profits (MOP million) and return metrics (1996–2000) 1996 Profit after tax Charges/operating profit ROAA Loans/assets

123.8 0.0% 1.31% 47.5%

1997 130.0 1.5% 1.23% 47.2%

1998 134.3 8.7% 1.24% 47.7%

1999 105.2 12.6% 1.04% 57.5%

2000 116.8 15.0% 1.09% 45.9%

Source: Seng Heng Bank Annual Reports

in 1996 to 15% in 2000 and this was a major factor in the fall of ROAA to just 1.09% (Table 3.6). Even in the face of a very challenging operating environment, Seng Heng Bank continued to deliver healthy shareholder returns with ROAE staying within the range of 16%–21% during this period. This was achieved despite a modest reduction in leverage that took place over 1996–2000 (Table 3.7). New Developments Banks typically borrow on a short-term basis and lend on a longer-term basis, which can create a mismatch between assets and liabilities in terms of maturity and pricing. Examples include fixed rate loans funded by fixed rate deposits with different maturities and fixed rate loans financed by floating rate deposit even when maturities are matched. To strengthen its management of interest rate risk, the bank purchased an Asset Liability Management (ALM) software package, “Sendero”. The new Sendero ALM system allowed management to identify and report its exposure to interest rate risk in the banking book to the Asset Liability

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Table 3.7  Profitability and leverage (1996–2000)

ROAA Assets/equity ROAE

1996

1997

1998

1999

2000

1.31% 16.9 23.2%

1.23% 15.3 19.7%

1.24% 18.7 20.9%

1.04% 14.6 17.2%

1.09% 15.1 16.1%

Source: Seng Heng Bank Annual Reports

Table 3.8  STDM investment in SHB and accounting returns (MOP million) 1989 Acquisition cost (124) Equity injections Dividend paid SHB book value

1990 1991 1992 1993 1994 1995 1996 1997 1998 (25)

(75) 300 560

Source: Seng Heng Bank Annual Reports

Committee (ALCO) on a regular basis and to conduct what-if exercises, simulations and stress tests. Despite the downturn SHB continued to invest in technology. In 1999, the bank established an E-Commerce team. This was responsible for the launch of a number of new services over the following four years. The team developed virtual ATM services via the JETCO network and set up an online stock trading system for investors. SHB’s website was enhanced to allow customers to easily find information on the bank’s products and services, and access data from a variety of markets (e.g. for interest rates, exchange rates, and stock prices). SHB also continued to develop its diversification strategy. In February 1998, Seng Heng Capital Ltd. was established to provide fund and investment management services to clients, making it the first bank in Macao to provide such services. STDM had invested a total of MOP224 million, and in 1998, it reported its first cash return on its investment. SHB was able to pay a dividend of MOP300 million to STDM in 1998 (Table 3.8). SHB’s book value after the dividend payment was MOP560m. In accounting terms, STDM had invested MOP224 million for a return of MOP860 million. When the acquisition of SHB by ICBC is examined, it becomes clear that the true investment returns were even better.

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3.4   Continued Growth after AFC (2001–2007) Sustainable Competitive Advantage Following the periods of rapid expansion and the challenges caused by the 1997 Asian Financial Crisis, Mr. Huen worked on improving the bank’s corporate governance and developing a strategic vision of sustainable competitive advantage that would take the bank through its next phase of managed growth. SHB also took action to improve its marketing function and human resource management. It continued to invest in technology and establish new business lines. In 2001 Mr. Huen developed a graphic for submission to The Banker magazine as part of a nomination for the Macao “Bank of the Year” award. This was used to articulate his, and SHB’s, strategy to develop a sustainable competitive advantage for the bank to stakeholders (Fig. 3.1).

Fig. 3.1  SHB’s sustainable competitive advantage. (Source: Seng Heng Bank 2001)

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SHB’s strategy of striving for sustainable competitive advantage comprised four parts, namely, market environment and competitors, human resources, technology, and relationship asset management. • Market environment—SHB’s executive management saw the need to constantly monitor the market environment for both opportunities and threats arising from drastic changes like the opening up of mainland China, the liberalization of Macao’s gaming sectors and the potential entry of mainland banks into Macao. By having both macro and micro views on the environment in which the bank operated, SHB was able to develop an informed view on likely developments and prepare for an uncertain future with foresight and a degree of confidence. • Human resources—Mr. Huen saw people, their skills and experiences as vital to the long-term success of the bank. Management recognised the need to actively search for talent to help achieve SHB’s goals and provide them with opportunities to advance their careers, help develop their skills and eventually move into senior management positions. • Software house—It was clear to management that having effective information management was needed to support a number of critical banking functions including risk and relationship management, marketing and customer acquisition and retention. Having an efficient processing capability was also vital for the bank to remain competitive and profitable. The bank built most of its computer system from scratch and actively used information technology to collect, analyse and process information to serve Macao companies and individuals better. • Relationship asset management—Mr. Huen regarded relationships as a key asset to be nurtured with great care. The bank actively managed its relationships with key stakeholders, including customers, investors, employees, the community, regulators and shareholders. Managed Growth over 2000–2007 Growth from 2000–2007 was at a far more controlled pace than during 1989–1997 but was still very impressive:

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• Deposits and total assets both increased by a factor or approximately 2.5x since the end of 2000, equivalent to a CAGR of nearly 14%. • Loans grew at a slightly slower pace but still came close to doubling, resulting in an effective CAGR of 10% (Table 3.9). Profits grew at a faster rate than assets, with profit after tax increasing by a factor of 2.8 times, equivalent to a CAGR of 15.8% (Table 3.10). SHB’s profitability during 2001–2007 was considerably lower than during the period from 1989 to 2000, but ROAA and ROAE were both very respectable at around 1.2% and 17%, respectively for 2007. In part the lower levels can be attributed to a lower risk profile: • Loans as a proportion of assets fell from 45.9% at the end of 2000 to just 35.5% and asset-equity gearing was down slightly from 15.1x to 14.5x (but well down from its peak of 24.3x in 1992 (Table 3.11). Unfounded Reports of US Money Laundering Allegations On 8 September 2005, the Wall Street Journal (WSJ) published an article entitled “U.S. Probes Banks’ North Korea Ties”, alleging that SHB and two other banks in Macao were being investigated by the US government agencies for laundering money for North Korea. Given the serious nature of these unwanted and unfounded allegations, Mr. Huen and the bank took immediate action to refute the allegations and resolve the crisis. SHB wrote to Monetary Authority of Macao (AMCM) on the day of the news report to confirm that the bank had no North Korean customers, nor it had any banking transactions relating to North Korea. SHB

Table 3.9  SHB key balance sheet items 2000–2007 (MOP million)

Deposits Loans Assets Equity

2000

2002

2002

2003

2004

2005

2006

2007

10,667 5,414 12,915 782

11,822 5,110 14,707 903

13,485 4,083 17,417 1,030

15,937 3,856 19,535 1,190

17,979 4,893 21,479 1,361

19,455 7,539 25,387 1,581

22,587 9,745 25,387 1,803

26,950 10,435 29,365 2,024

Source: Seng Heng Bank Annual Reports

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Table 3.10  SHB profits (MOP million) (2000–2007)

Profit after tax

2000

2001

2002

2003

2004

2005

2006

2007

116.8

120.9

126.8

160.0

171.2

242.9

311.5

325.9

Source: Seng Heng Bank Annual Reports

Table 3.11  SHB profitability metrics and leverage (2000–2007) 2000 ROAA Loans/assets Assets/equity ROAE

2001

2002

2003

2004

2005

2006

2007

1.09% 0.98% 0.92% 1.00% 0.93% 1.18% 1.23% 1.19% 45.9% 39.6% 27.8% 22.1% 25.0% 35.1% 38.4% 35.5% 15.1 14.3 14.3 14.6 14.4 13.6 14.1 14.5 16.4% 14.0% 13.1% 14.6% 13.3% 16.1% 17.3% 17.3%

Source: Seng Heng Bank Annual Reports

requested AMCM to conduct an on-site inspection and examination of the bank to confirm this as soon as possible. On 15 September 2005, an announcement from SHB was published in the South China Morning Post, a leading Hong Kong daily newspaper. This stated that Seng Heng Bank was not aware of any investigation by the US government; it confirmed that it had not engaged in any illicit activities; it had no clients who were citizens of North Korea; and it had no transactions with North Korean entities. It also mentioned that SHB’s lawyers were taking all necessary actions to protect the reputation of the bank. On 27 September 2005, the WSJ published a reply from Mr. Huen entitled “Seng Heng Bank Isn’t under US Investigation”, which indicated that the bank had no North Korea customers; it had no transactions with any North Korean companies; it had not engaged in any illicit activities; and it was not aware of any investigation by any U.S. government agency (Huen 2005). After two on-site inspections in October and November 2005, SHB received a letter from AMCM clearing SHB from all these reported allegations.

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Awards SHB won multiple awards for its credit card business, and for the bank as a whole, during this period highlights for the bank itself included being awarded: • “The Best Bank in Macao” from Global Finance magazine based in New York every year from 2004 to 2008. • “Bank of the Year’ for Macao from The Banker every year from 2001 to 2008. In 2006, SHB was ranked among Top 200 banks in Asia in terms of core equity capital.

3.5   Analysis of SHB’s Financial Performance The main drivers of Seng Heng Bank’s operating performance have included: • Growth of net interest income: Growth of net interest income was the main driver of SHB’s profit growth and this, in turn was driven by volume growth and interest spread. Volume growth includes the growth of loans and other interest earning assets and the deposits and other interest-bearing liabilities to fund them. Interest spread includes the spread that SHB earned between its interest-bearing liabilities and its interest-earning assets. • Growth of other income: Banks are always looking for ways to generate fee-based and operational income. Other income tends to be quite volatile as it is used to report trading profits and realised gains and losses on securities. • Expense control: The extent to which management is able to control expenses while growing its balance sheet. The more investment in technology and automated a bank the easier it is to grow without a corresponding increase in operating expenses. • Bad debt losses: When economies are doing well, bank loan losses are typically much lower. In a recession or downturn in asset markets, they can become particularly important.

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Investor returns (Return on equity) are driven by: • Operating performance: What is happening in terms of operating performance, which is measured by ROA. It is affected by asset utilization and profit margins. • Leverage: The degree of leverage (as measured by asset-­equity gearing). Net Interest Income Net interest income, which is defined as the difference between interest income and interest expense, remains the key source of income for commercial banks, and SHB is no exception: • Interest income from making loans and investing in government and commercial bonds in the investment portfolio provides the largest source of a bank’s revenue. Loans provide higher yields than bonds but also carry greater credit risk. • Interest expense paid to depositors and other creditors is the largest source of bank expense. Deposits account for approximately 90% of SHB’s funding. Net interest income increased from less than MOP150 million for 1993 to more than MOP450 million for 2007. The volume growth over this period was more than enough to compensate for the narrowing of the net interest income. As one would expect, net interest income increased very rapidly from 1993 to1996, flattened during the Asian Financial Crisis and contracted when interest rates hit bottom in 2002–2003. Net interest income enjoyed strong growth from 2003 to 2007, which more than doubled due to a widening and then flat net interest spread and steady volume growth (Fig. 3.2). Net interest income typically accounts for 70–80% of SHB’s operating income. This fell to just 50% in 2003, which resulted from a combination of weak net interest income and other income that was unusually high (almost certainly distorted by gains on fixed income securities). Volume Growth: Loans and Deposits We identified three distinct periods of SHB’s performance, which included the early growth years from 1989 to1996, the retrenchment caused by the

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Fig. 3.2  SHB net interest income and as % of operating income (1993–2007). (Source: Seng Heng Bank Annual Reports) Table 3.12  SHB compounded annual growth rates: assets, deposits, and loans

1989–1996 1997–1999 2000–2007

Assets

Deposits

Loans

44.7% (1.1%) 14.8%

46.9% (2.2%) 12.3%

50.2% 4.3% 8.5%

Source: Seng Heng Bank Annual Reports

Asian Financial Crisis of 1997–1990 and the period of steady growth of 2000–2007. In the period from 1989 to1996, assets, deposit and loans grew by a factor of 13x, 15x and 17x, respectively. Growth stagnated between 1997 and 1991 with total assets contracting by 3%. Growth recovered in 2000 and, from a much larger base than in 1989, assets, deposits, and loans increased by a factor of 3x, 3.1x, and 1.9x from the end of 1999 through 2007, respectively (Table 3.12). Growth of loans lagged behind that of deposits during the period from 2000 to 2007. The loan-to-deposit ratio fell from a high of 65% at the end of 1999 to less than 40% by the end of 2007 (Fig. 3.3). The slower growth of loans and falling loan-to-deposit ratios reflected the lack of wider lending opportunities in Macao. Banks in Macao are

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Fig. 3.3  SHB: loans, deposits and LDRs (1989–2007). (Source: Seng Heng Bank Annual Reports)

heavily exposed to real estate, both on the commercial development and investment side and the lower risk residential mortgage front. Asset Yields, Funding Cost and Net Interest Spread Loans as a percentage of assets increased rapidly in the early years of STDM’s ownership. Asset yields are only available from 1993 onwards, and they are largely affected by the level of interest rates more generally, as well as the asset mix. The effects of shifts in the level of loans as a % of assets on asset yields is evident from the charts below (Fig. 3.4). Commercial banks are exposed to the “endowment effect”—they generally have more fixed rate funding (in particular equity and demand deposits) than assets. Their net interest income is adversely affected by lower asset yields. Interest rates in the early 2000s fell sharply—funding costs fell below 1% for 2004. The narrowing of the net interest spread—it halved between 1993 and 2007 from 3.0% to 1.5%—can be attributed to a combination of increased competition, lower interest rates and a lower proportion of higher-yield loans as a proportion of total assets (Fig. 3.5).

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Fig. 3.4  SHB loans as % of assets and Asset yields (1989–2007). (Source: Seng Heng Bank Annual Reports)

Fig. 3.5  SHB funding costs and net interest spread (1993–2007). (Source: Seng Heng Bank Annual Reports)

Other Income Commercial banks made a significant effort to build up sources of non-­ interest income. It can be quite volatile as it includes trading gains and realised gains from securities disposals. We do not have that breakdown, but it is tempting to speculate that the big increase in 2003 for SHB came

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Fig. 3.6  SHB other income and as % of operating incomes (1993–2007). (Source: Seng Heng Bank Annual Reports)

from realising gains on securities which had appreciated in value as interest rates fell. This coincided with a particularly weak year for net interest income, which was down MOP22 million, while other income increased by MOP31million (Fig. 3.6). Operating Expenses Many factors affect a bank’s performance—the level of interest rates, what is happening to the economy, etc. Operating expenses are something management have more control over. Between 1993 and 2001 SHB’s expenses grew steadily, they were cut sharply in 2004 and 2006 but in 2007 returned to the level of 2003. The cost-income ratio, which shows how much of a bank’s operating income is taken in overheads was flat from 1993 to 1998, and it then rose for two years. It fell from just over 60% for 2001 to just under 40% during 2005–2007. This was possible because of the investments SHB had made in technology and automation (Fig. 3.7).

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Fig. 3.7  SHB operating expenses and cost-income ratios (1993–2007). (Source: Seng Heng Bank Annual Reports)

Credit Losses SHB has taken a fairly risk-averse approach to lending. As a result, it performed better than most banks in Macao when NPLs began to rise sharply during the 1997 Asian Financial Crisis, though it did not escape entirely. Non-performing loans as a percentage of loans for Macao as a whole reached 22% at the end of 2000. Earlier, SHB’s NPLs peaked at only just over 5% of its loans in 1998 (Fig. 3.8). SHB escaped the Asian Financial Crisis virtually unscathed. In 1993 bad debt charges had accounted for more than 20% of SHB’s operating profits but in the worst year of the Asian Financial Crisis the highest they reached was just 15% of operating profits (Fig. 3.9). It took a total of MOP60 million as bad debt charges from 1997 to 2000 but wrote back MOP25 million over the next three years. This implies net write offs of MOP35 million, which was roughly 0.6% of loans, equivalent to about 3 months of its operating profits at that time. Profitability and Gearing Seng Heng Bank saw ROAA increase from 1% in 1989 to reach approximately 1.5% in 2004 before falling steadily back to 0.9%–1.0% for 2000–2004 and then recovering to around 1.2% for 2005–2007.

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Fig. 3.8  SHB provision charges and write-backs (1993–2007). (Source: Seng Heng Bank Annual Reports and AMCM)

Fig. 3.9  SHB provision charges and write-backs (1993–2007). (Source: Seng Heng Bank Annual Report)

The gearing of the bank increased rapidly in the period from 1989 to 1993 as the bank enjoyed a period of rapid expansion, reaching around 24x for 1993. SHB lowered its gearing over the period 1993–1999 before stabilising at approximately 13x for 2000–2007.

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The ROAE is completely determined by ROAA and the level of asset equity leverage. For SHB, it started at just under 15% in 1989 and increased steadily as ROAA and leverage both expanded until 1993 when it reached nearly 35%. The ROAE then fell steadily as ROAA and leverage both fell before bottoming at around 13% in 2001, though it later recovered to reach 17% for 2007 (Fig. 3.10). Compared with other banks in Macao, SHB’s financial performance in the 2000–2004 was much better than its peer in almost all areas. The ROAA was much higher than the industry average, and SHB used far less financial leverage than the sector average. .

Fig. 3.10  SHB’s ROAA, asset-equity leverage and ROAE (1989–2007). (Source: Seng Heng Bank Annual Reports)

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The higher financial leverage is not surprising. Many of the other banks operating in Macao did so with branches rather than full subsidiaries, thereby avoiding the full regulatory capital requirements and Bank of China (the largest bank in Macao) with the backing of its parent could afford to have a smaller capital base than a standalone bank, including SHB.  Despite a better absolute performance, SHB’s ROAAs fell below those of the sector for 2005–2007. This is probably a reflection of it having a lower level of loans as a percentage of assets than most banks (Fig. 3.11). Selected Financial Data Tables 3.12 and 3.13 show that the loans, deposits and total assets grew at double digit rates over the years, except for the few years after the outbreak of the Asian Financial Crisis. Deposit growth was even stronger than that of loans. In terms of profitability, its total profits nearly tripled. Its ROA and ROE were very steady and consistent, reflecting that SHB’s risks were managed effectively. With a leverage of approximately 14x, the bank was fairly well-capitalized. Its cost to income ratio continued to decline, indicating that its operating efficiency was improving over the years. Figures 3.12 and 3.13 show that ROAA, ROAE, assets and equity of SHB from the period 1989 to 2007. The average ROAA was 1.16% and that of ROAE was 19.61% (Table 3.14).

3.6   Corporate Governance and Business Ethics Ownership and Board of Directors Initially, SHB was 100% owned by STDM. By the time it was sold to ICBC, STDM owned 70% of the bank, and Mr. Huen owned 30%. To enhance its professional image of the bank and meet the growing needs of its customers, Mr. Huen felt that it was imperative to strengthen the corporate governance of the bank. All 7 SHB directors of SHB were either directors or senior staff of STDM in the beginning. Some individual and companies were reluctant to bank with SHB, as it was viewed as a “casino bank” given its STDM background. Mr. Huen restructured the Board of Directors by appointing professional bankers, entrepreneurs and scientists. Except Dr. Stanley Ho, Dr. CHENG Yu Tung and Mr. Huen, the other directors were replaced to play down the perception that the bank was

48 

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Fig. 3.11  SHB vs sector ROAA, asset-equity leverage and ROAE (2000–2007). (Source: Seng Heng Bank Annual Reports and AMCM)

controlled by a casino operator. By 2006, four of the seven directors were independent of and unrelated to STDM. The new independent directors including Mr. CHUI Sai Cheong (a member and the First Secretary of the Legislative Assembly of Macao), Prof. KO Ping Keung (an engineering scientist), Dr. Francisco Luís Murteira Nabo (a Portuguese economist) and Dr. Charles YEUNG Chun Kam (a Hong Kong politician and entrepreneur). The excellent reputation and track record of the new board members paved the way for the subsequent acquisition by ICBC.

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Table 3.13  Statement of financial position, income statement and performance metrics 2000

2001

2002

2003

2004

2005

2006

2007

Balance Sheet (MOP million) Cash & cash equivalents Placements with banks Short-term investments Investment securities Loans and advances Property, plant & equipment

237

139

136

417

760

263

257

892

4,545

4,773

5,860

6,444

1,537

1,750

2,952

5,098

294

151

415

630

745

567

230

1,750

777

2,108

3,438

5,294 10,786 10,477 11,357

9,102

5,414

5,110

4,083

3,856

4,893

7,539

294

282

263

255

245

246

9,745 10,435 246

250

Other assets 224 350 513 521 568 638 601 1,839 Total assets 11,785 12,915 14,707 17,417 19,535 21,479 25,387 29,365 Customer 10,667 11,822 13,485 15,937 17,979 19,455 22,587 26,950 deposits Due to banks 84 17 5 3 3 109 665 88 Other liabilities 252 173 187 287 192 335 333 303 Total liabilities Owners’ equity

11,003 12,012 13,677 16,228 18,174 19,899 23,585 27,341 782

903

1,030

1,190

1,361

1,581

1,803

2,024

Income statement (MOP million) Interest income Interest expense Net interest income Other income Operating income Operating expenses Operating profits

2000

2001

2002

2003

2004

2005

2006

2007

766

637

420

385

394

665

1,087

1,224

(488)

(377)

(188)

(174)

(141)

(335)

(685)

(754)

278

259

232

210

254

330

402

469

86 363

93 353

134 366

202 412

112 366

92 422

185 587

131 600

(199)

(214)

(205)

(221)

(165)

(161)

(225)

(224)

165

138

161

192

200

260

362

376

(continued)

50 

P. W. M. HUEN ET AL.

Table 3.13 (continued) 2000 Provision (25) charges Share of loss of 0 associates Pre-tax profit 140 Tax expenses (23) Profit after 117 tax Performance metrics Interest 2000 margins Asset yields 7.32% Funding costs 4.87% Net interest 2.46% spread Net interest 2.42% margin Efficiency measures Cost-income 54.7% ratio Op. Expenses/ 1.85% average assets Other income/op. Income Effective tax rate Balance sheet measures Loan-to-­ deposit ratio Loans as % of assets Deposits as % of funding Equity as % of funding Profitability

2001

2002

2003

2004

2005

7

0

18

1

3

(6)

(3)

0

(7)

(6)

0

0

0

0

154 (27) 127

203 (43) 160

145 (24) 121

202 (31) 171

264 (21) 243

2006

356 (45) 312

2007

373 (47) 326

2001

2002

2003

2004

2005

2006

2007

5.28% 3.28% 2.00%

3.11% 1.47% 1.64%

2.44% 1.17% 1.27%

2.16% 0.82% 1.35%

3.28% 1.76% 1.52%

4.69% 3.15% 1.54%

4.51% 2.96% 1.55%

2.05%

1.61%

1.23%

1.32%

1.55%

1.60%

1.61%

60.7%

55.9%

53.5%

45.2%

38.2%

38.3%

37.3%

1.73%

1.48%

1.37%

0.90%

0.79%

0.96%

0.82%

23.6%

26.5%

36.7%

49.0%

30.6%

21.8%

31.5%

21.8%

16.5%

16.7%

17.7%

21.2%

15.2%

7.9%

12.6%

12.6%

50.8%

43.2%

30.3%

24.2%

27.2%

38.8%

43.1%

38.7%

45.9%

39.6%

27.8%

22.1%

25.0%

35.1%

38.4%

35.5%

90.5%

91.5%

91.7%

91.5%

92.0%

90.6%

89.0%

91.8%

6.63%

6.99%

7.00%

6.83%

6.97%

7.36%

7.10%

6.89%

(continued)

3  SENG HENG BANK (1972–2007) 

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Table 3.13 (continued)

Return on average assets Asset/equity (average) Return on average equity

2000

2001

2002

2003

2004

2005

2006

2007

1.09%

0.98%

0.92%

1.00%

0.93%

1.18%

1.23%

1.19%

14.9x

14.7x

14.3x

14.5x

14.5x

13.9x

14.1x

14.3x

16.1%

14.4%

13.1%

14.4%

13.4%

16.5%

17.3%

17.0%

Source: Seng Heng Bank Annual Reports

ROAA .016 .015 .014 .013 .012 .011 .010 .009

90

92

94

96

98

00

02

04

06

00

02

04

06

ROAE .350 .300 .250 .200 .150 .100

90

92

94

96

98

Fig. 3.12  ROAA and ROAE of SHB (1989–2007). (Source: Seng Heng Bank annual reports)

52 

P. W. M. HUEN ET AL.

Assets 30,000 25,000 20,000 15,000 10,000 5,000 0

90

92

94

96

98

00

02

04

06

00

02

04

06

Equity 2,000 1,600 1,200 800 400 0

90

92

94

96

98

Fig. 3.13  Total assets and equity of SHB (1989–2007). (Source: Seng Heng Bank annual reports)

The management capability of the bank was further enhanced by the hiring of experienced managers from Hong Kong. Mr. Huen recruited experienced bankers from the Hongkong and Shanghai Banking Corporation (HSBC), including Paul Selway-Swift, Edwin Lau and Joseph Fung, and an investment banking analyst, Stephen Frost. The honesty and integrity of the managers and other employees were also exceptionally important at SHB. Corrupt practices, such as accepting kickbacks by employees, were not tolerated at the bank. Mangers were

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Table 3.14  Selected financial data (MOP million) for SHB 1989–2007 Assets 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

758 1,524 2,323 3,642 4,946 6,062 8,829 10,046 11,126 10,485 9,722 11,785 12,915 14,707 17,417 19,535 21,479 25,387 29,365

y-o-y (%)

Loans

277 101.0 316 52.4 763 56.8 1,488 35.8 3,051 22.6 3,400 45.6 3,602 13.8 4,773 10.7 5,256 (5.8) 5,004 (7.3) 5,589 21.2 5,414 9.6 5,110 13.9 4,083 18.4 3,856 12.2 4,893 10.0 7,539 18.2 9,745 15.7 10,435

y-o-y (%) 14.2 141.1 95.0 105.0 11.4 5.9 32.5 10.1 (4.8) 11.7 (3.1) (5.6) (20.1) (5.6) 26.9 54.1 29.3 7.1

Deposits 628 1,399 2,174 3,431 4,659 5,493 8,156 9,258 10,211 9,387 8,659 10,667 11,822 13,485 15,937 17,979 19,455 22,587 26,950

y-o-y (%)

LDR (%)

Loans/assets (%)

123.0 55.3 57.9 35.8 17.9 48.5 13.5 10.3 (8.1) (7.8) 23.2 10.8 14.1 18.2 12.8 8.2 16.1 19.3

44.2 22.6 35.1 43.4 65.5 61.9 44.2 51.6 51.5 53.3 64.5 50.8 43.2 30.3 24.2 27.2 38.8 43.1 38.7

36.6 20.8 32.9 40.8 61.7 56.1 40.8 47.5 47.2 47.7 57.5 45.9 39.6 27.8 22.1 25.0 35.1 38.4 35.5

Source: Seng Heng Bank Annual Reports

encouraged to delegate, which allowed the subordinates to learn new skills and develop their own management capabilities. Managers were expected to guide their subordinates and be fully responsible for the tasks. Risk Management The bank had also spent a lot of effort in strengthening its risk management. Being a bank directly owned by STDM, Seng Heng Bank must be more careful than its peers to avoid being perceived to be involved in any money laundering activities. Like other international banks, Seng Heng Bank appointed a top manager to be fully in charge of complying with anti-money laundering guidelines, supervision and training. Training sessions were provided to both frontline and back office staff on a regular basis to help them identify suspicious transactions. Regarding credit risk, Seng Heng Bank strictly complied with AMCM requirements to limit the exposure of any one single customer within a

54 

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certain percentage of its owner’s equity. The bank had clear guidelines on lending to STDM and its related companies and individuals. These loans must be 100% secured by cash without any exception. The bank also performed ongoing analysis on its loan portfolio with its computer system to monitor the concentration risk by customers and by industry. In terms of interest risk management, Seng Heng Bank set up the Asset-Liability Management Committee (ALCO) to control the bank’s structural interest rate risk exposure. Members of the committee included the CEO, the Financial Controller and the Treasurer of the bank, as well as in-house risk managers and an external consultant who had been a top executive at other multinational banks. ALCO meetings were held at least once a month during which the global economic environment was examined and asset-liability management strategies were determined. The bank has also acquired Sendero, a computerized risk management system, which could run different scenarios of the bank’s exposure based on different assumptions and changes in long term and short term interest rates. In 2004, Seng Heng Bank set up the Centre for Investment and Risk Analytics (CIRA) staffed by young professionals with advanced degrees in finance and quantitative disciplines or Chartered Financial Analyst credentials. CIRA was responsible for quantitative analysis of portfolio risks and asset allocation as well as evaluation of investment opportunities and financial instruments. Corporate Social Responsibility The bank also took its social responsibility seriously. In 2005, it supported the establishment of the Finance and IT Centre of Macau (FIT) to attract global wealth management and high-technology firms to set up branches in Macao, which made it possible to take advantage of its unique geographical location to serve the Pearl River Delta West Region. The building, which is Macao’s first intelligent office building, was specifically designed to accommodate the particular needs of occupants in high-tech and financial services, with raised floors and a 24-hour data centre. It was considered to be a significant milestone for Seng Heng Bank to give back to Macao by actively promoting the city as a regional financial and IT hub. While trying to promote a healthy development of the financial sector, Seng Heng Bank has also sought to closely correspond with the needs of social development. Seng Heng Bank supported the establishment of the

3  SENG HENG BANK (1972–2007) 

55

Dr. Stanley Ho Medical Development Foundation to promote, develop and subsidize activities which elevate the standard of medical services in Macao and Mainland China by technology transfer. The Foundation established a cooperative partnership with the Chinese University of Hong Kong to organize joint activities, such as medical symposium, academic exchanges, scholarships and subsidies, to improve the skills, techniques and training of medical professionals in their specialized fields.

3.7   SWOT Analysis of SHB At the end of 2007 we see that SHB had the following Strengths, Weaknesses, Opportunities and Threats (SWOT): • Strengths—Its strengths included capable and stable management team led by Mr. Huen, a state-of-the art computer system and other electronic banking systems and a clear strategy and ethical value system. • Weaknesses—Its weaknesses include: its ownership by STDM acted as an impediment to gaining new customers to do business with the bank; the inability of its parent to inject capital to fund any mainland expansion; its exposure to real estate and its inability to diversify Macao credit risk. The tiny size of Macao meant that bank had too much exposure to a single small geographic location. • Opportunities—SHB had a few good opportunities: (1) the opening up of mainland China and its rapid growing economy; (2) the handover of Macao to China’s sovereignty enabling Macao’s gaming and tourism to grow at extraordinary rate. (3) the liberalization of Macao’s gaming sectors and the arrival of big players providing the bank with plenty of opportunities for expansion, e.g., in wealth management and loan syndication, and (4) Macao’s unique role as the bridge between China and Portugal and other Portuguese-speaking countries being a great opportunity for the bank. • Threats—The threats faced by SHB were: (1) the impact on its parent STDM from liberalisation of Macao gaming and its need to focus on its core business at the expense of its banking subsidiary; (2) the over-reliance of Macao’s economy on the gaming and related tourism sector posing some threats for the bank as its portfolio could have too much exposure to a particular sector; (3) intense competition from other banks in Macao which could be difficult for SHB to

56 

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retain its customers. The bank’s relatively small size meant that it risked being squeezed on market share and price; and (4) the potential entry of mainland banks seeking to expand outside of mainland China and challenge Bank of China in Macao.

References Huen, P. (2005). Seng Heng Bank isn’t under U.S. investigation. The Wall Street Journal, September 27, 2005. Seng Heng Bank. (2001). ‘Annual report’, 1996 to 2008.

CHAPTER 4

ICBC

4.1   History of ICBC ICBC bank was established as a state-owned bank on 1 January 1984 to provide banking services to the industrial and commercial sector after the People’s Bank of China ceased its commercial banking business to fulfil central banking functions, i.e., conducting monetary policy and regulating the financial services industry in China. It continued to expand its operations and market penetration, enhanced its financial accounting and management systems and increasingly focused on risk management and profitability of the bank. In the middle 1990s, ICBC, like other state-owned banks, was transformed into a commercial bank where policy lending and commercial lending were separated, forming the ‘Big Four’ commercial banks in China. In 1994, China established three development banks, namely, Agricultural Development of China, Export-Import Bank of China, and China Development Bank, for the purpose of financing large-scale national projects of infrastructure, energy, transport, etc. for example, the Three Gorges Dam, and Shanghai Pudong International Airport. In other words, they took over the policy lending function of the four state-owned commercial banks. Although the banking reforms made further progress in the late 1990s and early 2000s, a significant problem was the large number of non-­ performing loans (NPLs) of the state-owned banks, especially the ‘Big Four’ banks. Table 4.1 shows that NPLs of ICBC were 34.2% of its total © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3_4

57

58 

P. W. M. HUEN ET AL.

Table 4.1  ICBC total loans and NPLs (RMB 100 million)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Total loans

NPLs

NPLs as % of total loans

22,468.7 23,334.9 23,936.4 25,756.0 28,270.2 33,177.9 34,684.6 32,895.5 33,951.1 37,452.0 42,937.0

N.A. N.A. 8,181.3 7,859.4 7,496.8 7,328.4 6,849.2 N.A. 1,376.2 1,116.1 1,047.0

N.A. N.A. 34.2% 30.5% 26.5% 22.1% 19.7% N.A. 4.1% 3.0% 2.4%

Source: ICBC Annual reports

loans. The NPLs were due to the fact that Chinese state-owned banks were often told by the government to lend money to state-owned companies that were often not performing efficiently and losing money in the past before the banking reforms. To help banks reduce the NPLs accumulated in the past years, the Chinese government injected 270 billion yuan into the ‘Big Four’ banks to improve their asset quality, risk management, and capital base. In addition, the government established four asset management companies (i.e., China Huarong Asset Management Corporation, China Great Wall Asset Management Corporation, China Cinda Asset Management Corporation, and China Orient Asset Management Corporation) to take over approximately 1.4 trillion yuan of bad debts from the banks. China Huarong Asset Management Corporation was responsible for the transfer of 408 billion yuan from ICBC in exchange for 95 billion yuan of cash and non-transferable ten-year government bonds with a face value of 313 billion yuan (Allen et al. 2014). In April 2005, ICBC was restructured and recapitalized after disposing off its bad loans and become a joint-stock commercial bank with limited liability. Goldman Sachs Investment Group and National Council for Social Security Fund of China joined ICBC as strategic investors. On 27 October 2006, ICBC was listed simultaneously on both the Shanghai Stock Exchange (SSE) and the Hong Kong Stock Exchange (HKEX) through an “IPO of the century”. It was the largest IPO up to that time, valued at 21.9 billion US dollars. The amount consisted of 14

4 ICBC 

59

billion US dollars raised in Hong Kong through H-shares and 5.1 billion dollars raised in Shanghai through A-shares and an additional of US$2.8 billion through the exercise of green shoe options due to the heavy demand. The close price at the end of the first trading day was HK$3.52, representing an increase of 15% over the issue price of HK$3.07. After the IPO, ICBC continued to enhance its performance as measured by the rapid growth in total assets and profits, as well as the steady reduction in NPLs. Figure 4.1 shows the holding period returns of A-shares (i.e., listed on Shanghai Stock Exchange in mainland China) for ICBC, China Construction Bank (CCB), Bank of China (BoC) and Shanghai Composite index (SHCI). The chart shows that ICBC was the best performing bank among the three listed banks in the mainland. It was the only bank that had outperformed the index. BoC’s stock performance was lower than both ICBC and the index, and CCB’s stock performance was the worst among the three. Figure 4.2 shows the stock performance of H-shares (i.e., listed in Hong Kong Exchange) of the three banks vs the Hang Seng China Enterprise Index. The chart shows that CCB had the best performance

1.5

1

0.5

5/1/2019

10/1/2019

7/1/2018

12/1/2018

2/1/2018

9/1/2017

4/1/2017

6/1/2016

11/1/2016

1/1/2016

8/1/2015

3/1/2015

5/1/2014

10/1/2014

7/1/2013

12/1/2013

2/1/2013

4/1/2012

9/1/2012

6/1/2011

11/1/2011

1/1/2011

8/1/2010

3/1/2010

5/1/2009

10/1/2009

7/1/2008

12/1/2008

2/1/2008

9/1/2007

4/1/2007

-0.5

11/1/2006

0

-1 ICBC

CCB

BoC

SHCI

Fig. 4.1  Holding-period returns of ICBC, CCB, BoC and Shanghai Composite Index (A-Share, 2006–2020). (Source: Datastream)

60 

P. W. M. HUEN ET AL.

1.2

1 0.8 0.6 0.4 0.2

5/1/2019

11/1/2019

5/1/2018

11/1/2018

5/1/2017

11/1/2017

5/1/2016

11/1/2016

5/1/2015

11/1/2015

5/1/2014

11/1/2014

5/1/2013

11/1/2013

5/1/2012

11/1/2012

5/1/2011

11/1/2011

5/1/2010

11/1/2010

5/1/2009

11/1/2009

5/1/2008

5/1/2007

11/1/2008

-0.4

11/1/2007

-0.2

11/1/2006

0

-0.6 ICBC

CCB

BoC

HSCE

Fig. 4.2  Holding-period returns of ICBC, CCB, BoC and Hang Seng China Enterprise Index (H-Share, 2006–2020). (Source: Datastream)

among the three banks, followed by ICBC and BoC.  Both CCB and ICBC outperformed the index, while BoC underperformed the index.

4.2   ICBC’s Business Model and Expansion Strategy Historical Domestic Focus Historically, Chinese banks only operated in its domestic market, with little overseas exposure, except BoC, whose business focused on international banking and foreign exchange. Since 2000, ICBC has been particularly active in acquiring minority stakes in foreign banks to expand its international markets through establishments of subsidiaries, branches and representative offices in major financial centres, and thereafter, it tried to enter into overseas markets in various parts of the world, such as in Asia, Africa, Latin America, and North America. The expansion of ICBC’s will be discussed in more details later.

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Commercial Bank Intermediation Initially, the main business of ICBC was to take deposits and make loans. Over time, it has expanded into many other areas, providing a wide range of financial products and services such as corporate banking, personal banking, institutional banking, and international banking services. It has supported many infrastructure constructions, key enterprises, primary industries, and the development of small and medium-sized companies. While bank loans make up the largest part of bank assets and interest income is the main source of bank revenue, bank lending, especially corporate loans, tend to offer limited risk-adjusted rates of return. Attempts to Pursue Fee Generating Businesses Fee-based income has become very popular for banks worldwide because it offers both income diversification and higher risk-adjusted rate of return. Prior to its public listing, ICBC had been focusing on their fee- and commission-­based income, which primarily covered agency and custodian services, bank cards, RMB clearing and settlements, electronic banking, investment banking, and wealth management service business, with an approximately 27% growth in total fee income in 2005 compared to 2004. In addition, their wealth management fees benefited from the growing transactions in the distribution of mutual funds and insurance products. Table 4.2 presents the details of the fee income for each segment during the period from 2004 to 2007. As of 31 December 2005, ICBC was the largest commercial bank in China in terms of outstanding corporate deposits, and discounted bills. It was also the largest personal bank in China as measured by the outstanding personal loans and deposits. However, its overseas assets comprised less than 3% of its total assets, which was quite low by international standards. Opening up to Foreign Investors in Early 2000s One of ICBC’s remarkable moves was its opening to foreign investors in the early 2000s, such as the Goldman Sachs Group, Allianz Group, and the American Express Company, after China joined the World Trade Organization. A consortium composed of strategic foreign investors had formed various alliances with ICBC with the aims of helping ICBC

62 

P. W. M. HUEN ET AL.

Table 4.2  ICBC composition of net fee and commission income, 2004–2007 RMB (million)

2004

2005

2006

2007

RMB clearing and settlement business Bank card business Investment bank business Wealth management business Agency business Foreign exchange business Electronic banking business Asset custody business Guarantee and commitment business Others Total

2,374 1,616 1,234 1,843 963 778 235 182 166 389 9,780

2,824 2,346 2,018 1,929 1,081 879 421 263 261 354 12,376

4,656 3,228 3,099 3,280 1,254 1,006 693 341 433 539 18,529

5,294 4,547 4,505 15,453 1,498 1,343 1,283 1,989 562 975 37,439

Source: ICBC Annual Reports

establish a sound risk management system, follow the best business practices, as well as strengthen bank performance and efficiency. In particular, ICBC announced its alliance with Goldman Sachs in 2006 through various practices. For example, Goldman Sachs would share the best practices in corporate governance with ICBC, and assist the bank in its efforts to improve risk management, capital business, asset management, corporate banking and investment banking business, as well as provide expertise in the field of non-performing loan (NPL) management, disposal and restructuring of bad debt. In addition, Allianz Group worked with ICBC by providing leading financial products and services to the bank’s clients, while American Express worked with ICBC in bank card business. In Search of Excellence According to its website, ICBC’s mission is to achieve “excellence for you”. Specifically, it intends to provide “excellent service to clients”, achieve “maximum returns to shareholders”, obtain “real success for our people”, and make “great contribution to society”. In addition, its vision is to “build a world-class and modern financial enterprise with global competitiveness by adhering to the principles of delivering excellence, sticking to our founding mission, being customers’ favourite bank, leading in innovation, security and prudence, and being people-oriented”. Its values

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are “Integrity, Humanity, Prudence, Innovation, and Excellence”, believing that “Integrity Leads to Prosperity.” Using IT to Deliver Services and Manage Risks To accomplish its mission of serving the real economy, ICBC enhanced its capability of controlling and mitigating risks. Besides, ICBC focused its strategy on retail banking, asset management, investment banking as well as international banking. ICBC used IT and digital innovation to deliver specialized services and pioneered a specialized business model. The ways that corporate governance might play a role in the success of ICBC is discussed in the next section. ICBC established its first website in 1997 and launching the ‘95588 telephone banking’ services in 1999. Following the fast-growing trend in the internet usage in the late 1990s, ICBC provided its online commercial and personal banking services, mobile banking, business-to-business online services in 2000. In addition, Microsoft agreed to assist and provide personal internet banking security services for ICBC. A new personal internet product called Banking@home was then launched in 2002. Expansion Strategy After China implemented its “open-door” policy in 1978 and the reform of state-owned enterprises in the 1980s, the Chinese economy has become increasingly integrated with the world economy. International trade and foreign direct investment soared. To serve its customers better and compete with domestic and international banks, ICBC began to venture overseas in the early 1990s. Its strategy was to build a well-connected global service banking network through establishing branches on its own or mergers and acquisitions in developing and developed countries. In 1993, ICBC opened a branch in Singapore which was its first overseas branch. In 1997, ICBC Seoul Branch was established. In November 1997, ICBC opened its Tokyo Branch. Thereafter, in 1999, ICBC established an overseas branch in Luxemburg which was developed into its European headquarters in 2011. On 21 August 2000, ICBC bought Union Bank of Hong Kong which was listed on the Hong Kong Stock Exchange and renamed it ICBC (Asia) in July 2001. In April 2004, ICBC bought the retail and wholesale

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banking business of Fortis Bank Asia HK and renamed it Belgian Bank which became a wholly-owned subsidiary of ICBC (Asia). In May 2003, ICBC opened its branch in Macao. Its operations were later combined with those of SHB after the acquisition. After additional equity capital was injected, the bank was renamed as ICBC (Macau), a subsidiary of ICBC. As at the end of 2019, ICBC owned 89.33% of ICBC (Macau). It has 19 branches and 5 wealth management centres, with strength in internet banking, retail banking, trade finance and IT platform. In 2003, ICBC (London) PLC was established. Before that it had a representative office in London set up since 1995. In October 2007, ICBC acquired a 20% stake of Standard Bank of South Africa, for US$5.5 billion, with two seats on the board of directors. Standard Bank is the largest bank in Sub-Sahara Africa and allowed ICBC to expand its services indirectly to 20 countries in Africa. In November 2007, ICBC Moscow was established. It offered remittance and foreign exchange services. Later, ICBC obtained a banking license to take deposits in Russia. In August 2008, ICBC opened a branch in New  York to engage in lending, wholesale deposit-taking, financing of international trade and other banking services. In January 2010, ICBC bought a 70% stake of Bank of East Asia (Canada) and renamed it as ICBC Canada in July 2010. In September 2008, ICBC Sydney was established to provide a wide range of financial services to Australia and New Zealand markets. In November 2013, ICBC opened its New Zealand subsidiary in Auckland, being the first Chinese bank to have a presence in New Zealand, offering various banking services such as remittance, international settlements, trade finance, account management, and mortgages. In October 2009, ICBC (London) opened its first retail banking branch, Chinatown Branch, to expand its retail banking services. In November 2009, it opened another branch in Tokyo and an additional branch was set up in Osaka in 2010. On 21 December 2010, ICBC privatized ICBC (Asia) which became a wholly-owned subsidiary of ICBC.  ICBC (Asia) has more than 58 branches and 25 “Elite Club” wealth management centres in Hong Kong, providing a wide range of banking services to customers. In January 2011, ICBC Luxembourg S.A., a fully-owned subsidiary of ICBC, was renamed as ICBC (Europe). In the same month, it opened five branches in Europe, i.e., Amsterdam, Brussels, Madrid, Milan and Paris.

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In November 2012, ICBC purchased an 80% stake of Standard Bank of Argentina and changed the name to ICBC (Argentina) in April 2013. It currently has 107 outlets in Argentina and the only Chinese bank with a presence in the country. On 24 September 2014, ICBC opened a branch in Kuwait City, the only Chinese bank with a presence in Kuwait at that time and the 4th branch of ICBC in the Middle East, after establishing branches in Dubai, Abu Dhabi and Doha. Its presence in the Middle East and Europe was further strengthened by the acquisition of TekstilBank in Turkey and the establishment of ICBC (Turkey) subsidiary. In February 2015, ICBC acquired a controlling stake of Standard Bank’s global markets business in London, including Standard Bank PLC (in UK) and other international businesses. ICBC Standard Bank PLC, headquartered in London, has offices in Hong Kong, Shanghai, Singapore and New York, focusing on emerging markets and commodities. By the end of 2018, ICBC has established 426 institutions in 47 countries and regions, allowing it to provide a wide range of financial services to customers in Asia, Africa, Latin America, Europe, America, Australia, and New Zealand. Winner of Numerous Awards Through the efforts made to serve the real economy and pursuit of internationalization, ICBC has received numerous awards over the past 15 years. In 2017, ICBC was awarded the World’s Best Emerging Markets Bank by the Global Finance magazine for its satisfactory performance and contribution to the emerging markets. In addition, ICBC was granted the Best Bank in the Asia-Pacific region for the first time, and was elected again as the Best Bank in China 11 times. More recently, Euromoney, one of the most influential financial media globally, awarded the ‘2018 Best Bank in China’ to ICBC for the 10th time. According to Euromoney, ICBC distinguished itself from multiple candidates in the face of the first-growing and complicated financial environment, and it showed consistent earnings results over time. In particular, the annual net profit experienced a 3% increase in 2017 compared to the previous year, reaching RMB 287.5 billion. Moreover, asset quality remained stable, with NPL ratio decreased to 1.54% at the end of the first quarter in 2018.

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4.3   Financial Performance Table 4.3 shows the financial performance of ICBC over the period from 2004 to 2019. Net income of the bank has been increasing steadily. Return on assets (ROA) increased from less than 1% to 1.44  in 2013 before decreasing slightly over the past few years to 1.08% in 2019. Return on equity followed a similar trend. The equity multiplier or financial leverage has been decreasing steadily from 22.5 times to 12.4, reflecting the increasing strength of the bank’s equity position. As the largest commercial bank in terms of assets in China and the world (see Table 4.4), ICBC continued to perform well in the banking industry, with steady profit growth and deposit base, and effective cost management and risk control. This might be attributable to its precise positioning in the process of transformation and upgrading in the past few years. ICBC started to develop inclusive finance in 2017, which provided lending services to different stage of enterprises, and reduce lending to industries with excess capacity to ensure stable developments in the domestic market. In addition, ICBC has made strenuous efforts to

Table 4.3  Financial performance of ICBC

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net income (RMBm)

Return on assets (%)

Equity multiplier

Return on equity (%)

29,989 33,704 49,880 82,254 111,226 129,396 166,025 208,445 238,691 262,965 276,286 277,720 279,106 287,451 298,723 313,400

0.65 0.59 0.71 1.02 1.21 1.20 1.32 1.44 1.45 1.44 1.40 1.30 1.20 1.14 1.11 1.08

N/A 22.5 21.6 15.9 16.1 16.8 17.3 16.3 15.9 15.2 14.3 13.2 12.7 12.6 12.4 12.1

N/A 13.3 15.4 16.2 19.4 20.2 22.8 23.4 23.0 22.0 20.0 17.1 15.2 14.4 13.8 13.1

Source: ICBC Annual Reports

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Table 4.4  Top 25 banks in the world by assets

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Bank name

Country

Industrial and Commercial Bank of China China Construction Bank Agricultural Bank of China Bank of China Mitsubishi UFJ Financial Group JPMorgan Chase HSBC Holdings PLC Bank of America BNP Paribas Crédit Agricole Citigroup Inc. Japan Post Bank Wells Fargo Sumitomo Mitsui Financial Group Mizuho Financial Group Banco Santander Deutsche Bank Société Générale Groupe BPCE Barclays Bank of Communications Postal Savings Bank of China Royal Bank of Canada Lloyds Banking Group ING Group

China China China China Japan USA UK USA France France USA Japan USA Japan Japan Spain Germany France France UK China China Canada UK Netherlands

Assets (USD billions) 4,027.44 3,376.52 3,287.36 3,092.21 3,069.20 2,622.53 2,558.12 2,354.51 2,336.66 2,123.61 1,917.38 1,911.48 1,895.88 1,848.20 1,837.80 1,670.79 1,543.55 1,485.31 1,462.70 1,444.39 1,385.81 1,383.63 1,039.24 1,016.55 1,015.61

Source: 2019 S&P Global market intelligence report

support the Belt and Road Initiative by issuing the first Belt and Road green bond in the international market to provide financial support.

4.4   Corporate Governance of ICBC As at the end of 2019, A-shares and H-shares accounted for 75.65% and 24.35% of total shares outstanding, respectively. The main shareholders of A-shares included Central Huijin (45.89% of A-shares or 34.71% of total A-and H- shares), Ministry of Finance (41.16% of A-shares or 31.14% of total shares), National Social Security Fund (4.57% of A-shares), Ping An Life Insurance Company (1.37%) and Wutongshu Investment Platform Company (0.53% of A-shares).

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The major H-shares investors included Ping An Asset Management Company (14.02% of all H-shares), National Security Fund (9.98% of H-shares), Temasek Holdings (8.43% of H-shares), China Life Insurance Company (4.75%), The Vanguard Group (3.19%), Blackrock Institutional Trust Company (1.56%) and Dimensional Fund Advisors L.P. (0.9%). The concept of corporate governance is regarded as a means of providing effective corporate control of a firm, while the application of corporate governance could be difficult in China since most of the senior managers of a listed firm are appointed directly by the government. With the state being both the principal shareholder and China’s bank regulator, corporate governance reform in China has been a priority. In the early 2000s, ICBC redesigned its internal structure through a top-down driven process. The original business processes which focused on products and departments were replaced by a customer-centered product development and marketing system. In addition, ICBC actively restructured the supervisory and audit management systems, as well as the internal audit committee with the aim of expanding their compliance management functions. Figure 4.3 shows the board composition by ICBC prior to public listing. In particular, ICBC followed a modern corporate governance structure with the general meeting of shareholders sitting at the top, under which were the Board of Directors and Board of Supervisors. The establishment of a board of directors is an essential part of the corporate governance practice of all publicly listed companies. The Board of Directors In particular, the design of the governance structure was based on the Provisional Guidelines on Due Diligence of the Board of Directors of Joint-Stock Commercial Banks in China, which consisted of executive directors, non-executive directors, and independent directors. Among the non-executive directors, Mr. Christopher A. Cole was from Goldman Sachs, and the rest of the non-executive directors were government officials. By contrast, two of the independent directors were professors from Tsinghua University, and another independent director was a former investment banker from Hong Kong prior joining ICBC’s board. Most of the bank’s independent directors and non-executive directors joined its board within one year prior to ICBC’s IPO. There were no representative of minority shareholders serving on the board. In addition,

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Fig. 4.3  ICBC corporate governance structure prior to IPO. (Source: ICBC Annual Report in 2005)

there were five committees under board of directors, namely strategy, audit, risk management, compensation and nomination, and related-party transaction committees which then worked closely with the board of directors to provide professional consulting to the bank. There was also a supervisory board which implemented supervision over the performance and due diligence of the Board of Directors and reported to the Shareholders’ General Meeting. In 2013, ICBC’s board consisted of 15 directors. Among them, 4 were executive directors, 7 were non-executive directors and another 4 were independent directors. Two of them were women directors and all of the directors except one were Chinese nationals, namely, one British citizen, Sir Malcolm Christopher McCarthy (ICBC 2013). According to the articles of association of ICBC, each director was appointed for an initial term of three years and they were eligible for re-election upon completion of their term. By the end of 2018, the number of directors increased to a total of 16 members in the board, in which there were six independent directors to help balance governance to boost the confidence of the public and the

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international and domestic capital markets. In addition, ICBC attempted to set up a nomination committee and a director orientation training mechanism to identify and appoint suitable candidates to balance the interests of the bank’s various stakeholders.

Reference Allen, F., Qian, J. Q. J., Shan, S. C., & Zhao, M. (2014). T'he IPO of Industrial and Commercial Bank of China and the ‘Chinese Model’ of privatizing large financial institutions. European Journal of Finance, 20, 599–624. ICBC. (2013). Interim Report.

CHAPTER 5

Acquisition of Seng Heng Bank by ICBC

In this chapter, we look at the reasons for the acquisition. The prerequisites for a successful agreed sale and how the sale of SHB by the STDM group to ICBC met all of them. In particular, STDM’s openness to an offer, ICBC looking for opportunities, their bringing together to allow negotiations to start, how SHB had qualities that ICBC sought and the conditions to agree a price existed. • The process itself—The informal, and then formal, negotiations that led to an offer. We examine the terms of the offer including the price, payment means and other conditions, acceptance of the offer and completion. We see how the price paid by ICBC was full but fair. • Completion—The steps taken immediately after completion to take control of the bank and bring it into the ICBC group while maintaining continuity, upgrading the bank’s systems, renaming the bank ICBC (Macau) and incorporating the business of the former ICBC branch, • Highlights and financial performance post acquisition—Finally we look at some of the awards that ICBC (Macau) has won, how the competitive landscape of the Macao banking industry have been transformed since the acquisition and its financial performance post-acquisition.

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3_5

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5.1   The Reasons for the Acquisition STDM Openness to Offers After the liberalization of the gaming sector in Macao in the early 2000s, STDM had to deal with increasing competition from aggressive new entrants such as Las Vegas Sands and Wynn Resorts. The new entrants disrupted the market and the market share of Sociedade de Jogos de Macao (SJM) Holdings, the gaming subsidiary of STDM after the liberalization, fell sharply from 75% in 2005 to 40% in 2008. STDM had to focus on its core business of gaming and related services and invest more in order to compete more effectively with other casino operators such as Las Vegas Sands and Wynn Resorts as well as to absorb rising labour and construction cost. STDM had also begun construction of Grand Lisboa in 2003, at 58-floor and 261-meter tall the tallest building in Macao. The casino and restaurants opened in February 2007, and the hotel, with 430 rooms and suites, opened in December 2008. SJM was listed on the Hong Kong Stock Exchange in July 2008 in part to raise new capital to finance these investments and succeeded in raising a total of US$494 m. The sale of SHB would further bolster the financial position of the STDM group. Mr. Huen had come to recognise that there were two key factors which would restrict SHB’s future growth. • STDM’s ownership of SHB—SHB’s domestic client base was highly concentrated and it had proved difficult to attract new customers. An important reason for this difficulty remained SHB’s ownership by STDM. Potential customers were reluctant to do business with SHB because of its association with the gaming group and because they were concerned that the bank would disclose their financial situation to people in STDM. • Capital constraints—SHB had considered apply for a banking license to offer banking services in mainland China in a bid to capitalize on the opportunities there. SHB did not, however, have sufficient capital to pursue this strategy from its own resources. STDM’s investments were focused on protecting its core gaming interests and the group had none to spare for SHB. Mr. Huen had led SHB since 1989, and while he was still some way from considering retirement, he became increasingly involved in the Dr.

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Stanley Ho Medical Development Foundation which he set up in 2005. There was no obvious internal candidate to step into Mr. Huen’s shoes when he did decide to step back from his executive role. Macao had enjoyed strong economic growth for many years and had weathered the 1997 Asian Financial Crisis and 2008 Global Financial Crisis relatively unscathed but single-market banks in many other Asian countries were not so fortunate. SHB had looked for business opportunities in Portugal for the purposes of enlarging its client base but its exposure and revenue from businesses outside Macao was only a small part of its overall business. Mr. Huen had pursued a number of strategies to diversify its revenue streams but there was nothing that could be done to allow it to diversify its geographic risk: SHB’s remained heavily dependent on the Macao economy and real estate lending and these were risks it could not diversify and forced SHB to keep far more capital than it would need to if it were part of a larger, well-diversified banking group. Its low loan-to-deposit ratio and loans as a percentage of assets reflect management’s unwillingness to take on more credit risk. ICBC’s Appetite for Acquisitions ICBC has become one of the most profitable commercial banks in the world since the mid-2000s after its public listing in Hong Kong and Shanghai, but its revenues were almost entirely domestic in nature. It had started to look for ways to expand its operations outside of mainland China. ICBC realized that there were increasing demand for cross-border financial services from Chinese enterprises, and therefore, it has been actively setting up overseas branches and using cross-border mergers and acquisitions to expand its market and banking business around the world, especially in the developing market as discussed in Chap. 4. ICBC attempted to enter the banking sector in Macao in May 2003 by opening one branch with a few sub-branches but encountered significant barriers to entry. It had been able to grow its loan book but had struggled to attract depositors. This left it reliant on other sources of wholesale funding—the interbank market was likely a source. A bank such as Seng Heng Bank which had excess deposits would be especially attractive to ICBC because it would allow it to replace more expensive wholesale funding with cheaper deposits.

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In terms of total assets, ICBC is the largest bank in the world but this is almost entirely due to its domestic operations. Bank of China is far and away the most international among the Big Four mainland Chinese banks. This international dominance arises from its past historical role as the PRC’s chosen vehicle for overseas banking and foreign exchange. In 2007, Bank of China’s own operation in Macao had a 21% market share of loans and deposits, and with 26 branches, the largest branch network in Macao. It also owned 50.3% in another local Macao bank, Tai Fung Bank, bought in a rescue deal in mid-1980s. Tai Fung Bank had a 11%–12% stake of loans and deposits in Macao and had a further 21 branches. The Big Four cooperate with one another but they also enjoy intense rivalry. There seems little doubt that over time ICBC would intend to challenge Bank of China in the international arena. When strategic opportunities arose, and given its resources, price was likely to be a secondary factor. This was even more true with Macao, of great symbolic importance to the PRC and a market where ICBC could take on Bank of China head-to-head. Following the return of Macao to Chinese sovereignty on 20 December 1999 and the implementation of the “one-country, two-system” policy that was implemented in Macao after its return, the Chinese government was determined to ensure the continuing success and stability of Macao’s economy and society. ICBC is a state-owned bank, and while it maintains a degree of commercial independence, the government has used them as policy instruments in the past to support state objectives (for example with sector-directed lending). There can be little doubt that ICBC taking a major role in Macao would be supported by the Chinese government and that its acquisition of SHB would help to ensure long-term success of the territory. So ICBC’s goal of expanding outside of mainland China, its aim to match with Bank of China in Macao and that of the Chinese government’s goals for Macao were completely aligned. SHB as an Attractive Proposition Any bank with SHB’s financials and given its location that was potentially available for sale, it would have attracted interest from bidders. Propelled by the continuing growth in gaming revenue and tourism, the Macao economy appeared well placed in 2007 to continue to grow at a faster pace than mainland China or Hong Kong.

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Macao’s economy was expected to grow rapidly due to the liberation of the gaming license in 2002. Moreover, the launch of the Individual Visit Scheme (IVS) policy in July 2003 was also considered as an essential factor to boost Macao’s economic growth. As a result, the demand for Macao’s banking industry would increase significantly. In addition, the economy in the Pearl River delta or the Greater Bay Area was expected to integrate further, creating more business opportunities within the region. Mainland and international banks who had considered entering Macao found there were considerable barriers to entry besides from any regulatory banking hurdles, with established banks having taken the best locations for branches and ATM, they owned and controlled the payments systems and ATM network, and they were reluctant to open up either to new entrants. ICBC had also found cultural differences an obstacle when it tried to develop its own business. The Macao banking system has been an oligopoly and the presence of high barriers-to-entry meant that excess investor returns earned by these banks were likely sustainable. The combination of strong growth prospects and excess investor returns meant that incumbent banks in Macao deserved higher valuations on the basis of fundamentals than banks operating in markets such as Hong Kong which also had a banking oligopoly but had lower growth prospect and lower investor returns. Six of the eight largest banks operating in Macao were subsidiaries of either Chinese banks (Bank of China and Xiamen International) or Hong Kong banks (HSBC, Wing Hang and Dah Sing) (Table 5.1). Given the close interrelationship between Macao & Hong Kong and Macao & mainland China, the strong growth prospects, and better Table 5.1  Ownership and control of the 8 largest banks in Macao (2007) Bank

Ownership and control

Bank of China, Macao Branch Tai Fung Bank Limited Seng Heng Bank Limited Banco Nacional Ultramarino S.A. Wing Hang Bank Limited Luso International Banking Limited HSBC, Macao Branch Banco Comercial de Macao, S.A.

Macao Branch of Bank of China, China 50.3% held by Bank of China, China 70% held by STDM; 30% held by Mr. Patrick Huen Subsidiary of Caixa Geral de Depósitos, Portugal Subsidiary of Wing Hang Bank, Hong Kong Subsidiary of Xiamen International Bank, China Macao Branch of HSBC Subsidiary of Dah Sing Bank Limited, Hong Kong

Source: Banks’ annual reports and websites

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investor returns none of the mainland Chinese or Hong Kong banks would consider selling their Macao operations. That only left Seng Heng Bank and Banco Nacional Ultramarino (BNU). BNU is owned by Caixa Geral de Depósitos (CGD) a state-owned Portuguese bank. CGD is the largest and most international Portuguese financial group. Given the historical and continuing close links between Portugal and Macao and the deep pockets of its owners it seems unlikely CGD would consider a sale on commercial grounds only. Realistically, that only left Seng Heng Bank as potentially available, adding a premium for scarcity value. In addition, there were, however, also factors that were specific to SHB which made the bank in particular an attractive proposition. It is easy to point to SHB’s financials and operating statistics and argues that it was attractive simply on the basis of the numbers: • Size and branch network—In 2007, SHB was the third largest bank in Macao based on market share alone. Its branch network was smaller than most other banks, but its branches were generally larger and more strategically located (Table 5.2). • Profitability SHB had an impressive track record in terms of managed growth and delivering investor returns even during the Asian Financial Crisis. • Excess deposits SHB had a very low loan-to-deposit ratio leaving it with excess deposits which could be usefully employed by a bank that Table 5.2  Market shares and branches of the 8 largest banks in Macao (2007) Bank Bank of China, Macao Branch Tai Fung Bank Limited Seng Heng Bank Limited Banco Nacional Ultramarino S.A. Wing Hang Bank Limited Luso International Banking Limited HSBC, Macao Branch Banco Comercial de Macao, S.A.

Loans (%)

Deposits (%)

Branches

21.4 12.1 9.6 8.6 8.9 6.0 3.5 5.1

21.4 10.9 10.0 9.0 6.5 6.0 5.0 3.5

26 21 9 15 12 11 3 14

Source: Statistics and Census Service, Macao; banks’ annual reports and websites

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had customers who wanted loans but lacked the means to fund them other than through the wholesale market. In banking the numbers are important because they tell you where a bank has come from and where it is now, though if you want to understand where a bank is going, then you have to also look at the people and systems (in the broader sense of the word) in place. • Sound management and investments in people—Under Mr. Huen, a stable management team had been established with shared values. SHB’s emphasis on staff training meant it had better skilled staff that its local competitors with an emphasis on customer service. It also had IT staff which were in short supply in Macao. • Investments in technology and risk management—SHB’s investments in IT meant that its operations were run relatively efficiently and would scale or provide a starting point to migrate from. If an acquirer kept them they would be able to cope with substantial growth without the need to upgrade or replace them. However, if an acquirer decided to use their own systems it would be relatively easy to migrate from the existing systems using the technical staff that SHB had. SHB had also improved its risk management functions in terms of systems and practices. • Promotion of ethical business practices throughout—From his earliest days at SHB, Mr. Huen tried his utmost to keep the bank separate from its owner’s gaming activities. The bank’s value system was based on ethical business practices—and that would be important to a potential buyer. • Diversification of its business—Within the geographic constraints or Macao, SHB had succeeded in diversifying into a number or fee generating business away from traditional commercial banking. STDM’s ownership of SHB had been invaluable to the bank for many years but with gaming liberalisation its importance had reduced. A change in owner would make it easier for the bank to attract new customers. A Price Could Be Agreed ICBC and STDM could agree a price for SHB because the bank was worth more to ICBC than it was to STDM.  If ICBC controlled the bank the constraints on growth that STDM’s ownership’s imposed would be

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removed. As a much larger group ICBC could diversify SHB’s concentrated credit and business risk and operate with lower levels of risk capital if it chose to. It could also invest new capital if that were required. STDM, on the other hand, was unlikely to inject the capital to support SHB’s expansions and do anything about the issues with attracting new banking customers arising from its gaming business. It welcomed the opportunity to free up equity from its non-core banking business to reinvest in its core gaming business.

5.2   The Acquisition Process A Chance Meeting in London In 2006, the chief executive officer of SHB, Mr. Huen, was invited to attend the Bank of the Year award ceremony hosted by The Banker magazine in London. Mr. Huen was assigned to sit at the same table with Dr. Jiang Jianqing, then Chairman of ICBC and there to receive the Bank of the Year China award. Mr. Huen and Dr. Jiang talked about, among other things, the strategy of SHB. The meeting went very well as both men had quite a lot of common interests, e.g., IT systems. Dr. Jiang was also very interested in what SHB was doing in promoting China in Portugal and other Portuguese speaking countries. Talks Continued in China After the award ceremony, Mr. Huen was invited by Dr. Jiang to pay a visit to ICBC’s head office in Beijing. As the talks continued, ICBC might have realized that acquiring a local bank of reasonable size in Macao could further elevate its leading position in the Pearl River Delta. Given that SHB commanded a market share of approximately 10% both in terms of loans and deposits in Macao at that time, acquisition of SHB would substantially increase ICBC’s presence in this special administrative region. Informal Approach Leading to Formal Meeting The approach started when the former head of ICBC Macao Branch asked Mr. Huen if STDM would be interested in selling its stake to ICBC which

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Mr. Huen said they would be happy to consider. It was not long after this informal approach that a due diligence meeting was held in Zhuhai between the senior managers of SHB and ICBC. The meeting could not be held in Macao due to travel restrictions imposed by the Chinese government on the personnel of state-owned enterprises. Government officials and employees of state-owned enterprises must obtain approval from the government to travel to Macao, which is still the practice today. The meeting began with a presentation by Mr. Huen, and he was then requested to be absent for the rest of the meeting during which various department heads of ICBC had talked directly to their counterparts in SHB in great details. After these discussions between the two parties had concluded, ICBC outlined its formal proposal to acquire SHB. Advisors During the acquisition, ICBC was advised by Goldman Sachs, and STDM by Credit Suisse. Mr. Huen was also advised by his son, Mr. Ian Huen, a Princeton Economics graduate, and a Chartered Financial Analyst (CFA) charterholder with more than 15 years’ experience in global asset management. He is also the founder and the CEO of the Aptorum Group (APM), listed on Nasdaq, and an executive director and co-founder of Hong Kong-based Aeneas Capital Ltd. Terms of the Deal The acquisition plan was announced to the public by ICBC on 20 July 2007, in which ICBC proposed to purchase an 80% stake in Seng Heng Bank. Under the terms of the deal, ICBC had agreed to pay MOP4.68 billion or HKD 4.55 billion (US$ 583 m) for the entire stake owned by STDM and 10% stake owned by Mr. Huen, representing 3.25 times SHB’s net asset value (NAV). Mr. Huen and his wholly-owned company retained the remaining 20% of the shares in SHB. At the same time, ICBC entered into an agreement with Mr. Huen, which gave ICBC the option to buy the remaining stake from Mr. Huen.

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A Full but Fair Price The price paid by ICBC, at 3.25 times of NAV, was considered by some observers to be high by industry standard but it reflected the attractiveness of the Macao banking market, the particular attractiveness of SHB, its strategic fit for ICBC and scarcity value. When taking these factors into account, the price, though a full one, seems to have been a fair outcome for all parties to the deal. According to Tucker (2007), “The acquisition of Seng Heng by ICBC extended Beijing’s firm grip over Macao’s financial sector, whose largest participant is the Bank of China group” he also stated that ICBC believed that the price was justified by “Seng Heng’s strategic value, track record and management”. Other Conditions At that time, STDM had about 15,000 employees whose salary was paid through SHB, forming part of core deposits of the bank (Tucker 2007). As a condition of the deal, STDM had to agree, on a best effort basis, to ensure that the group and its related parties maintained their existing banking relationship with SHB for at least three years after the sale. STDM and Mr. Huen also told ICBC that they would not engage in any business which competed with SHB and its subsidiaries within 3 years. The negotiation process went very smoothly. A few non-performing loans were excluded from the deal after due diligence was carried out. It was also agreed that the payment for SHB would be in Hong Kong dollars instead of Macao patacas. The reason being that the amount involved was simply too large for Macao’s foreign exchange market to handle. Completion of Process On 29 August 2007, both ICBC’s and STDM’s Boards of Directors approved the acquisition proposal, in which ICBC agreed to purchase 119,900 shares of SHB, representing a 79.93% of its total share outstanding. The official signing ceremony was then held in Beijing on 12 September 2007. Among those who have attended were Dr. Stanley Ho, Chairman of SHB, Mr. Patrick Huen, CEO of SHB, Dr. Jiang Jianqing, Chairman of ICBC, Mr. Yang Kaisheng, President of ICBC, Mr. Li Xiaopeng, Deputy

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President of ICBC, Mr. Pan Gongsheng, Secretary of the Board of Directors of ICBC at that time. Following formal approvals of both the China Banking Regulatory Commission (CBRC) on 14 January 2008 and the Monetary Authority of Macau (AMCM) on 22 January 2008, the acquisition of SHB was completed on 28 January 2008. STDM’s Return on Its Investment It is worth taking a moment to work out STDM’s return on its investment. Its cash flows are presented in the following table. These cash flows provided STDM with a rate of return of more than 21% per year on its investments, a very impressive return over nearly twenty years (Table 5.3). Taken into the ICBC Group As is common with bank acquisitions, ICBC took immediate steps to bring SHB into its full control. Mr. Huen stepped down as CEO but remained as Vice Chairman to provide continuity. Mr. YU Hong, from ICBC took over as CEO and was also appointed Executive Director. Following the purchase of SHB, ICBC recruited a number of professional bankers to join the Board of Directors and the senior management team to provide advanced techniques and expertise to the bank. For example, ICBC sent banking officers who were specialized in the management of mortgage loans to SHB and established monthly meeting risk analysis meetings. ICBC (Macau) adopted a strategy of ‘based upon Macao, radiating to the Mainland, expanding into neighbouring regions and extending to Portuguese-speaking Countries (PSC)’ and an objective of become an Table 5.3  STDM investment in SHB and accounting returns (MOP million) 1989 Acquisition cost Equity injections Dividend paid to STDM Consideration from sale to ICBC Source: Seng Heng Bank annual reports

1991

1995

(25)

(75)

1998

2006

2007

2008

300

52.5

73.5

73.5 4,101

(124)

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excellent mainstream bank in Macao (Kuo 2019). This built on the strategy that Mr. Huen had developed for SHB. STDM maintained its banking relations with the banks, and Mr. Huen, who contributed significantly to the smooth acquisition, continued post-­ acquisition in the role of Vice-Chairman and Executive Director. Nobody was laid off as a result of the acquisition. Even during the Global Financial Crisis of 2008–2009, ICBC kept its promise not to lay off employees and actively encouraged them to stay in their positions. In addition, ICBC worked hard to retain SHB’s customers and related parties, including the 15,000 STDM employees whose salaries were paid through SHB. ICBC also paid special attention to provide opportunities to local employees, tried to build a working environment of mutual help and improvement, and encouraged employees to help local businesses expand. There are some important cultural differences between the management of local banks in Macao and that of state-owned banks in mainland China. Local banks, which are typically small in scale, rely more on relationship banking, personal judgement, and experience of managers in making certain business decisions. Large state-owned banks in the mainland rely more on systems, policies, and procedures of the bank to make such decisions. ICBC (Macau) has had to work out how to get the best from both approaches with some decisions better made on the basis of commercial logic and others following strict rules. Operation of Merger with ICBC ICBC Macao Branch and SHB finally merged on July 11, 2009. ICBC transferred all assets, rights and obligations of its Macao branch to SHB and also made an injection of additional cash capital. SHB was also officially renamed as Industrial and Commercial Bank of China (Macau) Limited (‘ICBC Macau’). ICBC implemented its self-developed overseas core business platform FOVA (foreign subsidiaries operation management system) into operation in SHB. It also took action to integrate SHB’s business and management into ICBC Group systems and ways of doing business. All of this was possible because of the base that had been created before the acquisition. Benefiting from its brand-new system platform, SHB further enhanced its risk management, customer relationship management, trade settlement, RMB clearing, and other operational and customer services.

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5.3   Post-Acquisition Era Highlights of Post-Acquisition In 2020, ICBC (Macau) is the largest locally incorporated bank in Macao, with 19 branches, assets of over MOP310 billion (39 billion US dollars), deposits and loans of over MOP200 billion, and employing more than 1000 people. It has also won the ‘Best Bank in Macao’ for 10 years in a row, awarded by international financial magazines such as Global Finance and the Banker. It was also ranked among top three of the ‘500 Strongest Banks in Asia Pacific’ by The Asian Banker for three years. Mr. Huen has maintained a relationship with the bank and remains as Executive Director and Vice Chairman of ICBC (Macau); and chairs the Audit Committee of its Board of Directors. The competitive landscape of the Macao banking industry has also been transformed in the years since ICBC acquired SHB. HSBC, Wing Hang Bank and Banco Comercial de Macao (Dah Sing’s subsidiary) have been pushed out of the top 8 banks in Macao based on market share. In the place of the Hong Kong banks we now have China Construction Bank, Bank of Communications and Agricultural Bank of China. ICBC (Macau)’s market share of loans has doubled from 10.4% to 20.0%. Its market share of deposits has increased from 10.0% to 24.4%. This appears to have been achieved by offering more competitive rates as the expense of lower margins. The Bank of China group has responded to the challenges from the entry of ICBC, CCB, BoCom and ABC. Its own operations plus those of Tai Fung bank now command a 46% market share of loans and control 48% of Macao’s deposits, up by 12 percentage points for loans and 16 for deposits. The large Chinese banks have taken a dominant position in Macao. The five largest mainland Chinese banks now have a market share of 78.5% of loans and 81% of deposits in Macao. Counting Luso international as well, which is controlled by mainland Xiamen International Bank, that goes up to 89.7% for loans and 95.6% for deposits (Table 5.4). Strong Sector Growth in Demand for Loans and Deposits Even in times of financial uncertainty, ICBC (Macau) continued to enjoy rapid growth in terms of its total assets and deposits. These impressive

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Table 5.4  Market shares and branches for top 8 banks in Macao (2007–2019) Loans

Deposits

Branches

2007 2019 Change 2007 2019 Change 2007 2019 Change (%) (%) (%) (%) (%) (%) Bank of China, 21.4 35.7 Macao Branch Tai Fung Bank 12.1 9.8 Limited Controlled by 33.5 45.5 12.0 Bank of China ICBC 9.6 20.0 10.4 Luso International 6.0 11.2 5.2 China 5.7 5.7 Construction Bank Bank of 4.6 4.6 Communications Agricultural Bank 2.7 2.7 of China Banco Nacional 8.6 2.3 (6.3) Ultramarino

21.4

37.5

26

33

7

10.9

10.9

21

26

5

32.3 48.3 16.0

47

59

12

10.0 6.0

9 11

24 13 9

15 2 9

9.0

24.4 14.6 1.3

14.4 8.6 1.3

4.3

4.3

1

1

2.7

2.7

1

1

3.2

(5.8)

20

5

15

Source: Statistics and Census Service, Macao; Banks’ Annual Reports and Websites

figures could be attributed to the rapid growth of the gaming industry in Macao. Specifically, several integrated resorts initiated their new projects in Cotai in early 2010, which provided abundant opportunities for small and medium enterprises (SMEs) to have business with these large corporations. These new projects also demanded a large number of imported workers which has increased the core deposit base of local banks substantially. The following two charts show the growth of loans and deposits in absolute terms and the shift in balance sheet structure and risk tolerance that took place (Fig. 5.1). Strong Growth in Loans and Deposits After the acquisition ICBC (Macau) grew its balance sheet at a rapid pace. There was a big initial expansion from the July 2009 injection of its existing business which, together with organic growth saw loans increase by a factor of 3.6x between 2007 and the end of 2009, deposits by a factor of

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Fig. 5.1  ICBC (Macau) loans, deposits and LDRs (2007–2018). (Source: Seng Heng Bank and ICBC (Macau) annual reports) Table 5.5  Loans and deposits of SHB and ICBC (Macau) 2007–2009 Loans (MOP million) Deposits (MOP million) 2007 (SHB) 2009 ICBC (Macau) Original ICBC branch Without original branch Organic growth CAGR

10.4 37.1 6.2 30.9 20.5 72.4%

26.7 42.6 5.2 37.4 10.7 18.3%

Source: Seng Heng Bank and ICBC (Macau) Annual Reports

2.0x and equity by 1.6x. Stripping out the effects of the consolidation of the original business loans, growth was at a compounded annual rate of 72.4% from the end of 2007 through 2009 and deposits at a rate of 18.3% (Table 5.5). The bank went from having a loan-to-deposit ratio of 38.7% at the end of 2007 to 87.1% at the end of 2009. From 2009 loans grew at a compounded annual rate of 19.1% and deposits at a rate of 17.1% (Table 5.6). ICBC (Macau) is much larger now than SHB ever was due to a combination of the incorporation of ICBC’s existing business, sector level growth and from taking market share from the Hong Kong-based banks in Macao.

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Table 5.6  ICBC (Macau) balance sheet growth (2007–2018)

2007–09 2009–2018 CAGR

Loans

Assets

Deposits

Equity

3.6x 5.8x 21.5%

1.8x 6.0x 22.0%

2.0x 4.8x 19.1%

1.6x 6.3x 22.6%

Source: Seng Heng Bank and ICBC (Macau) annual reports

Increased Risk Appetite There was also a significant shift in the bank’s risk profile. With the strength of its parent behind it, ICBC (Macau) was able to take larger risks. ICBC also had the connections with Chinese corporations both in Macao and from the mainland needing financing to place loans. Its loan-to-deposit ratio, which at SHB in 2007 was below 40%, had risen above 80% by the end of 2009—as it incorporated the loans and deposits of the existing ICBC Branch balance sheet—and by the end of 2018 had risen above 100%. The loans from ICBC’s former branch and deposits represented only MOP6 billion and MOP4 billion of the increase, respectively. Loans as a percentage of assets also increased sharply, from below 40% before the acquisition to 70% at the end of 2009 and remained between 60% and 70% for the next ten years. SHB did not have the appetite to take on such a level of credit risk. This is one of the largest changes in the bank’s profile post-acquisition. Financial Performance  argins and Return on Assets M The higher credit risk taken on has not resulted in higher margins—which is somewhat surprising. The net interest margin fell from 1.73% for SHB for 2007 to just 1% for 2009. Thereafter it remained fairly stable between 0.8% and 1% for 2009–2018. As you would expect in an economy enjoying such strong growth and at a bank expanding so rapidly NPLs have remained very low and have been below the sector average. Return on average assets also fell from 1.2% to 1.0% and for 2018 had fallen to 0.8%. We can infer from the smaller fall in ROAA compared to the net interest margin that the bank’s

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Fig. 5.2  ICBC (Macau) net interest margin and ROAE (2007–2018). (Source: Seng Heng Bank and ICBC (Macau) annual reports)

cost-income ratio post-acquisition fell. ICBC (Macau) appeared to have gained considerable scale economies which have allowed it to price its products (both loans and deposits) more competitively and goes some way to explain how it gained market share) (Fig. 5.2). When compared to the overall banking industry in Macao, ICBC (Macau) has outperformed the industry average. Despite the fall in ROA this was still higher than the industry average for all years except for 2018.  inancial Leverage and Return on Equity F ICBC (Macau) has chosen a similar level of financial leverage as SHB had. Average equity to average assets for 2007 was just over 13x and it has had levels varying between 11x and 15x over 2009–2018. ICBC (Macau) generated lower investor returns than SHB had achieved historically. For 2007, SHB had a 17% ROAE, and this had fallen to 11% for ICBC (Macau) 2018, and with unchanged financial leverage, this is completely due to its lower ROAA (Fig. 5.3). It appears clear from this analysis that post-acquisition ICBC chose to prioritise growth and market share over margins and profitability.

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Fig. 5.3  ICBC (Macau) asset-equity gearing and ROAE (2007–2018). (Source: Seng Heng Bank and ICBC (Macau) annual reports) Table 5.7  Selected financial data (MOP million) ICBC (Macau) 2009–2019

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Assets

y-o-y (%)

Loans

y-o-y (%)

Deposits

y-o-y (%)

LDR (%)

Loans/assets (%)

51,822 71,645 88,914 116,530 140,323 177,218 191,897 209,230 231,068 310,969 351,827

76 38 24 31 20 26 8 9 10 35 13

37,116 47,723 58,580 69,023 88,324 117,807 124,565 135,920 164,888 213,914 224,253

256 29 23 18 28 33 6 9 21 30 5

42,620 56,484 68,073 93,804 113,112 139,354 150,027 160,899 177,274 206,075 226,029

58 33 21 38 21 23 8 7 10 16 11

87.1 84.5 86.1 73.6 78.1 84.5 83.0 84.5 93.0 103.8 99.2

71.6 66.6 65.9 59.2 62.9 66.5 64.9 65.0 71.4 68.8 63.7

Source: ICBC (Macau) Annual Reports

S elected Financial Data Tables 5.7 and 5.8 show that ICBC (Macau) experienced strong growth in terms of deposits, loans and total assets over the period from 2009 to 2019. Its loan to deposit ratio (LDR) was quite high, ranging from 73.6% to 103.8%. Its ROA was about 1%, and its ROE ranged from 11.1% to 14.7%.

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Table 5.8  Net interest margin, gearing and returns for ICBC (Macau) 2009–2019

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net interest margin (%)

ROAA (%)

Assets/equity (average)

ROAE (%)

1.03 0.85 1.00 0.86 1.04 1.11 1.09 1.09 1.10 0.97 1.06

0.98 1.04 1.00 0.95 0.96 0.96 1.10 1.08 1.00 0.82 0.93

14.2 10.9 12.0 13.6 14.4 15.3 11.4 11.2 11.2 13.6 13.1

14.4 12.9 12.0 12.9 13.9 14.7 12.6 12.1 11.2 11.1 12.2

Source: ICBC (Macau) Annual Reports

References Kuo, M. (2019). Banking on Macao. Macao Business, July 5, 2019. Tucker, S. (2007). ICBC clinches 80% stake in Seng Heng. Financial Times, August 30.

CHAPTER 6

Conclusions

STDM has been handsomely rewarded for their investments in Seng Heng Bank, Dr. Ho’s confidence in Mr. Huen and STDM’s willingness not to interfere in the running of the bank. From 1989, when STDM bought SHB from Mr. Riady’s Lippo Group until the sale of the bank to ICBC in 2007, STDM invested a total of MOP224 million and was paid dividends totalling approximately MOP500 million and received MOP4,101 million in 2008 from the sale. This is a very impressive annually compounded rate of return of more than 21% per year on STDM’s investment. In this concluding chapter, we review the acquisition in hindsight, considering the changes in the Macao banking industry since the acquisition, and then revisit the key factors that led to SHB’s successful performance prior to its takeover.

6.1   The Acquisition by ICBC: Hindsight Acquisition by ICBC seemed a natural choice at the time. STDM was open to offers to divest from a non-core business and ICBC was looking for opportunities to expand outside mainland China. STDM received the capital to invest in its core gaming interests, and ICBC got a solid foundation on which to build in Macao. Without international expansion and diversification, it is exceedingly difficult for small single-market banks to survive even in larger markets such as Singapore and Hong Kong. SHB lacked the capital, connections or experience for international expansion. © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3_6

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In hindsight, SHB also escaped the existential threat of the large banks in mainland China. Macao has become a proxy battleground for their domestic rivalries. China Construction Bank (CCB), Agricultural Bank of China (ABC) and Luso Bank (owned by Xiamen International Bank) have all gained market share at the expense of incumbents. Bank of China has been vigorously defending its own position with considerable success. If ICBC had not acquired SHB it seems highly likely it would have built up its Macao operations in any event. Mainland banks have squeezed the Hong Kong banks out of the Top 8 banks in Macao and the only non-­ mainland bank remaining, BNU, has seen its market share of loans fall by 73% and of deposits by 64%. Without the sale to ICBC, SHB would have seen its market share and profitability enter prolonged decline. With its parent weakened by gaming liberalisation and its difficulty to undertake any meaningful expansion in China, SHB’s prospects in such a market would appear bleak. Instead, as a result of the acquisition by ICBC, the bank’s employees have enjoyed being part of the largest bank in the world and also seen their own part expand rapidly, and with it, their own opportunities to progress. The timing of the sale of SHB appeared fortuitous because it occurred immediately before the 2008 Global Financial Crisis. With the benefit of hindsight, it is possible to see just how good a decision it was to accept ICBC’s offer.

6.2   A Success Story Before the acquisition, SHB had enjoyed 18 years of profit-making with an average ROAE of 21%, and even in its worst year, it was still above 13%. It had maintained the momentum for development even during the 2008 Global Financial Crisis, making a satisfactory after-tax profit of MOP214 million while many banks in a lot of other countries fought for survival and had to be bailed out by their own governments. This is an enviable financial performance for any bank. SHB had also been very innovative in its banking operations. It was the pioneer to offer systematic staff training programme in Macao. It was the first bank in Macao to offer asset management and pension fund management services. It had been a leader in the application of Information Technology. It had been the leading credit card merchant and issuing bank. SHB also received “The Best Bank in Macao” rewards from Global Finance magazine based in New York and

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“Bank of the Year”—awards from The Banker magazine based in London on numerous occasions.

6.3   What Can Be Learned? The bank’s success can be attributed to a combination of internal and external factors. In this chapter, we examine these internal factors in more depth to better understand how SHB equipped itself to capitalize on the favourable external factors (e.g., the social stability in Macao); rapid growth of the economies of mainland China and Macao; the huge increase in wealth and the surging property prices in both mainland China and Macao to become one of the best banks in Macao and the lessons we can learn from the case. Corporate Governance and Business Ethics Two of the most important factors behind the success of SHB concern corporate governance and business ethics. The ownership of a deposit-­ taking bank by a non-financial conglomerate always poses particular corporate governance challenges. In many countries such ownerships of banks by conglomerates is not permitted but Asia had many such banks in the 1990s. The biggest risks of this ownership concern connected lending, connected transactions and shared information. • Connected lending refers to the bank making loans, funded by its depositors to members of the wider group on more favourable terms and with less collateral than to other borrowers. • Connected transactions refers to the bank buying assets from the conglomerate at inflated prices or sells assets to the conglomerate at below market prices and paying dividends to owners that are sufficiently large enough to weaken the bank’s capital position. • Shared information refers to the bank passing on commercially sensitive information about the financial affairs of its customers to its owner. The risks of connected lending and transactions are greatest when an economy is in crisis and the conglomerate is most in need of support from its banking subsidiary. Many such banks failed during the Asian Financial

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Crisis in Thailand and Indonesia as a result of connected lending and transactions and had to be bailed out in Malaysia, Taiwan and South Korea. Regulators routinely impose restrictions on the level of connected lending, but banks are often able to find creative ways to circumvent such restrictions. Wholesale depositors recognise that these risks exist and that it was not possible to tell solely from bank financial statements if connected lending and transactions were being undertaken. They are consequently reluctant to deal with such banks. Closely related to good corporate governance is strong business ethics. After its acquisition by STDM, SHB had focused on staff training and business ethics. Business ethics are a form of applied or professional ethics that deals with a code of conduct that should be followed while doing business. While doing the right thing sounds easy, it can be exceptionally hard in practice. Top management and supervisors can create an ethical workplace environment by acting as a role model and setting an example for employees to follow which Mr. Huen ensued was the case. Business ethics is important for all businesses and it is especially true for banking as banking is about building trust and maintaining public confidence in order to attract and retain short term deposits with which to fund longer-term loans. Deposit withdrawals are on a “first come, first served and full amount” basis. If customers are concerned about the safety of their money, contagious bank runs can occur and even well-managed banks can fail, threatening the stability of the entire banking system. By contrast, bank loans are privately negotiated financial contract, the information collected by banks when evaluating creditworthiness is highly confidential and sensitive. In the absence of full deposit protection, depositors will not keep their funds with a bank where they have concerns about the quality of the bank’s assets—especially when the bank’s owner is a conglomerate. By having a reputable, strong and independent board of directors, SHB was able to create a conducive environment where ethical behaviour was promoted and trust of customers was maintained. Arms-Length Relationship with STDM After the acquisition of SHB by STDM in 1989, Mr. Patrick Huen realized that casino-related directors in SHB might hinder the potential growth of the bank due to their lack of banking experience and expertise,

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as well as concerns of potential customers about banking with SHB. After convincing Dr. Stanley Ho of the need to restructure the board, Mr. Huen hired professional bankers, entrepreneurs, and scientists to form a diversified but professional board. These directors had not only professional expertise in banking but also an excellent reputation. SHB was helped by the fact that, at least until gaming liberalisation, STDM had no need to borrow from anyone. SHB acted as an asset manager for STDM’s excess funds. This type of business held far less risk to the bank and its depositors. After gaming liberalisation this changed, STDM needed funds to invest in its core gaming operations. Borrowing from SHB would have seriously eroded depositors’ trust and STDM turned to the equity markets instead by listing its shares on Hong Kong stock exchange. SHB succeeded in keeping the relationship with its owner arms-­ length and this was a prerequisite for its continuing success. Risk Management The bank’s management system was sufficiently robust that it was able to cope with various crises including the 1997 Asian Financial Crisis, the hospitalization of Mr. Huen, the CEO, for weeks due to SARS infection in 2003, the accusations of money laundering by Wall Street Journal in 2005 as well as the 2008 Global Financial Crisis. SHB put in place systems to monitor and manage traditional bank risks (e.g. credit risk, interest rate risk and foreign exchange risk). It is possible to hedge interest rate and foreign exchange risks, but it is extremely difficult for any bank to hedge credit risk and is impossible for a bank operating in Macao. The best that most banks can hope for is to diversify credit risk. There is a limit to how much a small single-market bank can diversify credit risk. This was particularly true in Macao. The lending opportunities in Macao in the 1990s and 2000s were quite limited in terms of sector, and almost all of them involved some degree of real estate exposure, whether it was in loans to property investors or developers or the lower risk residential mortgages or in the form of collateral. Banks in Macao in the 1990s and 2000s had to choose between profitability and risk: the higher the level of loans the higher the interest margin but the greater the credit risk and exposure to real estate. SHB management chose to turn down more lucrative lending opportunities because of the risks involved. Management allowed loans as a percentage of assets to

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fall and accepted a narrowing of margins as the price of taking a more conservative, risk averse lending stance than most other banks in Macao. This paid off during the 1997 Asian Financial Crisis. In the run up to the crisis in 1997 loans fell from 62% of assets at the end of 1994 to 41% at the end of 1996. NPLs for Macao as a whole reached 22%, but reached only 5.4% at Seng Heng Bank. It avoided the heavy bad debt losses of some of its peers as a result. By the time of the offer from ICBC, SHB had significantly a lower level of financial leverage than in its early years and had a lower asset-equity leverage, lower loan-to-deposit ratio and lower proportion of loans as a % of assets than most other banks in Macao. When the sale took place, SHB had a clean balance sheet with a low loan-to-deposit ratio that ICBC had the risk appetite to exploit. International Expansion Strategy Another lesson one can learn from the success of SHB is the importance of diversification of the banking businesses. It was not possible for SHB to diversify its lending risks, but it could seek to expand its revenue sources and diversify its broader business risks. Under the leadership of Mr. Huen, SHB sought to diversify its banking activities in several different ways. It looked for new business lines in Macao but Macao is tiny in terms of its physical area and its economy highly dependent on the gaming and the tourism sectors so SHB also looked for opportunities outside Macao. SHB had brought in new customer delivery services, such as its ATM network that generated fee income. It provided foreign exchange to the many foreign visitors Macao hosted each year. SHB was the first bank to initiate pension fund management in Macao and the first local bank to set up an asset management company (i.e. Seng Heng Capital Management Limited). It also developed fund management for high net-worth individual clients and institutions and online stock trading for investors. It became the leading credit card merchant bank and the second largest issuer. Generally speaking, fee income offers higher risk-adjusted returns to banks as most of the risks were borne by the customers or investors. Bank lending is often regarded as a fool’s game as its upside potential is very limited and the downside risk is huge. Credit risk control and mitigation is, therefore, critical for commercial banks.

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SHB had sought to capitalize on opportunities in the Pearl River Delta region in China through investment banking services and the development of fund management for high net-worth individual clients and institutions. SHB intended to diversify further by offering banking services in the mainland, however, it did not have necessary financial resources to do so as STDM needed to focus on its core business of gaming in Macao. SHB extended its connections with the European market by forming an alliance with the Portuguese Caixa Geral de Depósitos group to promote trade activities between the East and the West in 2005. In order to cater for the growing banking and capital accumulation needs of Macao’s booming economy, SHB opened a representative office in Portugal. The move was intended to position the bank for increased cross-border business between China and Portuguese-speaking countries via Macao. Staff Development and Training SHB took the lead in training its staff. Management hoped that this would allow it to provide a better, consistent service to its customers and lower the staff turnover rate which for all banks in Macao was alarmingly high. SHB established a 465 square-meter training centre, where in-house courses and seminars could be held for its staff. The bank also encouraged its staff to attend external courses in Hong Kong and overseas and sit for external examinations to obtain professional qualifications like Certified Banker (CB), Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). At one time, SHB had more CFA Charterholders than any other financial institutions in Macao. Adoption of Information Technology Another lesson one can learn from the success of SHB is the importance of the IT and use of computer systems in banking. Soon after the acquisition of SHB by STDM, Mr. Huen decided to invest significantly in IT for the bank to allow it to offer new banking products and services as well as to increase efficiency and improve customer service. Over the years, it continued to invest in software to support service delivery, customer relationship management (CRM), accounting and risk management. Its up-to-date computer system and skilled

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personnel were selling points in the sale of SHB to ICBC and helped ICBC to link up its systems in its Macao subsidiary with those of its parent in mainland China.

6.4   Concluding Remarks In the United States and many other countries, Capital adequacy, Asset quality, Management, Earning, Liquidity, and Sensitivity (CAMELS) are widely used by regulatory authorities to assess the strength of commercial banks. SHB was well capitalized with relatively low financial leverage. Its asset quality was exceptionally good as indicated by the very low NPLs to total loan ratio. It had an outstanding management team. Its earning was steady and consistent with a ROA of around 1% and a ROE in the mid-­ teens. Its liquidity position was strong as the ratio of loans to total assets was quite low. As the saying goes, a rising tide lifts all boats. When the economy is doing well, all banks, good or bad, can report good earnings. But when the economy is in trouble, some banks may go bankrupt, some can barely survive and need to be bailed out by taxpayers, but professionally managed banks will continue to thrive. SHB was indeed one of those banks that had performed well in bad times as well as good, resulting an impressive rate of return to shareholders of over 21% per year over the 20-year period. It is equivalent to turning every dollar invested at the beginning of the period into 45 dollars at the end of the 20-year period.

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Index

A Allianz Group, 61, 62 American Express, 61, 62 Anti-money laundering, 21, 53 Asian Banker Research, 3 Asian Financial Crisis, 6, 9, 11, 18, 23, 27, 30–34, 39, 40, 44, 47, 73, 76, 93–96 ATM, 17, 33, 75, 96 B Banco Comercial de Macau, 2, 14 Banco Nacional Ultramarino, 14, 15, 75, 76, 84 The Banker, 2, 34, 38, 78, 83, 93 Bank of China Macau Branch, 17 Banque Nationale de Paris, 25 Beijing, 7, 12, 78, 80 Bretton Woods Agreement, 15 C Caixa Geral de Depósitos, 13, 76, 97 Capital adequacy, 3, 16, 17

Cathay Pacific, 15 Central Huijin, 67 Centre for Investment and Risk Analytics, 54 Certified Banker, 97 Charles YEUNG, 48 Chartered Financial Analyst, 97 CHENG Yu Tung, 24, 47 China Cinda Asset Management Corporation, 58 China Great Wall Asset Management Corporation, 58 China Huarong Asset Management Corporation, 58 China Life Insurance Company, 68 China Orient Asset Management Corporation, 58 CHUI Sai Cheong, 48 Corporate governance, 5, 7, 34, 62, 63, 68, 93, 94 Counter-terrorist financing, 21 Credit cards, 27 Credit monitoring, 5 Credit risk, 5, 20, 21, 30, 39, 55, 95, 96

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2021 P. W. M. Huen et al., Seng Heng Bank, https://doi.org/10.1007/978-981-16-0398-3

103

104 

INDEX

D Dah Sing Bank, 2 Deposit insurance, 20 E Euromoney, 65 F Fee-based income, 96 Finance and IT Centre of Macau, 54 Foreign exchange risk, 20, 95 Fortis Bank, 64 Francisco Luís Murteira Nabo, 48 Frost, Stephen, xi, 52 G Galaxy Entertainment, 11 Gaming, 3–7, 9–13, 17, 21, 24–27, 35, 55, 72, 74, 75, 77, 78, 84, 91, 92, 95–97 Gates, Bill, 26 Gearing, 36, 39, 44–47, 89 Global Finance, 2, 3, 38, 65, 83, 92 Global Financial Crisis, 3, 6, 9, 11, 19, 20, 73, 82, 92, 95 Gold, 14–16 Goldman Sachs, 58, 61, 62, 68, 79 Greater Bay Area of China, 7 H HO Yin, 24 Hong Kong Exchange, 59 Hong Kong-Macao Ferry Terminal, 28 Hong Kong Shanghai Banking Corporation (HSBC), 14, 25, 26, 31, 52, 75, 83 Hotel Lisboa, 28

HSBC, see Hong Kong Shanghai Banking Corporation Huen, Ian, 79 Huen, Patrick, 23, 25–27, 29, 34–37, 47, 52, 55, 72, 73, 77–83, 91, 94–97 I ICBC acquisition offer, 2–3 A-shares, 59, 67 awards, 65 Board of Directors, 68, 69, 81 expansion strategy, 63 fee-based income, 61 financial performance, 66 history, 2, 57, 60 H-shares, 59, 68 IPO, 58 mission, 62 New York Branch, 64 non performing loans, 57 ownership, 67 post-acquisition successes, 3 Seoul Branch, 63 Singapore branch, 63 Sydney Branch, 64 Tokyo Branch, 63 Turkey, 65 ICBC (Argentina), 65 ICBC (Asia), 63, 64 ICBC (Europe), 64 ICBC (London), 64 ICBC (Macau), 15, 85–89 awards, 3, 83 balance sheet growth, 84 Board of Directors, 83 cost-income ratio, 87 financial data, 88–89 financial performance, 83, 85–89 gearing, 88

 INDEX 

history, 64 leverage, 88 market share, 83 merger with SHB, 3 post-acquisition successes, 3 risk appetite, 86 ROE, 87 strategy, 6, 81 total assets, 3 IMF, see International Monetary Fund Insurance companies, 13 Interest expense, 39 Interest income, 39, 49 Interest rate risk, 5, 20, 21, 32, 54, 95 International Monetary Fund (IMF), 11, 13, 15, 17, 18, 21 J Jiang Jianqing, 78, 80 K KO Ping Keung, 48 L Lehman Brothers, 6, 20 Li Xiaopeng, 80 Liquidity risk, 5 LOU Tou Vo, 24 M Macao banking history, 13–14 banking system, 75 bank profitability, 18 economy, 9, 75 financial sector, 13–21 GDP, 9–11, 13, 17 history, 1, 11, 14 One Centre, One Platform, 6–7 population, 1, 9, 16

105

Macao Air Transport Company, 15 Macau International Airport, 25, 28 Market risk, 18, 20 Melco-Crown, 11 MGM Mirage, 11 Ministry of Finance of China, 67 Monetary Authority of Macao, 36, 37, 53, 81 Multi-Fiber Agreement, 11 N National Security Fund, 68 National Social Security Fund, 67 Net asset value, 2, 79, 80 Net interest income, 39, 40, 49 Non-interest income, 42 Non-performing loans, 57, 58, 62 North Korea, 36, 37 O OCBC bank, 2 Operational risk, 20 Overseas Trust Bank, 14 P Pan Gongsheng, 81 Payment and clearing services, 5 Pearl River, 1, 15, 54, 75, 78, 97 Ping An Asset Management Company, 68 Ping An Life Insurance Company, 67 Portuguese-speaking countries, 6, 27, 55, 97 R Return on assets (ROA), 19, 29–31, 39, 47, 66, 87, 88, 98 Return on equity (ROE), 16, 19, 30, 87 Riady, Mochtar, 24, 25, 28, 91

106 

INDEX

ROA, see Return on assets ROE, see Return on equity Rogue Choi, 24 Role of banks, 4–5 S Sendero, 32, 54 Seng Heng Bank Asset-Liability Management Committee, 54 ATM, 28 awards, 2, 27, 38 Board of Directors, 25, 47, 94 book value, 33 business ethics, 47–55, 93, 94 business model, 26 computerisation, 26 corporate governance, 23, 47, 93 cost-income ratio, 43 credit card centre, 27 credit risk, 53, 73, 86 diversification, 27, 77, 96 Easiphone, 28 financial data, 47, 53 financial performance, 28–32, 36, 38–41, 43, 44, 46, 47 gearing, 45, 46, 96 history, 2, 23 IT, 23, 26, 29, 35, 54, 55, 97 net interest income, 38 non-performing loans, 44 other income, 38 risk management, 95 staff training, 24, 26, 53, 77, 92, 94, 97 sustainable competitive advantage, 23–24, 26, 34, 35 SWOT, 55–56 Shanghai Stock Exchange, 58, 59

Shun Tak Centre, 25 Singapore, 3, 26, 65 Sociedade de Jogos de Macao, 11, 24, 72 Sociedade de Turismo e Diversões de Macao (STDM), 11, 23–26, 28, 29, 33, 47, 53–55, 71–73, 75, 77–82, 91, 94–95, 97 South China Morning Post, 17, 37 Standard Bank, 64, 65 Stanley Ho, 24–26, 47, 55, 73, 80, 95 STDM, see Sociedade de Turismo e Diversões de Macao Stephens, Jackson, 24, 25 T Tai Fung Bank, 14, 15, 17, 74–76, 83, 84 Temasek Holdings, 68 U Union Bank of Hong Kong, 63 W Wall Street Journal, 36, 95 Wing Hang Bank, 2, 27, 83 World Bank, 15, 17 Wynn Resorts, 11, 72 Y Yang Kaisheng, 80 Yaohan Department Store, 28 Z Zhuhai Special Economic Zone, 25