Profit Before Tax of £55 million was £9.5 million (21%) higher than last year and the after tax return on opening equity was 23.5%.

The increase in earnings arose from higher Operating Profits (before Bad Debts) which grew by £11.4 million (17%), fuelled by a solid rise in Operating Income. Credit quality remained stable and the charge for Bad Debts increased in line with the growth in Loan balances.
 

The Bank's Balance Sheet remained robust throughout the year with strong Liquidity and Capital Ratios. The Risk Asset Ratio was 11.6% at the half year and increased to 12.8% at the year-end, substantially in excess of the regulatory standards. During the year the Bank's sole equity shareholder increased its investment by £5 million and, in January 1998, the Bank issued £30 million of Subordinated Perpetual Notes which further increased the regulatory capital base. This will ensure the Bank maintains a strong Risk Asset Ratio whilst expanding the business during 1998.

Balance Sheet stability has been underpinned by £1.9 billion of highly-rated Debt Securities. These include a closed-end Investment Portfolio of £650 million designed to provide a source of stable, long-term income. At the year-end, the market value of this Portfolio exceeded Book Value by £22 million.

The Bank has also continued to develop its distinctive market position based on its Ethical and Ecological Policies, innovative products and superior customer service. It now offers its personal customers probably the most extensive and convenient customer service facilities in the UK. Cash and Deposit services for personal customers are now available at 15,500 Post Offices in addition to the Bank's 24-hour automated outlets, full service branches and in-store facilities. The Bank is also a founder member of the LINK ATM network, with over 14,000 cash machines in the UK. Telephone Banking facilities have continued to attract ever more customers and, during the year, nine million incoming telephone calls were received from both personal and corporate customers. The Bank's reputation for innovation will be reinforced in 1998 with its new Internet Banking service. Despite increased competition, retail Savings and Loan balances continued to rise substantially and the Bank's Net Interest Margin improved slightly. Deposit balances continued to grow faster than Loans.

Internet Banking

Average Retail Lending balances of £2,305 million increased by £235 million (11%) in 1997. Most of the increase arose in the Personal Sector where Average Loan balances of £1,187 million were £215 million (22%) higher than last year. Visa balances increased by £142 million (39%), driven by the success of the new Advantage product and the continuing appeal of the Gold Card.

The Co-operative Bank Visa Goldcard

Overall, total Average Retail Deposits exceeded lending by £578 million, an increase of £230 million. Wholesale Placements and Deposits also increased in 1997 as a result of placing surplus deposits in the financial markets and hedging Interest Rate Risk in addition to proprietary trading. On average, Wholesale Placements exceeded borrowing by £981 million in 1997, higher than last year by £262 million. A majority of market placements were in the form of high-grade liquid securities.

Operating Income of £316 million was £29.5 million (10%) higher than last year. Most of the increase arose from Net Interest Income of £209 million which increased by £28.5 million (16%), driven by the growth in Loan and Deposit balances. The Bank's overall Net Interest Margin remained stable at 4.5%, increasing slightly by 0.1% due to the contribution from Current Accounts. The interest spread (being the difference between the interest rate paid on Deposits and the interest earned on Loans) was in line with the previous year. In 1997, Corporation Tax rates were reduced, resulting in a £1.2 million write-down of finance lease receivables on contracts where the benefits of tax changes are to be passed to the customer. The consequent reduction in Operating Income has been offset by a lower tax charge.

Non-Interest Income of £107 million was £1 million higher than last year. In 1996, Non-Recurring Income of £1.6 million arose from a subsidiary that was sold later in the year and from the re-purchase of the Bank's Subordinated Notes. Visa and Insurance Commission increased steadily. Other Fees and Commissions to personal customers also increased but Transmission Income was lower than that last year and incremental hedging Income was reduced as positions matured. Credit quality remained stable in 1997. The charge for Bad Debts of £26.3 million was £2.6 million higher than last year, a rise of 11%, equivalent to the growth in Retail Lending. The Bad Debt charge represented 1.1% of Average Customer Lending which was in line with last year. Personal Sector charges were £25 million, an increase of £3.9 million (18%) due to the higher Loan balances.

The Bad Debt charge represented 2.1% of the Average Balances, 0.1% better than last year. Provision rates remained much lower than industry norms, particularly in the case of Visa. Corporate Sector provisions were also at a low level. The charge for Bad Debts of £1.3 million was half of last year's charge and represented only 0.1% of the Loan Portfolio which mainly consists of small and medium size enterprises. The Bank operates a prudent provisioning policy and, in recent years, has benefited from write-backs of prior provisions as problem loans have been eventually resolved.

The low level of Bad Debt charges in recent years reflects several factors; the state of the UK economy, the improvements in credit cycle management and the improving quality of the customer base. Some increase in the provisioning rates are expected as the pace of economic growth declines and there are fewer large write-backs of prior years' provisions.

Expenses of £237 million were £18.1 million (8%) higher than last year but this increase was £11.4 million less than the rise in Operating Income. The Bank has continued to develop its customer service facilities and its core technology systems whilst realising some early benefit from reorganising its Branch and Regional Network.

Details of all the foregoing are set out in a separate results summary which has been produced as a complementary document to the financial statements.

financial markets

The Bank is a participant in the wholesale financial markets in respect of the placement of surplus deposits and the use of market instruments to manage interest rate risk

A comprehensive programme is well-advanced to test, enhance and replace systems ensuring they will not be impaired when the date changes on 1st January 2000. This extensive programme is being controlled by a dedicated Project Team. They will ensure computer hardware, software, peripherals and other equipment with embedded time systems, will be fully-operational in the new millennium. Key customers and suppliers are being advised and monitored to minimise the risk of third party failure. The incremental cost of the Year 2000 programme was £6 million in 1997, in addition to the Bank's re-deployment of internal resources. In 1998, the core programming work will be substantially completed and facilities for the new Single European Currency will also be developed. Technology underpins most of the Bank's development programmes and, including Year 2000, systems developments and data centre costs increased by £10 million year-on-year.

Developments in customer service facilities have resulted in lower costs of operating the Branch and Regional Network and higher expenditure within the Telephone Banking Centres. As a result of the rationalisation programme, Branch and Regional Network costs of £73 million have been reduced by £3 million. Bullion handling has been outsourced to another clearing bank and this will generate further savings in 1998. In 1997, the costs of the Telephone Banking Centres were £53 million, an increase of £7.4 million. Telephone calls have been increasing by approximately 20% a year.

One of our 24-hour automated outlets

The Bank also incurred reorganisation expenses of £4 million, including severance costs of £2.1 million which were higher than last year by £0.9 million, but these were largely offset by lower premises rationalisation expenses in 1998.
The principal operating, credit and market risks facing the Bank are assessed by the Board or designated sub-committees of the Board. High Level Controls and the detailed policies, key procedures and limits, are approved by the Board and discretions are allocated to the appropriate line management. Specialist departments within business divisions and Head Office are responsible for the monitoring and control of sector risks. Head Office departments monitor aggregate exposures and administer the process whereby the Board approves all large exposures, regularly reviews the key consolidated exposures and areas of risk.

As a Settlement Bank, operating at the core of the UK money markets, The Co-operative Bank is well placed to use Wholesale market instruments to manage Interest Rate Risk. In recent years, Retail Deposit balances have consistently exceeded Loan balances and, hence, the Bank is consistently placing surplus funds into the wholesale financial markets whilst using the full range of market instruments, including derivatives, to manage interest rate exposures within approved limits. Transactions for proprietary trading positions, investment management and hedging activities to manage structural and product interest risk, are segregated and managed within distinct controls and limits for each activity. Accounting Policies are consistent with the Statements of Recommended Accounting Practice issued by the British Bankers' Association and the Accounting Standards Board as disclosed in the Notes to the Accounts.

The Asset and Liability Committee of Executive Directors is responsible for the Bank's structural Interest Rate Risk exposure and Balance Sheet hedging policies. The objective is to manage Interest Rate Risk to ensure that the effect of adverse rate movements can be offset by normal business management actions such as product pricing, volume and cost control. Hedging transactions provide rate protection and ensure that mis-matches between the interest rate maturities of Assets and Liabilities are controlled.

Derivatives are mainly used for hedging purposes and to meet the needs of customers.

Straightforward, frequently-traded contracts with standard documentation are used and counterparties are of the highest credit quality. The Bank is not a market-maker.

Derivatives are subject to the same credit approval and control procedures as are used for other credit transactions and all are aggregated to monitor total counterparty exposure within an approved limit for each counterparty. In addition to normal credit criteria, there are limits on the proportion of derivative exposure within each individual counterparty limit and on the aggregate of all derivative exposures.

The Bank has established a defensible position in its chosen markets within the highly competitive UK market place. It has established a track record of solid business growth along with investment in new methods of banking practice and customer service delivery which will be its platform for the future.

Our Telephone Banking Centre at the Pyramid, Stockport