Financial Highlights
In 2001, The Co-operative Bank recorded a Profit Before Tax of £107.5 million, £11.2 million (11.6%) higher than 2000, despite significant business development expenditure. Earnings attributable to the equity shareholder, after tax, were £68.5 million, a rise of 15.7%, and the Return on Opening Equity, after tax, was 21.1%.

The increase in profitability arose from higher operating profits, before bad debts, up by 11.3%, reflecting a 6.2% rise in Operating Income and a further improvement of 1.7 percentage points in the Cost/ Income Ratio. Credit quality remained stable, and the charge for bad debts, which increased by £6.3 million, was slightly better than last year, at 1.71% of loans and advances to customers.

The Balance Sheet remained strong throughout the year, with continuing robust liquidity and capital ratios. The year-end Risk Asset Ratio was 13.7%, with a Tier 1 Ratio of 9.9%, substantially higher than the regulatory standards. At the year-end, Balance Sheet liquidity was underpinned by £2.7 billion of highly-rated debt securities.

Business Highlights
There are various indications of growing pressures within the UK economy. Output has been falling, with manufacturing businesses slipping into recession, but consumer confidence and retail demand have so far generally remained robust. These imbalances are unlikely to be sustainable indefinitely, and the timing of an economic recovery is particularly uncertain, with other major world economies experiencing severe slowdowns or recessionary conditions. In this unusual business climate, the bank has continued to grow steadily whilst continuing to adopt a cautious lending policy.

In 2001, retail customer deposit and lending balances both grew strongly. Average retail deposit balances of £4,887 million increased by £935 million (24%) and were £1,344 million higher than average retail lending balances which, at £3,543 million, increased by £485 million (16%).

The growth in retail customer deposits was spread fairly evenly across the Personal and Corporate sectors, with average Personal deposits growing by 28% and average Corporate deposits by 17%. Both the Personal and Corporate sectors increased their retail lending, although growth was stronger in the Corporate sector, with an increase in average lending of £357 million. In the Personal sector, average lending increased by £128 million. This had the effect of better balancing the retail lending portfolio between the Corporate and Personal sectors, and reflected both our successful focusing on specific opportunities within the Corporate sector, and the more targeted marketing and tighter acceptance criteria within our Personal sector credit application and behavioural scoring systems.

Corporate and Business banking in general had a fruitful year, which included a substantial financing arrangement for Manchester Airport, and participation in major syndications for high quality national companies. It also benefited from the specialist expertise developed in the community, voluntary and environmental sectors, and business was increased in all these areas. In addition, during the last year, the banking business of a further eight Local Authorities was gained, consolidating and strengthening the bank's position as a major provider of financial services to that sector. The bank is now, for the first time, banker to all ten Local Authorities in Greater Manchester.

In September 2001, the bank received the prestigious award "Charity Bank of the Year" from the Charity Times, reflecting the bank's reputation for superior service and product offerings, alongside its ethical and environmental policies.

In addition, business banking facilities for small and medium-sized companies were re-aligned, working in partnership with several trade associations.

Personal Banking also had a successful year, balancing careful control of new lending with timely and well-received new product launches to meet the changing needs of customers.

In June 2001, 'Privilege', a new current account was launched. As well as offering full current account facilities, including a guaranteed overdraft at a preferential rate, it also provides a wide range of attractive lifestyle benefits at discounted prices, and all for a small monthly fee. So far, take up of Privilege has been very encouraging.

The bank re-entered the mortgage market in late 2000, initially offering mortgages mainly to existing customers. In 2001, the mortgage product range was extended to include fixed-rate and capped-rate products, delivered across a range of channels, including telephone, internet, branches and intermediaries. The mortgage range was also promoted to attract new customers to the bank as well as to appeal to existing customers.

Growth has continued in the personal loan market, where efforts have been focused on existing customers and established introducers, rather than extensive direct marketing to non-customers. As part of this programme, the bank trialled new pricing structures which relate the interest rate on a loan to the credit risk profile of individual customers.

VISA credit cards were also promoted selectively and new products were also introduced. There was solid growth in our affinity card base, where we welcomed two major new affinity partners in Barnardo's and ActionAid. In the Platinum card market, we launched both an innovative 5-year fixed-rate product and a competitive variable-rate product; and in our own Co-operative sector we introduced a credit card specifically tailored to retail non-food customers.

Also, within the Co-operative movement, we continued to expand our network of cash machines located in retail stores. By the end of the year these numbered 650, a figure which will rise during 2002 as more installations are completed.

Operating Income
Operating Income of £455.6 million was £26.6 million (6.2%) higher than last year, reflecting steady growth in both Net Interest Income and Non-Interest Income.

Net Interest Income was £313.5 million, an increase of £19.4 million (6.6%). The rise in Net Interest Income was mainly due to growth in customer balances, partly offset by a reduction in the overall net interest margin. Although margins for certain products have narrowed in line with industry trends, the reduction in the overall margin mainly arose from mix changes, where the growth in Corporate lending and wholesale asset balances was higher than in Personal lending. The bank's increase in wholesale assets mainly arose because retail deposits overall grew faster than retail lending and these incremental deposits were placed in the financial markets.

Corporate and wholesale lending attracts a lower margin than unsecured Personal lending because such lending generally represents a lower credit risk. As a result of this improvement in the credit profile, the bank's net interest spread (the difference between interest rates paid on deposits and that earned from loans) reduced by 0.2% to 3.7%. In addition, the contribution from interest-free liabilities was reduced by 0.2%, due to the lower interest rate environment. Hence, the overall net interest margin was 4.4% compared with 4.8% last year.

Average interest-earning assets of £7,175 million increased by £983 million (15.9%), reflecting growth in retail customer lending of £485 million and an increase in wholesale market placements of £498 million. Average interest-bearing liabilities rose by £856 million (16.6%) to £6,001 million, driven by growth in interest-bearing retail customer deposits of £860 million. The increase in average interest-free balances mainly arose from higher Current Account balances and the bank's retained earnings.

Non-Interest Income of £142.1 million was £7.2 million higher than last year, an increase of 5.3%. Net commission and fee income increased by £8.1 million (9.1%) mainly reflecting higher inter-bank commission from the bank's expanded ATM network, along with higher VISA commission and customer service fees. Insurance commission income was slightly higher than last year by £0.4 million. Other income was £1.3 million lower than last year due to lower dealing income in 2001. Most of the bank's income from its Treasury activities is included in Net Interest Income.

Operating Costs
Operating Costs of £281.9 million were £9.0 million higher than last year, a rise of 3.3%. The increase in costs reflects business development expenditure. The Cost/Income Ratio improved to 61.9%, better than last year by 1.7 percentage points.

Staff costs were £3.9 million (3.5%) higher than last year, mainly reflecting the annual pay award and staff profit share. Staff numbers have remained stable, with additional staff in the new smile and mortgage service centres more than offset by staff reductions in the rest of the bank.

Other Administrative and Depreciation costs increased by £5.1 million (3.2%) mainly reflecting incremental expenditure on strategic business developments, such as the extended ATM network, the new mortgage service centre and enhancements to the bank's major payment systems (including banking industry initiatives such as the introduction of chip cards and "newCHAPS" systems). Excluding this investment spending, core Operating Costs were lower than last year.

Despite a significant growth in business, the Operating Costs of smile, the internet banking service, were slightly lower than last year. smile's customer base has grown impressively since its launch two years ago and approximately 75% of its customers are new to The Co-operative Bank group. Earlier in the year, smile's internet operating system and content management systems were completely re-designed to further enhance customer service and internet response times. The product range was also extended and smile now offers insurance, travel, mortgages and a funds supermarket in addition to its current and savings accounts, loans and credit cards.

Bad and Doubtful Debts
The Profit and Loss charge for bad debts of £66.2 million was £6.3 million higher than last year due to growth in customer lending balances. The bad debt charge represented 1.71% of Loans and Advances to Customers, slightly lower than last year by 0.07%.

Personal sector bad debt charges of £61.1 million rose by only £2.4 million (4.1%). During the last two years, credit criteria have been progressively tightened and bad debt charges in 2001 have risen at a slower rate than lending balances.

The bank's Corporate lending is largely to small and medium-sized business enterprises and credit quality has remained stable in recent years. Corporate sector bad debt charges were £5.1 million, higher than in 2000 by £3.9 million. However, last year's Corporate bad debt charge of £1.2 million was particularly low, representing a combination of low provisions for new debt and high recoveries of previously provided debt. The bank's problem loan portfolio has now been reduced to minimal levels, hence there are fewer provisions to be released.

Despite the current uncertainties within the economy, and record levels of consumer debt, there are no firm signs yet of a significant deterioration in the credit climate. Interest rates, unemployment and company failures remain low by historic standards. Although unemployment increased, albeit slightly, during the fourth quarter of 2001, this followed a long period of steadily falling unemployment. Despite a manufacturing slowdown and declining corporate profitability, there are no firm indications of an increasing trend in business failures.

However, at a time when many of the major world economies are experiencing an economic slowdown, the timing of economic recovery in the UK is inevitably uncertain and the credit climate is likely to be weaker in 2002 than in recent years.

Summary
In 2001, the bank continued to grow strongly, despite increased competition. Profitability has risen, cost efficiency has improved and an excellent return on capital has been generated. Innovative new products and services have been introduced and The Co-operative Bank continues to be well placed to compete in the changing UK retail financial services market.