Financial Highlights
In 2002, The Co-operative Bank achieved a Profit Before Tax of £122.5 million, £15.0 million (14.0%) higher than 2001. Earnings attributable to the equity shareholder, after tax, were £78.2 million, an increase of 14.2%, and the Return on Opening Equity, after tax, was 19.8%.

The increase in profitability arose from higher operating profits, before bad debts, reflecting a 6.1% 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 £3.9 million, was better than last year at 1.60% of year-end loans and advances to customers.

The Balance Sheet remained robust throughout the year with continued strong liquidity and capital ratios. The year-end Risk Asset Ratio was 14.1% with a Tier I Ratio of 10.6%, substantially higher than the regulatory standards. At the year end, Balance Sheet liquidity was underpinned by £2.5 billion of highly-rated debt securities.

Business Highlights
The outlook for the UK economy is currently uncertain, with the sectoral imbalances within the economy creating some risks to stability. Economic growth was supported during 2002 by generally strong levels of consumer spending alongside historically low interest rates and high house price inflation. In contrast, the manufacturing sector continued to have difficulties, with the result that business investment has fallen and insolvency levels are on the increase. With household borrowing now at record levels, any sharp correction could depress future economic growth. In this more uncertain business environment, however, the bank has continued to grow steadily whilst continuing to adopt a cautious lending policy.

In 2002, retail customer deposit and lending balance growth was relatively strong and balanced. Average customer retail deposits of £5,478 million grew by £591 million (12%) and were £1,533 million higher than retail lending balances. Average customer retail lending balances were £3,945 million, higher than last year by £402 million (11%).

The growth in retail customer deposits was particularly strong within the personal sector. Average personal sector balances of £3,673 million were £507 million (16%) higher than last year, including continued growth in deposits at smile, the bank's internet banking operation. smile's customer base has grown impressively since its launch with over 80% of its customers being new to The Co-operative Bank group. Over the past year, smile's product range has been extended, and now offers many new products including smileinvest sharedealing, a quick and easy low-cost way for customers to buy and sell shares 24 hours a day, and a new smile credit card offering customers many 'best buy' features.

The bank's savings product range has been extended to include fixed-rate, fixed-term deposit accounts, including a FTSE4Good Guaranteed Stock Market Deposit Bond and an updated range of fixed-term deposit offers. Our added-value current account, Privilege, launched in 2001, has proved attractive to both new and existing customers and has also contributed to the growth in deposits. As well as offering full current account facilities, Privilege provides a wide range of attractive benefits, all for a small monthly fee. Average corporate and business deposit balances increased by 5% to £1,805 million, reflecting steady growth in both larger company relationship banking and in banking for small and medium-sized enterprises (SMEs). Business Direct, the bank's successful telephone and internet banking service for SMEs, was re-launched in October 2002 as Business Directplus, and the initial response from customers has been very encouraging. Business Directplus enhancements included a no-fee arranged overdraft, increased credit interest rates and an eighteen months free banking introductory offer. Over the last year, the banking business of a further five Local Authorities was gained, thus consolidating the bank's position as a major provider of financial services to this important sector. The bank has also expanded its profile and business base within the community and charity sectors, and was delighted to be appointed banker for the newly formed Charity Bank.

Although the overall credit climate has been relatively benign so far, the current uncertainties within the UK economy could increase medium-term business and credit risk. During the last year, the bank's lending growth has been carefully targeted to both maintain credit quality and to maintain a balanced portfolio across personal and corporate business. Lending increased in both the corporate and personal sectors, with growth being stronger in the personal sector where average lending increased by £315 million (17%) to £2,205 million. This reflected increased demand for the bank's range of residential mortgages along with a steady rise in VISA credit card balances. Average corporate and business lending balances increased by £87 million (5%).

The bank re-entered the UK residential mortgage market in late 2000, and during 2001 and 2002 the product range and delivery channels have been developed and extended. Base Rate Tracker mortgages and a broader range of fixed-rate, capped-rate and discount-rate products were developed and introduced. Specialist mortgage advisers are now in place within our branch network and professional intermediaries are also now in place as a key service channel as an extension to the bank's existing branch, direct mail, telephone, and internet offerings.

Against a background of intense competition, VISA credit card balances of £843 million increased by £69 million (9%) reflecting a mixture of promotional activities and the successful launch of new products. The Platinum VISA card, launched last year, was expanded with the introduction of a Platinum Base Rate Tracker card. A new Gold Fixed Rate card was also launched during 2002. The bank's successful collaboration with other organisations continued and, in 2002, new affinity card partnerships were formed with WaterAid and Stroud & Swindon Building Society. New VISA credit cards, with special Dividend features, have also been introduced specifically for both food and non-food customers of the Co-operative Group's extensive retail operations.

In addition to credit cards, the bank also has an attractive range of Co-op branded savings accounts and other services specially developed for retail customers of the Co-operative Group and the wider Co-operative movement. During 2002, an additional 355 cash machines (ATMs) were installed at Co-operative retail stores to bring the total number of cash machines in the bank's estate at the year end to over 1,100. Several hundred additional cash machine installations are also planned for 2003.

In April 2002, Co-operative Financial Services (CFS) was created to bring The Co-operative Bank and Co-operative Insurance Society (CIS) under common leadership. Co-operative Financial Services Limited is an Industrial and Provident Society and is the new holding company for these two major businesses. One of the key objectives of this important development has been to focus on the range of products, services and distribution channels available to the customers of both the bank and CIS, and to explore how these can be brought closer together to provide the combined customer base with a more comprehensive, convenient and co-operative financial services offering. Whilst CFS has had little impact on the bank's results for 2002, it has the potential to create significant opportunities for the future.

Operating Income
Operating Income of £483.4 million was £27.8 million (6.1%) higher than last year, reflecting growth in both Net Interest Income and Non-Interest Income.

Net Interest Income was £329.6 million, an increase of £16.1 million (5.1%), mainly reflecting the growth in customer balances, partly offset by a reduction of 0.2% in the bank's overall net interest margin. Product margins have remained relatively stable overall and the bank's interest spread (the difference between interest rates paid on deposits and that earned from loans) at 3.7% was unchanged from 2001. The contribution of interest-free liabilities declined by 0.2% to 0.5% as a result of the lower interest rate environment. The bank's overall net interest margin was 4.2% compared with 4.4% last year.

Average interest-earning assets of £7,755 million increased by £580 million (8.1%), reflecting growth in retail customer lending of £402 million and an increase in wholesale market placements of £178 million. Average interest-bearing liabilities rose by £453 million (7.5%) to £6,454 million, driven by growth in average interest-bearing retail customer deposits of £496 million, partially offset by lower wholesale deposits. The increase in average interest-free balances mainly arose from higher Current Account balances and the bank's growing retained earnings.

Non-Interest Income of £153.8 million was £11.7 million higher than last year, an increase of 8.2%. Net commission and fee income increased by £12.4 million, mainly reflecting higher inter-bank commission from the bank's expanded ATM (cash machine) network together with higher VISA commission, mortgage arrangement fees and customer service fees.

Insurance commission income was higher than last year by £0.4 million. Other income was £1.1 million lower than in 2001 due to lower dealing income and wholesale commission. Most of the bank's income from Treasury activities is included in Net Interest Income.

Operating Costs
Operating Costs of £290.8 million were £8.9 million higher than last year, a rise of 3.2%. The increase in costs arose mainly from additional business development expenditure and higher staff costs. The bank's Cost/Income Ratio improved to 60.2%, better than last year by 1.7 percentage points.

Staff costs were £5.7 million (4.9%) higher than last year, mainly reflecting the annual pay award, higher pension contributions and business growth. Staff numbers increased due to planned expansion in the smile and mortgage customer service centers.

Other Administrative Expenses and Depreciation costs increased by £3.2 million (1.9%), reflecting incremental expenditure on strategic business developments such as the expanded ATM (cash machine) network and investment in new technology. Major IT projects in 2002 included initial work on re-designing the underlying technical infrastructure of our banking systems, development of the bank's payment systems in response to industry initiatives, and the development of sophisticated risk management systems. Excluding this additional investment spending, other Administrative Expenses were lower than last year.

Bad and Doubtful Debts
The Profit and Loss Account Charge for bad debts of £70.1 million was £3.9 million higher than last year, mainly due to higher corporate and business sector provisions. The bad debt charge represented 1.60% of year-end Loans and Advances to Customers, an improvement of 0.11% over 2001.

The credit quality of the personal portfolio remained stable and personal sector bad debt charges increased by only £0.5 million (0.8%). The bank's credit acceptance criteria have been progressively tightened over the last three years and the bad debt charge increased at a slower rate than the growth in customer balances.

The bank's corporate and business lending is largely to small and medium-sized business enterprises (SMEs) and credit quality has remained stable with relatively low bad debt charges in recent years. This partly reflects the write-back of prior year provisions following the realisation of previous problem loans. In response to a more uncertain economic outlook, the bank's credit approval standards have become more conservative, with more stringent standards applied related to the quality of security and a customer's ability to generate positive cash flow during an economic downturn. In addition, the management of potentially higher-risk lending sectors has been strengthened. Increased provisions have been raised against a small number of accounts within these sectors to reflect this higher risk exposure. As a result, corporate sector bad debt charges were £8.5 million, higher than in 2001 by £3.4 million. The bad debt charge in the year, as a percentage of average balances, was 0.5%, compared to 0.3% last year.

Summary
In 2002, the bank continued to grow both its balance sheet and profits despite increased competition. Cost efficiency has improved and an excellent return on capital has been generated. The creation of Co-operative Financial Services (CFS) in 2002, bringing together the bank and the Co-operative Insurance Society under common leadership, is clearly an important and positive development. Whilst CFS has had little impact on the bank's results for 2002, it has the potential to create significant opportunities for the future. In an intensely competitive and changing UK retail financial services market, the bank continues to be well placed to compete, and should be even stronger under the auspices of CFS.