Financial performance

Commentary

Context The Co-operative Bank is a public limited company and its sole equity shareholder is the Co-operative Group. The bank also has approximately 2,500 preference shareholders who receive a half-yearly fixed dividend. CIS is a co-operative society registered under the Industrial and Provident Societies Act. CIS' share capital consists of 105,000 £1 shares, held by Co-operative Financial Services (CFS) and the Directors of CIS, who each hold one share for the duration of their office. CIS and the bank are now held by CFS, an Industrial and Provident Society formed in April 2002 to bring the two businesses together under common leadership. Whilst the financial accounts of the bank and CIS remain discrete, both contain central costs associated with the creation of CFS, which are apportioned between the two businesses on an agreed basis.

Financial results - Bank In 2003, The
Co-operative Bank achieved a profit before tax of £130.1 million, £7.6 million (6.2%) higher than 2002 despite significant investment in business development. Earnings attributable to the equity shareholder, after tax and before an ordinary dividend payment of £20 million, were £83.4 million, a rise of 6.6%. The return on opening equity, after tax, was 17.6%. The increase in profitability arose from a 4.0% rise in operating income and a 9.7% reduction in the charge for bad debts, which was partially offset by higher operating costs.

Balance sheet - Bank The balance sheet remained robust throughout the year with strong liquidity and capital ratios. The year-end risk asset ratio was 13.5% with a Tier 1 ratio of 10.5%, substantially higher than the regulatory requirements. In 2003, growth in both retail customer deposit and lending balances was strong. Average customer retail deposits of £6,158 million grew by £680 million (12%) over the year and were £1,208 million higher than retail lending balances. Average customer retail lending balances increased at a faster rate than deposits and were £4,950 million for the year, higher than 2002 by £1,005 million (25%), reflecting particularly good growth in secured mortgage balances. Follow this link for details of CFS' mortgage activity. As a result, average retail deposits were 124% of average retail lending balances compared to 139% in 2002. During 2003, asset growth was targeted carefully at the residential mortgage market thus improving the bank's product mix, whilst maintaining both credit quality and a diversified yet balanced portfolio of personal and corporate business. As a result, although lending increased in both the Corporate and Personal sectors, growth was stronger in the Personal sector during 2003. Personal sector average lending increased by £976 million to £3,181 million, due to the strong growth in mortgage lending together with an increase in Visa credit card lending. Personal loan balances remained stable, reflecting the impact of the bank's cautious credit criteria.

Financial results - CIS In 2003, CIS' total premium and unit trust income decreased to £1,971 million, a fall of 11%. Profit before tax from the general insurance business (excluding short-term investment fluctuations) rose to £61.7 million, compared with £27.5 million in 2002. The result, including short-term investment fluctuations, was a pre-tax profit of £134.6 million, compared with a pre-tax loss of £257.5 million in 2002.

Financial strength - CIS CIS has always maintained a strong capital position. CIS supports the industry's and the FSA's move to the realistic basis of calculating solvency capital. The proposed new solvency requirements are undoubtedly challenging, but CIS has been monitoring their effect on the balance sheet of its with-profits fund for some time. CIS is continuing to work towards these new requirements and is confident that it will remain appropriately capitalised. The amount of money managed on behalf of investors rose by £1.6 billion to £19.1 billion. £313 million was transferred to the Fund for Future Appropriations, compared with a transfer from reserves during 2002 of £1.2 billion. CIS has maintained the dividend on co-operative societies at the same rate as in previous years, resulting in a distribution of £3.3 million to the societies that trade with CIS. Follow this link for details of CIS' dividend on co-operative societies.

Investments - CIS Investment activity continued to focus on ensuring an appropriate balance between equities and other assets such as gilts, bonds and commercial property. The UK equity market (stock market), in common with all other major equity markets, fell further and sharply in the early part of 2003; and at one stage, the UK equity market fell to its lowest point since 1997. However, as evidence emerged of a recovery in the global economy, these markets recovered some of their earlier losses and generally continued to rise during the rest of 2003. As a result, for the first time in four years, equities performed better than any other asset class invested in by CIS. The total growth return over the year for the UK equity market was 20.8% and, for overseas markets, the FTSE World (excluding UK) Index provided a total sterling return of 20.7%. The property market continued to perform well, producing an estimated return of 11.3%; however, UK gilts and bonds were relatively disappointing, with longer-dated government securities only showing returns of around 1.2%. During 2003, CIS carried out a large programme of sales of both UK and overseas equities held by the long-term business fund. In total, almost £3 billion of equities were sold, mostly towards the end of the year when markets had shown significant recovery from their lows. CIS invested most of the proceeds of this programme - together with the net new cash flow of over £270 million that became available for investment - in the sterling fixed-interest markets, and retained the rest as cash. Significant dealings in the UK commercial property market resulted in net sales of around £50 million. Corporate activity in the equities market was at a much lower level than in 2002, with the fund receiving less than £50 million from takeovers and capital reconstructions. For the general business funds, a net cash flow of around £60 million became available for investment, which was retained as cash. CIS also reduced its exposure to equities. Investment income for the long-term business fund, excluding investment gains and losses, and net of investment expenses, was £724 million. The corresponding figure for the general funds was £99 million.

Sustainability value analysis For some time, The Co-operative Bank has been recognised as a leading proponent of the sustainable development business model. MORI Financial Services conducts research, published biannually, into the influence of various factors on the opening of personal current accounts. This research strongly indicates that, whilst 'ethics' is a major determining factor for customers of The Co-operative Bank (24% cite ethics as being influential in opening an account, and this is by far the most frequently specified reason), it is only rarely specified by customers of other banks (fewer than 1% of customers cite ethics as being influential in opening an account).i This is the third year in which a sustainability value analysis has been undertaken in relation to the bank, and the first year for CIS. The analysis contains two elements:

• Estimate of the total profitability contribution made by the bank's ethical and sustainability positioning. Currently, this analysis is restricted to the bank. At the moment, CIS does not have a significant core of customers for whom 'ethics' is a major driver. It is anticipated that the development of a customer-mandated CIS Socially Responsible Investment Policy will result in increases from 2005 and beyond. Follow this link for details of CIS' SRI Policy development. The total profitability contribution has, to date, been determined by aggregating the profitability contribution derived from ethically and environmentally motivated customers for each product. This year, the bank has refined its research process and has added an additional 'motivational' category - co-operative movement/heritage - which enables the bank to capture information on those customers who are attracted by the co-operative aspects of the bank's brand positioning (as opposed to 'ethics' and 'environment'). The bank's co-operative, ethical and sustainability positioning has contributed to the bank's profitability. In 2003, 30% of bank profits can be attributed to customers who cite these as important factors (2002: 24%), and 17% to customers who cite these as the most important factors (2002: 13%). Of the profitability attributed to customers who cite this positioning as the most important factor, 72% is attributable to Personal Banking customers (2002: 72%) and 28% to Corporate and Business Banking customers (2002: 28%). Of the profitability attributed to customers who cite it as an important factor, 70% is attributable to Personal Banking customers (2002: 68%) and 30% to Corporate and Business Banking Customers (32%).
• Costs/benefits to CIS and the bank of particular sustainability initiatives. The impact of ethical factors on specific CFS decisions is calculated and disclosed (e.g., the additional costs associated with the purchase of green electricity), together with any ethical overheads (e.g., the costs associated with maintenance of the Sustainable Development Team). Individual findings are presented throughout the report and a summary is available on the website.ii No attempt is made to integrate or 'net off' these two elements. The first part of the analysis relates to 'real' profitability calculations, whilst the second part includes 'hypothetical' costs (e.g., the opportunity cost of declining corporate business as a result of the bank's Ethical Policy) and savings (e.g., the cost savings arising from the switch to remanufactured toner cartridges across CFS). The two elements are considered to present different aspects of the costs and benefits of pursuing sustainable development. For further details of how the bank determines the total profitability contribution made by its ethical and sustainability positioning visit the website.ii

Wealth creation - CFS 'Economic Value Added' expresses the contribution to national wealth made by a commercial organisation,iii and seeks to recognise that a variety of Partners can benefit from such wealth creation. For example, economic value can be disbursed to staff in the form of salaries and other benefits, to the state in the form of taxes, to charitable causes in the form of donations, and to owners in the form of profit, dividend and reserves. Of the £278.1 million Economic Value Added created by The Co-operative Bank in 2003, £112.2 million (40.3%) was distributed to the bank's owners, £39.1 million (14.1%) to the state and £126.8 million (45.6%) to staff. Of the £471.9 million Economic Value Added created by CIS in 2003, £146.1 million (31%) was distributed to CIS' owners and £327.7 million (69.4%) to staff.iv Further analysis of CIS' and the bank's Economic Value Added is provided on CFS' website.v

Summary - CFS The Co-operative Bank's profitability has continued to grow steadily, despite increased competition and a narrower interest margin. In 2003, trading conditions continued to be generally quite difficult for the insurance industry, with continued low consumer confidence in investments and some particularly tough challenges for the life industry. However, throughout the year, CIS continued to maintain its customer focus, and apply sound, prudential management to the running of its business. The development of CFS as the financial services provider for co-operative customers, together with a unique ethical stance, ensures that both businesses are well placed to innovate and compete in a challenging and changing UK financial services market.

i MORI Financial Services Survey, twelve months ending December 2003.
ii www.cfs.co.uk/sustainability2003/costbenefit
iii Where 'Economic Value Added' equals the sum of operating profit, employee costs, depreciation and amortisation.
iv In 2003, CIS recovered tax of £1.9 million on profit on ordinary activities.
v www.cfs.co.uk/sustainability2003/valueadded
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Performance

Bank

Profit before taxation (£m)

Operating Income (£m)

Return on equity

Cost/Income ratio (%)

Average retail Balances (£m)

		Profitability contribution made by customers who state that ethics is the most important factor	Profitability contribution made by customers who state that ethics is an important factor
As a percentage of profit before tax	2001 vi	14%	25%
	2002 vii	13%	24%
	2003 viii	17%	30%

General Insurance technical results (£m) ix

General Insurance profit (£m) x

Insurance funds under management (market value (£bn)

General Insurance premium income (£m)

 

vi Profit before tax as reported in the bank’s interim results to 28th July 2001: £60.2 million.
vii Profit before tax as reported in the bank’s full year results: £122.5 million.
viii Profit before tax as reported in the bank’s full year results: £130.1 million.
ix Profit before tax from the general insurance business (excluding short-term investment fluctuations.
x Post tax profit/loss for the general insurance business.