The Co-operative Bank plc The Co-operative Bank plc Annual report and accounts Annual report and accounts 2013 2013 Overview Strategic report Corporate governance Risk management Financial statements Other information Contents Page Page Key Performance Indicators Risk management 3 Bank performance 70 Risk Governance structure 71 Board and sub-committees Strategic report 72 Executive and Management Committees 7 Chairman’s statement 75 Risk management 8 Our two business areas: Core and Non-core 117 Capital management 9 Our strategy 10 Business model Financial statements 11 Chief Executive’s review 124 Independent auditor’s report to the members 13 Summary financial review of The Co-operative Bank plc only 15 Detailed financial review 127 The Bank financial statements 21 Detailed financial review – Outlook 134 Notes to the Bank financial statements 22 Detailed financial review – An update on capital raising 220 The Company financial statements 23 Detailed financial review – Key Performance Indicators 226 Notes to the Company financial statements 25 Detailed Key Performance Indicators 26 Principal risks and uncertainties Other information 29 Social, community and human rights 265 Shareholder information 30 Group structure 266 Glossary 274 Forward looking statements Corporate governance 275 Appendix 1 – EDTF recommendations 32 Biographies of the Board 34 Directors’ report 36 Corporate Governance report 44 Audit Committee report 51 Risk Committee report 54 Nomination Committee report 55 Values and Ethics Committee report 57 Board effectiveness 58 Statutory disclosures information 59 Statement of Directors’ responsibilities 60 Directors’ Remuneration report The Co-operative Bank plc Annual report and accounts 2013 1 Overview Strategic report Corporate governance Risk management Financial statements Other information Key Performance Indicators The Key Performance Indicators presented below4 reflect the way in which the performance of the Bank was measured in 2013. As it implements the Turnaround Plan, management intends to review these measures. Total Bank Statutory profit (loss) before tax (£m) Net Interest Margin5 (%) Common Equity Tier 1 (CET1) Ratio1, 2 (%) Leverage ratio1, 2 (%) 54.2 (673.7) (586.2) 1.23 2013 Target: Upper end 7.2 2.4 1.11 1.09 of a 7% to 9% range 5.0 1.8 n/a n/a 2011 2012 2013 2011 2012 2013 2011 2012 2013 2011 2012 2013 The continued statutory loss before tax The broadly stable Net Interest Margin The improvement in the CET1 ratio despite Following the LME we have increased our reflects principally the high level of credit reflects a strengthening retail performance continuing losses reflects the successful ratio by 0.6% impairments and charges for conduct risk offset by lower Treasury returns completion of the LME in December 2013 offset by profit from the LME in 2013 Cost of Risk (%) Cost Income Ratio (%) Return on Equity (%) Staff Engagement3 (%) 1.54 93.6 2.2 (27.5) (42.1) 68.0 1.39 59.0 67.1 73.7 0.35 n/a 2011 2012 2013 2011 2012 2013 2011 2012 2013 2011 2012 2013 The increase in cost of risk reflects Driven by lower net interest income from The increased negative return on equity in Our staff engagement scores reflect a very predominantly the improved impairment balance sheet contraction and significant 2013 reflects a reduced loss being more difficult year in 2013 and we are committed strategies implemented in the first half of one-off costs than offset by the reduction in equity to improving staff engagement during 2014 the year Core Bank4,6 Non-core Bank4,6 Net Interest Margin (%)5 Customer Deposits (£bn)7 Customer Assets (£bn) Customer Assets (£bn) 1.7 1.7 34.2 18.6 17.6 14.6 31.4 12.5 2014 target: c.£11.0bn 2012 2013 2012 2013 2012 2013 2012 2013 Cost Income Ratio5 (%) Primary Current Account Holders Credit RWAs (£bn) Credit RWAs (£bn) 88.0 663,504 664,775 5.0 10.9 74.9 4.4 8.3 Longer term target: <60% 2012 2013 2012 2013 2012 2013 2012 2013 Please see ‘Key Performance Indicators’ on page 25 for explanations of why these metrics are important and how they are calculated. 1. Capital ratios not reported in respect of 2011 as calculation methodology for CRD IV was still in development. 2. Restated for CFSMS (see note 3 to the accounts) and on a CRD IV fully loaded basis. 3. As part of The Co-operative Group in 2012 and for the majority of 2013, staff engagement scores were measured in respect of The Co-operative Banking Group (rather than the Bank). 4. KPIs are calculated on a management accounts basis as this is how we manage our business. 5. Excludes provision for customer redress. 6. 2012 figures have been restated, please see note 5 of the accounts for details. 7. Includes BaCB deposits which have reduced by £2.6bn in 2013. Retail deposits have reduced by £0.2bn (see page 19). 2 The Co-operative Bank plc Annual report and accounts 2013 Overview Strategic report Corporate governance Risk management Financial statements Other information Bank performance The results today reflect the magnitude of the issues that have come to light since I joined The Co-operative Bank ten months ago. In addition, as we outlined on the 24 March 2014, further costs have materialised since the completion of the Liability Management Exercise (LME) in December 2013 as a result of a continuing review of The Co-operative Bank’s legacy operations, assets and liabilities by the new Executive Team. During 2013 the task for the new management was to keep the Bank alive. The successful completion of the LME prevented the Bank from going into resolution, preserving the Bank for our customers and protecting jobs without cost to the taxpayer. However, there continue to be significant issues which need to be resolved. As already announced on 24 March 2014, the management team’s continuing review has unearthed a range of conduct and legal issues since December 2013 which has contributed to the need to further strengthen the Bank’s capital position over and above The Co-operative Group’s 2014 contribution. Whilst these risks were identified in the LME prospectus, the financial impact of these additional items, together with the higher than expected cost of separation from The Co-operative Group, means that the starting capital position of the Bank for the 4-5 year recovery period is weaker than in the plan announced last year. The proposed capital raising will enable us to reset this starting point and continue with the execution of our original business plan which remains unchanged. It is early days but initial progress on our business plan is encouraging and we remain enthusiastic about the long term potential for the Bank. We have started to simplify the business; we are reducing costs and are currently ahead of schedule in de-risking our assets. We are also beginning to fix the fundamentals of the Bank as we drive the change needed to return to our roots as a bank focused on our retail and SME customers. Community banking is the heart of our business and despite our recent troubles the Core Business has seen significant stability. Year on year, our Core Retail deposit balances are broadly unchanged. In the future, we will be investing in IT to both deliver digital banking in a way that meets our customers’ expectations and also improve the systems that lie behind our products. We will also be asking our customers’ opinions as we renew the values and ethical principles that remain at the centre of why they choose to bank with us. There are still major hurdles ahead to overcome. The level of change required in improvement in processes, systems and culture is significant. We are determined to rebuild trust in the Bank after the events of last year and reward the loyalty our customers and shareholders have shown us. We appreciate that customers and other stakeholders continue to feel angry about how past failings placed the future of the business so seriously at risk. I would like to apologise to them, to thank them for their continued loyalty and to thank colleagues for their commitment during such difficult times. Niall Booker Chief Executive The Co-operative Bank plc Annual report and accounts 2013 3 Overview Strategic report Corporate governance Risk management Financial statements Other information Bank performance continued Key highlights and outlook The Bank ended a very difficult year with stable Run down and exit of Non-core underway with liquidity and an improved capital position; further disposals programme ahead of schedule capital is required: • Reduction in Non-core customer assets from £14.6bn to £12.5bn; with • Liquidity built mid-year successfully saw the Bank through the volatility £1.5bn reduction in second half of 2013 of the second half of 2013 • Corresponding reduction in Non-core credit risk weighted assets from • The Liability Management Exercise (LME) generated £1.2bn of Common £10.9bn to £8.3bn Equity Tier 1 (CET1) before costs • Non-core firmly on track to meet previously stated target of £11.5bn of • Further provisions and charges for customer redress and legal issues of Non-core loans at the end of 2014; target now re-set to c.£11.0bn at the £412m, the write down of the deferred tax assets of £158m and higher end of 2014 than expected costs of separation from The Co-operative Group of £39m have adversely impacted CET1 Simplification of the business underway as • As a result, the year end CET1 ratio of 7.2% is below prior guidance we reshape • As announced on 24 March 2014, additional CET1 is required in addition • Exit from international operations underway with the previously announced to the 2014 contribution