The Bank of Nova Scotia
Annual Report 2016

Plain-text annual report

2016 Annual Report Banking the real economy *Adjusted – please refer to page 13 of the MD&A CONTENTS 1 6 Message from President and Chief Executive Officer Executive Management Team 7 8 Message from Chairman of the Board 10 Management’s Discussion and Analysis Board of Directors 129 Consolidated Financial Statements E hare efer to page 13 of the MD&A ss and geography; providing sustainable and growing earnings CEO Message to Shareholders Brian J.Porter President and Chief Executive Officer Dear Fellow Shareholders, AGAINST THE BACKDROP OF ONGOING MARKET VOLATILITY, GLOBAL ECONOMIC AND POLITICAL UNCERTAINTY AND HISTORICALLY LOW INTEREST RATES, SCOTIABANK ENDED THE YEAR IN A STRONG POSITION. WE BANK — WHAT WE CALL THE REAL ECONOMY, THAT IS, FAMILIES, COMMUNITIES AND BUSINESSES SEEKING TO BECOME FINANCIALLY BETTER OFF. WE ARE PROUD OF OUR RESULTS DESPITE A RAPIDLY CHANGING OPERATING ENVIRONMENT. In 2017, we will increase our focus on the areas that will create long-term shareholder value. This includes investing in businesses that need additional scale, and strengthening our existing operations in Canada and our key Pacific Alliance markets. We have made good progress and are generating significant momentum towards becoming one of the world’s most customer-focused banks. We are committed to delivering a superior experience for our customers and strong results for our shareholders. Economic Update from our Major Markets As 2016 comes to a close, the narrative around Canada’s economic outlook is more positive. Despite some ongoing challenges related to commodity prices in certain regions, the Bank is forecasting improved growth in 2017. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 1 We are confident in our global footprint, which includes the Caribbean and Central America as well as the countries of the Pacific Alliance trading bloc – Mexico, Peru, Chile and Colombia. In particular, the Pacific Alliance presents attractive growth opportunities for the Bank. Together, the four countries represent the world’s sixth largest economy – when measured by purchasing power – and its seventh largest exporter. The countries have stable governments and policy makers focused on growing the middle class, making critical structural reforms and attracting investment. The Pacific Alliance economies are expected to have relatively strong GDP growth in the range of 3% during 2017-20, compared with about 1.6% on average in the G7. To properly showcase our Pacific Alliance operations, we hosted an investor day in Mexico City earlier this year. Our conference included visits by the Central Bank governors from each of the four Pacific Alliance countries who reiterated what we have been saying for some time: The trading bloc is an excellent place to invest, and run a business. Global asset managers and equity analysts who attended the conference left Mexico with greater confidence in our operations, our local and global leadership teams, and – most importantly – our strategy in the Pacific Alliance. We are very comfortable with our footprint in this region, and continue to expect it will generate strong results for our shareholders. Financial Results I would like to draw your attention to a few of our financial highlights. Overall, Scotiabank delivered strong operating and financial results for our shareholders. The Bank earned $7.4 billion in 2016. Our earnings growth was driven by steady performances in our personal and commercial banking businesses – both in Canada and internationally – which generated approximately 80% of our earnings. Canadian Banking contributed more than half of the Bank’s earnings in 2016, with net income of $3.7 billion, up 12% compared to 2015. The Bank selectively grew assets in a prudent manner and made good progress in gathering core deposits. As a result, Canadian Banking improved its risk-adjusted margin by 10 basis points. We also did a good job in managing expenses, achieving positive operating leverage of 3.2%; meaning that we grew our revenue faster than expenses. Looking forward, Canadian Banking will remain focused on delivering a superior customer experience (which will help us to grow primary relationships with our customers), improving our business mix and growing our risk-adjusted margin. International Banking gained very good momentum over the year and delivered a strong performance in 2016. The business earned $2 billion, which represents growth of 12% year-over-year. These results reflect continued strong loan, deposit and fee income growth – particularly in the Pacific Alliance region – improved credit trends, and well-managed expenses. These efforts supported International Banking’s ability to deliver positive operating leverage of 2.9% in 2016. Global Banking and Markets had a slower start to the year – in part, due to elevated energy loan losses. However, performance in the second half of the year improved, with net income growing to $1.6 billion. Stronger results were driven by the fixed income, corporate lending and commodities businesses, as well as the positive impact of foreign currency translation. Credit quality also improved during the second half of the year. In summary, your Bank’s 2016 results reflect strong momentum in our business lines, each of which contributed to our overall financial success. Looking ahead to 2017, I am confident that our continuing focus on our customers and our efforts to strengthen the Bank will guide our future success. Progress Against Our Strategic Agenda We are focused on delivering a superior customer experience, and creating shareholder value. While driving consistent and predictable financial performance in the near term, the ultimate objective is to position Scotiabank for success over the longer term. The foundation of this effort is what we call our Strategic Agenda. 2 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Scotiabank’s Strategic Agenda was shaped over the past two years and includes five, highly-integrated components. Customer Focus Our unwavering commitment to being a customer-focused organization is reflected in our new “Why We Bank” platform, which we launched across the Bank early in 2016. “Why We Bank” is an expression of our renewed purpose: “We believe every customer has the right to become better off.” To enable our commitment to customer- focus, we recently rolled out a new customer experience management system across our retail banking operations in Canada, Mexico, Peru, Chile and Colombia. This capability will allow us to actively listen to our customers in real time, and dynamically shape a better customer experience. Leadership and Employee Engagement We have enhanced the depth, diversity and deployment of our leadership teams. Our leaders are now more reflective of our customer and employee populations, and highly motivated by our customer focus objectives. As an example, we have had very good success in attracting leading talent – particularly digital talent. What’s more, 30% of our senior leaders across the Bank are now women – a new high- water mark for your Bank, which we expect will continue to rise. Scotiabank has a strong culture of operating ethically, acting with integrity and effectively managing our risk. To achieve our longer-term goal of building an even better Bank, however, we are taking important steps to shift elements of the Bank’s culture. Specifically, the Bank is now more intensely focused on our customers and more performance-oriented. Our evolving culture has been embraced by our leadership teams, and is resonating strongly across the Bank. We firmly believe that one of the best investments the Bank can make is in our people. We are providing employees with more tools and training opportunities so they can reach their full potential. We are also supporting 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 3 individualized development of Bank employees through on-the-job training and coaching, targeted development planning and greater alignment of career planning with business needs and career aspirations. Structural Cost Transformation A critical goal of the Bank’s Strategic Agenda is to become more efficient while continuing to improve our customers’ experience. To do so, we have adopted a continuous improvement mindset. In other words, our ability to consistently embrace change is a strategic advantage for the Bank, especially in today’s competitive environment. We have made good progress in this regard. For example: (cid:129) As digital trends and changing customer preferences re-shape the role and utility of our branch network, we are introducing more digital options so that customers can bank how, when and where they want. The approach is a win for our customers and shareholders. Customers benefit from a superior experience in branches that are better tailored to their needs and shareholders benefit from lower operating costs (online and mobile channels are significantly more efficient than in-branch transactions). (cid:129) In Q2, we announced a restructuring charge to invest in strengthening our businesses through a series of important initiatives that will enhance our operating model and respond to changing customer preferences. The charge also came with the commitment to deliver a meaningful improvement in our productivity ratio of 200 to 250 basis points for 2019. We are constantly re- evaluating how we deliver products and services across the enterprise. This helps to ensure that we are, for example, fully leveraging our global scale to drive value for shareholders. AVERAGE ASSETS BY GEOGRAPHY Driving a Digital Transformation We made excellent progress this past year in advancing our Digital Strategy. We now have a deep, experienced and dynamic leadership team in place for our digital efforts across the Bank. And we are investing in our digital capabilities to improve outcomes for our customers, employees and – ultimately – for our shareholders. As a tangible example of our commitment to becoming a digital leader, we have launched “Digital Factories” in our priority markets of Canada, Mexico, Peru, Chile and Colombia. At the Factories, employees from our business lines and corporate functions work together to re-invent the way our customers bank with us. Our five Digital Factories are virtually connected to each other, and they are continuously sharing innovative customer solutions – an approach that allows us to benefit from our global footprint. Our Digital Factories are designed to build solutions that will benefit our customers – we chose to name them factories to emphasize this key point. The Bank’s heightened efforts in digital and mobile banking are already delivering results. For example, in June of 2016, Forrester Research awarded Scotiabank the highest overall score among our Canadian peers for mobile banking functionality. And in November, Forrester ranked our online account opening process number one among the five largest banks in Canada – up from fifth place last year. 80 126 165 529 $ BILLIONS CANADA............. 59% U.S. ..................... 14% OTHER INTERNATIONAL .. 18% PACIFIC ALLIANCE ............ 9% 4 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T We will continue to develop our digital capabilities across the Bank, and we aspire to become a digital leader in all of our major markets. Business Mix Alignment We have undertaken a comprehensive series of efforts to enhance profitability, and ensure that financial resources are well-deployed and well-aligned with our Strategic Agenda. Among other things, this includes enhancing our already strong approach to capital allocation, managing our capital more efficiently and prudently growing both sides of our balance sheet. Our focus on growing deposits and strategic capital allocation will continue to enhance the Bank’s risk adjusted margin. The banking industry continues to face a multitude of shifting regulatory, competitive and economic factors. To manage these factors – and to ensure we deploy our valuable financial resources and optimize our business mix – we have several important efforts underway to further strengthen our capabilities. children in Latin America and the Caribbean. Last summer, the Bank made an investment of US$2 million to implement their “Road to Success” program. The three-year initiative aims to benefit more than 50,000 youth across 17 countries in Latin America and the Caribbean. Finally, we are also supporting our communities and the Canadian economy more generally through some innovative approaches with several leading academic partners. Recently, the Bank entered into digital partnerships through investments with the Smith School of Business at Queen’s University, the Sobey School of Business at Saint Mary’s University, the Ivey Business School at Western University and the Rotman School of Management at the University of Toronto. These win-win partnerships are helping the next generation of business leaders succeed in the digital economy by providing opportunities for hands-on learning experience. They are also providing the Bank with excellent access to leading digital talent and research. We expect to launch more of these partnerships across our footprint in 2017. Employees and Community Our Shared Vision for an Even Better Bank Scotiabankers believe we have a responsibility to give back and make a positive difference in the communities in which we live and work. We do this by supporting organizations that are building strong and resilient communities. In 2016, Scotiabank contributed in excess of $70 million in donations, sponsorships and other forms of assistance globally. In addition, Scotiabank employees dedicated more than 400,000 hours of volunteering and fundraising time to local causes. As an example, after the Fort McMurray wildfires, the Bank was there to help. Scotiabankers came back early to our three Fort McMurray branches to ensure that they were open for business when evacuees returned home. What’s more, the Scotiabank MacDonald Island Summer Camps hosted 1,800 local children, with a number of employees volunteering at the camps. We are proud of the way that Scotiabankers helped to make a real and lasting difference for our customers and for families in the community. The Bank is also a strong supporter of Junior Achievement Americas, which delivers financial literacy education to Next year marks Scotiabank’s 185th Anniversary. What started as a small bank in Halifax, Nova Scotia, is now Canada’s International Bank, with more than 80,000 employees, serving 23 million customers in more than 50 countries. We are among the largest 25 banks in the world. We have an excellent brand and a reputation that is a source of tremendous pride to all Scotiabankers. Looking forward, we will continue to build on our momentum, become even more relevant to our customers, implement our Strategic Agenda, and build an even better Bank. I’m very proud of the Scotiabank team, and I’m especially grateful to our shareholders for the trust you have shown in us. I am very confident that the Bank’s best days are ahead as we continue to build on our momentum. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 5 EXECUTIVE MANAGEMENT TEAM Brian J. Porter President and Chief Executive Officer Ignacio “Nacho” Deschamps Group Head, International Banking and Digital Transformation Stephen P. Hart Chief Risk Officer Dieter W. Jentsch Group Head, Global Banking and Markets Barbara Mason Group Head and Chief Human Resources Officer Sean D. McGuckin Group Head and Chief Financial Officer James O’Sullivan Group Head, Canadian Banking EXECUTIVE VICE PRESIDENTS Deborah M. Alexander Executive Vice President and General Counsel Andrew Branion Executive Vice President and Group Treasurer John W. Doig Executive Vice President and Chief Marketing Officer Terry Fryett Executive Vice President and Chief Credit Officer Marianne Hasold-Schilter Executive Vice President and Chief Administrative Officer, International Banking Mike Henry Executive Vice President, Retail Payments, Deposits and Unsecured Lending Marian Lawson Executive Vice President, Global Financial Institutions and Transaction Banking Kyle McNamara Executive Vice President and Co-Head Information Technology, Business Systems James McPhedran Executive Vice President, Canadian Banking Daniel Moore* Executive Vice President and Chief Market Risk Officer James Neate Executive Vice President, International Corporate and Commercial Banking Dan Rees Executive Vice President, Operations Gillian Riley Executive Vice President, Canadian Commercial Banking Shawn Rose Executive Vice President, Digital Banking Maria Theofilaktidis Executive Vice President, Retail Distribution, Canadian Banking Michael Zerbs Executive Vice President and Co-Head Information Technology, Enterprise Technology * As at November 29, 2016 1,118 1,995 BRANCHES & OFFICES OUR GLOBAL FOOTPRINT EMPLOYEES INTERNATIONAL CANADA 35,000 35,000 40% 40% 35,350 53,500 53,500 60% 60% 53,551 6 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Chairman’s Message to Shareholders Thomas C. O’Neill Chairman of the Board, Scotiabank Dear Fellow Shareholders, HAVING OVERSEEN THE BANK’S TRANSFORMATIONAL JOURNEY OVER THE PAST FEW YEARS, YOUR BOARD IS PLEASED WITH THE TREMENDOUS PROGRESS THE MANAGEMENT TEAM HAS MADE IN 2016 IN DELIVERING ON THE PILLARS OF THE STRATEGIC AGENDA. THIS MOMENTUM HAS CONTRIBUTED TO CONSISTENT EARNINGS GROWTH AND POSITIONS YOUR BANK FOR SUSTAINED GROWTH OVER THE LONG TERM. Scotiabank’s employees around the globe have been working toward delivering on the strategic priorities of being more customer-focused; enhancing leadership depth, diversity and deployment; being better organized to serve customers while reducing structural costs; driving a digital transformation and aligning our business mix with deeper customer relationships. Your Board fully supports these as key drivers of growth that will have a lasting impact on shareholder value. While the current financial landscape is certainly not without its challenges, the management team has demonstrated critical focus on delivering against these priorities, and your Board is pleased with how aggressively the team is taking on these challenges and the advancements made to date. Our Corporate Governance Underpinning the success of your Bank is your Board’s commitment to having effective corporate governance. Ongoing, active oversight and holding the executive management team accountable are key factors to Scotiabank’s success. We are focused on balancing and protecting the interests of stakeholders, including shareholders, customers, employees and communities over the long term. Your directors are regional, national and international business and community leaders who bring financial expertise, technology acumen, risk management insight and sound business judgement to the Board’s table. We are extremely proud of the age, ethnic, gender and global diversity of the Board. Additionally, one of the hallmarks of our success is ensuring we maintain an independent Board, and I am pleased to say 15 of our 17 members are independent of the Bank. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 7 In 2016, we welcomed the appointment of three new members: > Scott B. Bonham brings extensive experience and critical insights into technological developments with a depth of experience in Silicon Valley and Canada. > Una M. Power brings deep financial and risk management expertise, as well as extensive international business knowledge. > L. Scott Thomson brings diverse international business experience across a multitude of Canadian industries. Building on our momentum Your Bank is building for the future, and this excitement is shared by the Board. As Scotiabank reaches its 185th year, BOARD OF DIRECTORS Thomas C. O’Neill Chairman of the Board. Scotiabank director since May 26, 2008. COMMITTEE CHAIRS Ronald A. Brenneman Corporate director. Risk Committee Chair. Scotiabank director since March 28, 2000. Aaron W. Regent Founding Partner of Magris Resources Inc. Human Resources Committee Chair. Scotiabank director since April 9, 2013. Susan L. Segal President and Chief Executive Officer of the Americas Society and Council of the Americas. Corporate Governance Committee Chair. Scotiabank director since December 2, 2011. Paul D. Sobey Corporate director. Audit and Conduct Review Committee Chair. Scotiabank director since August 31, 1999. BOARD OF DIRECTORS Nora A. Aufreiter Corporate director. Scotiabank director since August 25, 2014. Guillermo E. Babatz Managing Partner of Atik Capital, S.C. Scotiabank director since January 28, 2014. we have great confidence in the future of the Bank and we look forward to building on the nearly two centuries of continuous and limitless success. I would like to thank Brian Porter – your Bank’s President and CEO – his leadership team and the thousands of Scotiabankers around the world who are collectively guided by their core belief that the Bank’s 23 million customers have the right to become better off. And finally, my sincere thanks to you, our shareholders for your steadfast confidence, patronage and trust. Scott B. Bonham Corporate director and co-founder of Intentional Capital. Scotiabank director since January 25, 2016. Charles H. Dallara, Ph.D. Executive Vice Chairman of the Board of Directors of Partners Group Holding AG and Chairman of the Americas. Scotiabank director since September 23, 2013. William R. Fatt Corporate director. Scotiabank director since January 27, 2015. Tiff Macklem, Ph.D. Dean of the Rotman School of Management at the University of Toronto. Scotiabank director since June 22, 2015. Eduardo Pacheco Chief Executive Officer and a director of Mercantil Colpatria S.A. Scotiabank director since September 25, 2015. Brian J. Porter President and Chief Executive Officer of Scotiabank. Scotiabank director since April 9, 2013. Una M. Power Corporate director. Scotiabank director since April 12, 2016. Indira V. Samarasekera, O.C., Ph.D. Senior advisor at Bennett Jones LLP and a corporate director. Scotiabank director since May 26, 2008. Barbara S. Thomas Corporate director. Scotiabank director since September 28, 2004. L. Scott Thomson President and Chief Executive Officer of Finning International Inc. Scotiabank director since April 12, 2016. 8 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Highlights of Management’s Discussion and Analysis MEDIUM-TERM FINANCIAL OBJECTIVES Objective Achieved TOTAL ASSETS NET INCOME Return on Equity* 14+% Earnings Per Share Growth 5 - 10 % Achieve Positive Operating Leverage Maintain Strong Capital Ratios *Adjusted - please refer to page 13 of the MD&A $ 896 BILLION $ 7.4 BILLION REVENUE $ 26 BILLION DEPOSITS $ 612 BILLION LOANS $ 480 BILLION TOTAL TAXES PAID $ 3.1 BILLION TOTAL RETURN TO COMMON SHAREHOLDERS Share price appreciation plus dividends reinvested, 2005 = 100 Scotiabank S&P/TSX Banks Total Return Index S&P/TSX Composite Total Return Index 250 200 150 100 50 06 07 08 09 10 11 12 13 14 15 16 EARNINGS BY BUSINESS LINE % COMMON EQUITY TIER 1 CAPITAL RATIO % % INCOME BY GEOGRAPHY 12 10.8 10.3 11.0 51 21 28 8 4 14 15 16 Canadian Banking International Banking Global Banking and Markets For more information, please see page 32 18 6 18 58 Canada Other International U.S. Pacific Alliance TOTAL TAXES PAID $26 $612 $ 3.1 BILLION BILLION BILLION *Adjusted - please refer to page 13 of the MD&A TOTAL RETURN TO COMMON SHAREHOLDERS Share price appreciation plus dividends reinvested, 2005 + 100 Scotiabank S&P/TSX Banks Total Return Index S&P/TSX Composite Total Return Index EARNINGS BY BUSINESS LINE % Canadian Banking International Banking Global Banking and Markets COMMON EQUITY TIER 1 CAPITAL RATIO % For more information, please see page 32 % INCOME BY GEOGRAPHY Canada Other International U.S. Pacific Alliance 2016 SCOTIA BANK ANNUAL REPORT 2016 Annual Report Banking the real economy Scotiabank ement’s Discussion and Analysis MEDIUM-TERM FINANCIAL OBJECTIVES Objective Achieved Return on Equity* 14+% Earnings Per Share Growth 5 - 10 % Achieve Positive Operating Leverage Maintain Strong Capital Ratios TOTAL ASSETS NET INCOME LOANS $896 $7.4 $480 BILLION BILLION BILLION 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 9 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 9 Enhanced Disclosure Task Force (EDTF) Recommendations The Enhanced Disclosure Task Force (EDTF) was established by the Financial Stability Board in May 2012 with the goal of developing fundamental disclosure principles. On October 29, 2012 the EDTF published its report, “Enhancing the Risk Disclosures of Banks”, which sets forth recommendations around improving risk disclosures and identifies existing leading practice risk disclosures. Below is the index of all these recommendations to facilitate easy reference in the Bank’s annual report and other public disclosure documents available on www.scotiabank.com/investorrelations. Reference Table for EDTF Type of risk Number Disclosure General Risk governance, risk management and business model Capital Adequacy and risk-weighted assets Liquidity Funding Market Risk Credit Risk Other risks 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 The index of risks to which the business is exposed. The Bank’s risk to terminology, measures and key parameters. Top and emerging risks, and the changes during the reporting period. Discussion on the regulatory development and plans to meet new regulatory ratios. The Bank’s Risk Governance structure. Description of risk culture and procedures applied to support the culture. Description of key risks from the Bank’s business model. Stress testing use within the Bank’s risk governance and capital management. Pillar 1 capital requirements, and the impact for global systemically important banks. a) Regulatory capital components. b) Reconciliation of the accounting balance sheet to the regulatory balance sheet. Flow statement of the movements in regulatory capital since the previous reporting period, including changes in common equity tier 1, additional tier 1 and tier 2 capital. Discussion of targeted level of capital, and the plans on how to establish this. Analysis of risk-weighted assets by risk type, business, and market risk RWAs. Analysis of the capital requirements for each Basel asset class. Tabulate credit risk in the Banking Book. Flow statements reconciling the movements in risk-weighted assets for each risk-weighted asset type. Discussion of Basel III Back-testing requirement including credit risk model performance and validation. Analysis of the Bank’s liquid assets. Encumbered and unencumbered assets analyzed by balance sheet category. Consolidated total assets, liabilities and off-balance sheet commitments analyzed by remaining contractual maturity at the balance sheet date. Analysis of the Bank’s sources of funding and a description of the Bank’s funding strategy. Linkage of market risk measures for trading and non-trading portfolios and the balance sheet. Discussion of significant trading and non-trading market risk factors. Discussion of changes in period on period VaR results as well as VaR assumptions, limitations, backtesting and validation. Other risk management techniques e.g. stress tests, stressed VaR, tail risk and market liquidity horizon. Analysis of the aggregate credit risk exposures, including details of both personal and wholesale lending. Discussion of the policies for identifying impaired loans, defining impairments and renegotiated loans, and explaining loan forbearance policies. Reconciliations of the opening and closing balances of impaired loans and impairment allowances during the year. Analysis of counterparty credit risk that arises from derivative transactions. Discussion of credit risk mitigation, including collateral held for all sources of credit risk. Quantified measures of the management of operational risk. Discussion of publicly known risk items. (1) In the Supplementary Financial Information Package Pages Financial Statements Supplementary Regulatory Capital Disclosures 185 163, 202-206, 209-210 163, 202-206 205-206 1-2 4, 5, 7 6 7 10-12 10-19, 23-26 16-19, 24-25 9 207-210 207-210 209-210 MD&A 66, 70, 80 63, 65 46, 68-69, 76-79 32, 89-90, 106-107 60-63 63-65 66-67 64 31-32 33 34-35 31-32 38-42, 67, 115-116 38-42 38-42 38, 42 40-41 87-91 89-90 93-95 91-93 86 81-87 81-87 81-87 75-77, 109-116 170-171, 204-205 11-19, 15-21(1) 144-145, 171 74, 110, 113, 114 171 16-19(1) 161, 163 72-73 72, 75 42, 96-97 46 10 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S T A B L E O F C O N T E N T S Forward-looking statements 12 13 Non-GAAP measures 14 Financial highlights (cid:2) Overview 15 15 16 17 Financial results Economic outlook Shareholder returns Impact of foreign currency translation (cid:2) Group Financial Performance Provision for credit losses 18 Net income 18 Net interest income 20 Non-interest income 21 24 Non-interest expenses 24 25 27 29 Income taxes Financial results review: 2015 vs 2014 Fourth quarter review Trending analysis (cid:2) Group Financial Condition Statement of financial position 30 31 Capital management 42 Off-balance sheet arrangements 45 46 Financial instruments Selected credit instruments – publically known risk items (cid:2) Business Lines 47 49 52 55 58 Overview Canadian Banking International Banking Global Banking and Markets Other (cid:2) Risk Management Credit risk 70 80 Market Risk Liquidity risk 87 Other risks 96 Operational risk 96 Reputational risk 97 Environmental risk 97 Insurance risk 98 Strategic risk 98 (cid:2) Controls and Accounting Policies 99 99 103 106 107 Controls and procedures Critical accounting estimates Future accounting developments Regulatory developments Related party transactions (cid:2) Supplementary Data 109 Geographic information 112 Credit risk 117 119 120 Revenues and expenses Selected quarterly information Eleven-year statistical review 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 11 MANAGEMENT’S DISCUSSION AND ANALYSIS FORWARD LOOKING STATEMENTS Our public communications often include oral or written forward-looking statements. Statements of this type are included in this document, and may be included in other filings with Canadian securities regulators or the U.S. Securities and Exchange Commission, or in other communications. All such statements are made pursuant to the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995 and any applicable Canadian securities legislation. Forward-looking statements may include, but are not limited to, statements made in this document, the Management’s Discussion and Analysis in the Bank’s 2016 Annual Report under the headings “Overview-Outlook,” for Group Financial Performance “Outlook,” for each business segment “Outlook” and in other statements regarding the Bank’s objectives, strategies to achieve those objectives, the regulatory environment in which the Bank operates, anticipated financial results (including those in the area of risk management), and the outlook for the Bank’s businesses and for the Canadian, U.S. and global economies. Such statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intent,” “estimate,” “plan,” “may increase,” “may fluctuate,” and similar expressions of future or conditional verbs, such as “will,” “may,” “should,” “would” and “could.” By their very nature, forward-looking statements involve numerous assumptions, inherent risks and uncertainties, both general and specific, and the risk that predictions and other forward-looking statements will not prove to be accurate. Do not unduly rely on forward-looking statements, as a number of important factors, many of which are beyond the Bank’s control and the effects of which can be difficult to predict, could cause actual results to differ materially from the estimates and intentions expressed in such forward-looking statements. These factors include, but are not limited to: the economic and financial conditions in Canada and globally; fluctuations in interest rates and currency values; liquidity and funding; significant market volatility and interruptions; the failure of third parties to comply with their obligations to the Bank and its affiliates; changes in monetary policy; legislative and regulatory developments in Canada and elsewhere, including changes to, and interpretations of tax laws and risk-based capital guidelines and reporting instructions and liquidity regulatory guidance; changes to the Bank’s credit ratings; operational (including technology) and infrastructure risks; reputational risks; the risk that the Bank’s risk management models may not take into account all relevant factors; the accuracy and completeness of information the Bank receives on customers and counterparties; the timely development and introduction of new products and services in receptive markets; the Bank’s ability to expand existing distribution channels and to develop and realize revenues from new distribution channels; the Bank’s ability to complete and integrate acquisitions and its other growth strategies; critical accounting estimates and the effects of changes in accounting policies and methods used by the Bank as described in the Bank’s annual financial statements (See “Controls and Accounting Policies – Critical accounting estimates” in the Bank’s 2016 Annual Report) and updated by this document; global capital markets activity; the Bank’s ability to attract and retain key executives; reliance on third parties to provide components of the Bank’s business infrastructure; unexpected changes in consumer spending and saving habits; technological developments; fraud or other criminal behavior by internal or external parties, including the use of new technologies in unprecedented ways to defraud the Bank or its customers; increasing cyber security risks which may include theft of assets, unauthorized access to sensitive information or operational disruption; anti-money laundering; consolidation in the financial services sector in Canada and globally; competition, both from new entrants and established competitors including through internet and mobile banking; judicial and regulatory proceedings; natural disasters, including, but not limited to, earthquakes and hurricanes, and disruptions to public infrastructure, such as transportation, communication, power or water supply; the possible impact of international conflicts and other developments, including terrorist activities and war; the effects of disease or illness on local, national or international economies; and the Bank’s anticipation of and success in managing the risks implied by the foregoing. A substantial amount of the Bank’s business involves making loans or otherwise committing resources to specific companies, industries or countries. Unforeseen events affecting such borrowers, industries or countries could have a material adverse effect on the Bank’s financial results, businesses, financial condition or liquidity. These and other factors may cause the Bank’s actual performance to differ materially from that contemplated by forward-looking statements. For more information, see the “Risk Management” section Bank’s 2016 Annual Report. Material economic assumptions underlying the forward-looking statements contained in this document are set out in the 2016 Annual Report under the heading “Overview-Outlook,” as updated by this document; and for each business segment “Outlook”. The “Outlook” sections are based on the Bank’s views and the actual outcome is uncertain. Readers should consider the above-noted factors when reviewing these sections. The preceding list of factors is not exhaustive of all possible risk factors and other factors could also adversely affect the Bank’s results. When relying on forward-looking statements to make decisions with respect to the Bank and its securities, investors and others should carefully consider the preceding factors, other uncertainties and potential events. The Bank does not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on its behalf. Additional information relating to the Bank, including the Bank’s Annual Information Form, can be located on the SEDAR website at www.sedar.com and on the EDGAR section of the SEC’s website at www.sec.gov. November 29, 2016 12 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | O V E R V I E W MANAGEMENT’S DISCUSSION & ANALYSIS The Management’s Discussion and Analysis (MD&A) is provided to enable readers to assess the Bank’s financial condition and results of operations as at and for the year ended October 31, 2016. The MD&A should be read in conjunction with the Bank’s 2016 Consolidated Financial Statements and Notes. This MD&A is dated November 29, 2016. Additional information relating to the Bank, including the Bank’s 2016 Annual Report, are available on the Bank’s website at www.scotiabank.com. As well, the Bank’s 2016 Annual Report and Annual Information Form are available on SEDAR at www.sedar.com and on the EDGAR section of the SEC’s website at www.sec.gov. Non-GAAP Measures The Bank uses a number of financial measures to assess its performance. Some of these measures are not calculated in accordance with Generally Accepted Accounting Principles (GAAP), which are based on International Financial Reporting Standards (IFRS), are not defined by GAAP and do not have standardized meanings that would ensure consistency and comparability among companies using these measures. The Bank believes that certain non-GAAP measures are useful in assessing underlying ongoing business performance and provide readers with a better understanding of how management assesses performance. These non-GAAP measures are used throughout this report and defined below. T1 Impact of the 2016 restructuring charge The table below reflects the impact of the 2016 restructuring charge of $378 million pre-tax ($278 million after tax)(1). For the year ended October 31, 2016 ($ millions) Net income ($ millions) Diluted earnings per share Return on equity Productivity ratio Operating leverage (1) Calculated using the statutory tax rates of the various jurisdictions. T2 Adjusted diluted earnings per share The adjusted diluted earnings per share (EPS) is calculated as follows: Reported Impact of the restructuring charge Adjusting for the restructuring charge $ 7,368 5.77 $ 13.8% 55.2% (1.9)% $ 278 $ 0.23 0.5% (1.5)% 2.9% $ 7,646 6.00 $ 14.3% 53.7% 1.0% For the year ended October 31 ($ millions) Net income attributable to common shareholders (diluted) (refer to Note 33) Restructuring charge Net income attributable to common shareholders (diluted) adjusting for restructuring charge Other 2014 notable items(2) Net income attributable to common shareholders (diluted) adjusting for restructuring charge and other notable items Amortization of intangible assets, excluding software 2016 2015 2014 Diluted EPS(1) $ 7,070 278 $ 5.77 0.23 $ 6,983 – 7,348 – 7,348 76 6.00 – 6.00 0.05 6,983 – 6,983 65 Diluted EPS(1) $ 5.67 – 5.67 – 5.67 0.05 $ 6,924 110 7,034 (400) 6,634 62 Diluted EPS(1) $ 5.66 0.09 5.75 (0.32) 5.43 0.06 Adjusted net income attributable to common shareholders (diluted) $ 7,424 $ 6.05 $ 7,048 $ 5.72 $ 6,696 $ 5.49 Weighted average number of diluted common shares outstanding (millions) 1,226 1,232 1,222 (1) Adjusted diluted earnings per share calculations are based on full dollar and share amounts. (2) Refer to T15 Notable items. Core banking assets Core banking assets are average earning assets excluding bankers’ acceptances and average trading assets within Global Banking and Markets. Core banking margin This ratio represents net interest income divided by average core banking assets. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 13 MANAGEMENT’S DISCUSSION AND ANALYSIS T3 Financial highlights As at and for the years ended October 31 Operating results ($ millions) Net interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income tax expense Net income Net income attributable to common shareholders Operating performance Basic earnings per share ($) Diluted earnings per share ($) Adjusted diluted earnings per share ($)(1)(2) Return on equity (%) Productivity ratio (%)(3) Operating leverage (%)(3) Core banking margin (%)(1)(3) Financial position information ($ millions) Cash and deposits with financial institutions Trading assets Loans Total assets Deposits Common equity Preferred shares Assets under administration Assets under management Capital and liquidity measures Common Equity Tier 1 (CET1) capital ratio (%) Tier 1 capital ratio (%) Total capital ratio (%) Leverage ratio (%) CET1 risk-weighted assets ($ millions)(4) Liquidity coverage ratio (LCR) (%) Credit quality Net impaired loans ($ millions)(5) Allowance for credit losses ($ millions) Net impaired loans as a % of loans and acceptances(5) Provision for credit losses as a % of average net loans and acceptances Common share information Closing share price ($)(TSX) Shares outstanding (millions) Average – Basic Average – Diluted End of period Dividends per share ($) Dividend yield (%)(6) Market capitalization ($ millions)(TSX) Book value per common share ($) Market value to book value multiple Price to earnings multiple (trailing 4 quarters) Other information Employees Branches and offices 2016 2015 2014 14,292 12,058 26,350 2,412 14,540 2,030 7,368 6,987 5.80 5.77 6.05 13.8 55.2 (1.9) 2.38 46,344 108,561 480,164 896,266 611,877 52,657 3,594 472,817 192,702 11.0 12.4 14.6 4.5 364,048 127 2,446 4,626 0.49 0.50 13,092 10,957 24,049 1,942 13,041 1,853 7,213 6,897 5.70 5.67 5.72 14.6 54.2 (1.6) 2.39 73,927 99,140 458,628 856,497 600,919 49,085 2,934 453,926 179,007 10.3 11.5 13.4 4.2 357,995 124 2,085 4,197 0.44 0.43 12,305 11,299 23,604 1,703 12,601 2,002 7,298 6,916 5.69 5.66 5.49 16.1 53.4 2.8 2.39 56,730 113,248 424,309 805,666 554,017 44,965 2,934 427,547 164,820 10.8 12.2 13.9 N/A 312,473 N/A 2,002 3,641 0.46 0.40 72.08 61.49 69.02 1,204 1,226 1,208 2.88 4.7 87,065 43.59 1.7 12.4 88,901 3,113 1,210 1,232 1,203 2.72 4.4 73,969 40.80 1.5 10.8 89,214 3,177 1,214 1,222 1,217 2.56 3.8 83,969 36.96 1.9 12.1 86,932 3,288 (1) Refer to page 13 for a discussion of Non-GAAP measures. (2) Refer to T2 Adjusted diluted earnings per share. (3) Effective 2016, the taxable equivalent adjustment is no longer included in the calculation. Prior period amounts have been restated. (4) As at October 31, 2016, credit valuation adjustment (CVA) risk-weighted assets were calculated using scalars of 0.64, 0.71 and 0.77 to compute CET1, Tier 1 and Total Capital ratios, respectively. (5) Excludes loans acquired under the Federal Deposit Insurance Corporation (FDIC) guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. (6) Based on the average of the high and low common share price for the year. 14 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | O V E R V I E W Overview Financial Results The Bank’s net income for the year was $7,368 million, up 2% from $7,213 million last year and diluted earnings per share (EPS) were $5.77 compared to $5.67 last year. Return on equity was 13.8% in 2016 compared to 14.6% last year. The Bank recorded a restructuring charge of $378 million pre-tax, or $278 million after tax, in 2016 (refer T1). Adjusting for the restructuring charge, net income was $7,646 million, up 6% and diluted earnings per share rose 6% to $6.00 compared to last year. Return on equity was 14.3% compared to 14.6% last year. Current year net income was positively impacted by increases in net interest income and non-interest income, as well as acquisitions and the favourable impact of foreign currency translation. Partially offsetting were higher provision for credit losses, non-interest expenses and income taxes. Net interest income increased $1,200 million or 9% to $14,292 million, driven by growth in core banking assets across all business lines and acquisitions. The core banking margin was 2.38%, down one basis point from last year. Non-interest income increased $1,101 million or 10% to $12,058 million from the prior year. Strong growth in banking and trading revenues, acquisitions and the favourable impact of foreign currency translation contributed to the increase. Also contributing to the increase was a gain on sale of a non-core lease financing business in Canada, while gains on sale of real estate this year were largely offset by lower net gains on investment securities. The total provision for credit losses was $2,412 million, up $470 million from last year. Contributing to this increase were higher provisions related to energy exposures in Global Banking and Markets, higher commercial provisions in International Banking, and higher retail provisions in Canadian Banking, primarily in credit cards and automotive loans, generally in line with volume growth. Partially offsetting were higher acquisition-related benefits this year. Non-interest expenses were $14,540 million this year, an increase of $1,499 million or 11% over last year. Adjusting for the restructuring charge (refer T1), expenses increased 9%. The increase reflects the impact of acquisitions, higher performance-based compensation, as well as higher business initiative and volume-driven costs including technology and professional fees, software amortization, and deposit insurance. As well, last year benefited from lower pension benefit costs of $204 million related to modifications made to the Bank’s main pension plan partly offset by the costs relating to the reorganization of Canadian shared services of $61 million. Operating leverage was negative 1.9% on a reported basis, or positive 1.0% adjusting for the restructuring charge (refer T1). The provision for income taxes was $2,030 million, an increase of $177 million from last year. The Bank’s overall effective tax rate for the year was 21.6% compared to 20.4% in 2015. The increase in the effective tax rate was due primarily to lower tax-exempt income and higher taxes in foreign jurisdictions this year. The all-in Basel III Common Equity Tier 1 ratio was 11.0% as at October 31, 2016, compared to 10.3% last year, and remained well above the regulatory minimum. Economic Outlook The United States will be the reference point for economic developments in the year ahead owing to the potentially large shifts brought about by the results of the November 2016 elections. After an initial period of uncertainty as the priorities of the new American administration are clarified, we expect U.S. economic activity to continue picking up as additional fiscal stimulus, delivered through tax cuts and infrastructure spending, accelerates the recovery in U.S. domestic demand that has already been buoyed by reasonably strong gains in employment, consumer spending, and residential construction. Canadian output growth is rebounding owing to the rebuilding of Fort McMurray after the devastating wildfires in early May, a resumption of crude oil shipments from Alberta post-fire, and a modest pick-up in non-energy exports. Although uncertainty about the new U.S. government’s approach to trade policy may temporarily dampen investment growth in early 2017, capital spending should pick up again as Canada’s federal stimulus package and U.S. demand growth both take hold later in the year. Consumer demand should be reasonably well supported in the year ahead by recent employment gains and the anticipated impact of the Canada Child Benefit. A number of downside risks to Canada’s economy remain, including stretched valuations in the Vancouver and Toronto housing markets and high household indebtedness, but these appear well-managed. The outlook for the Pacific Alliance countries remains closely tied to the U.S. economy. Some country-specific risks will remain salient in the year ahead, but the medium-term outlook for the region remains strong. We are positive about Mexico’s underlying strengths, and we also anticipate further economic rebound in Brazil. Across the Atlantic, most economic indicators in the U.K. point to much stronger than expected growth in the aftermath of the ‘Brexit’ vote as currency movements provide a cushion for real activity. Despite this unanticipated resilience, we continue to expect the U.K. economy to slow as the British government moves towards negotiations on withdrawal from the E.U. The knock-on effects in Europe, alongside financial sector challenges and local political uncertainty, are likely to provide a drag on growth across the Continent. Japan’s recovery will probably remain muted as the authorities strive to make new monetary and fiscal measures effective. The pace of growth throughout the rest of the Pacific Rim will be favourable, with indicators pointing to a pick-up in China’s industrial activity. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 15 MANAGEMENT’S DISCUSSION AND ANALYSIS Shareholder Returns In fiscal 2016, the total shareholder return on the Bank’s shares was 22.5%, which outperformed the 12.6% total return of the S&P/TSX Composite Index. The total compound annual shareholder return on the Bank’s shares over the past five years was 11.1%, and 8.2% over the past 10 years. This exceeded the total return of the S&P/TSX Composite Index, which was 7.0% over the past five years and 4.8% over the last ten years, as shown in chart C2. Quarterly dividends were raised twice during the year – a two cent increase effective the second quarter and a further two cent increase effective in the fourth quarter. As a result, dividends per share totaled $2.88 for the year, up 6% from 2015. The Bank was within its target payout range of 40-50%, with a payout ratio of 49.6% for the year. T4 Shareholder returns For the years ended October 31 Closing market price per common share ($) Dividends paid ($ per share) Dividend yield (%)(1) Increase (decrease) in share price (%) Total annual shareholder return (%)(2) 2016 72.08 2.88 4.7 17.2 22.5 2015 61.49 2.72 4.4 (10.9) (7.0) 2014 69.02 2.56 3.8 8.9 13.2 (1) Dividend yield is calculated as the dividend paid divided by the average of the high and low common share price for the year. (2) Total annual shareholder return assumes reinvestment of quarterly dividends, and therefore may not equal the sum of dividend and share price returns in the table. C1 Closing common share price as at October 31 $80 70 60 50 40 30 06 08 10 12 14 16 C2 Return to common shareholders Share price appreciation plus dividends reinvested, 2006=100 240 200 160 120 06 08 10 12 14 16 Scotiabank S&P/TSX Banks Total Return Index S&P/TSX Composite Total Return Index 16 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Impact of Foreign Currency Translation The impact of foreign currency translation on net income is shown in T5. T5 Impact of foreign currency translation For the fiscal years U.S. dollar/Canadian dollar Mexican Peso/Canadian dollar Peruvian Sol/Canadian dollar Colombian Peso/Canadian dollar Chilean Peso/Canadian dollar Impact on net income(1) ($ millions except EPS) Net interest income Non-interest income(2) Non-interest expenses Other items (net of tax) Net income Earnings per share (diluted) Impact by business line ($ millions) Canadian Banking International Banking(2) Global Banking and Markets Other(2) (1) (2) Includes impact of all currencies Includes the impact of foreign currency hedges. 2016 2015 2014 Average exchange rate % Change Average exchange rate % Change Average exchange rate % Change 0.754 13.666 2.539 2,307 514.549 (6.4)% 10.3% 1.3% 10.8% 0.5% 0.806 12.386 2.505 2,082 512.203 (12.2)% 2.8% (3.0)% 16.4% 0.2% 0.918 12.049 2.582 1,789 511.261 (6.5)% (3.7)% (1.3)% (1.4)% 6.8% 2016 vs. 2015 2015 vs. 2014 2014 vs. 2013 $ (51) 182 86 (34) $ 183 $ 0.15 $ 14 44 65 60 $ 232 243 (151) (62) $ 262 $ 0.21 $ 20 84 110 48 $ 191 195 (134) (70) $ 182 $ 0.15 $ 8 80 85 9 $ 183 $ 262 $ 182 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | O V E R V I E W 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 17 MANAGEMENT’S DISCUSSION AND ANALYSIS GROUP FINANCIAL PERFORMANCE Net Income Net income was $7,368, up 2% compared to $7,213 last year. Included in this year’s results is a restructuring charge of $378 million pre-tax, or $278 million after tax (refer T1). Adjusting for the restructuring charge, net income increased $433 million or 6%. Net Interest Income Net interest income was $14,292 million, an increase of $1,200 million or 9% from the prior year. This increase was driven by a 9% growth in core earning assets, including acquisitions, as the core banking margin was in line with last year. Canadian Banking’s net interest income was up $608 million or 9% driven by strong asset and deposit growth, expansion in margin, and the impact of an acquisition. Net interest income increased $652 million or 11% in International Banking primarily due to strong asset growth and the impact of acquisitions. Global Banking and Markets net interest income increased $222 million or 21% driven by an increase in both average earning assets and margin. Partially offsetting these increases were lower contribution from asset/liability management activities reflected in the Other segment. Core banking assets increased $50 billion to $598 billion. The increase was driven by strong growth in both retail and commercial loans in International Banking, corporate loans in Global Banking and Markets, automotive and credit card loans in Canadian Banking and higher volume of assets held for liquidity purposes in the Other segment. Also contributing to the asset increase was the positive impact of foreign currency translation. The core banking margin of 2.38% was in line with the previous year. The margin increase in Canadian Banking was offset by lower contribution from asset/liability management activities reflected in the Other segment. Outlook Net interest income is expected to increase in 2017 mainly due to growth in core banking assets across all business lines. The total margin is expected to be in line with 2016, as improvements from business mix, both on the asset and deposit side, are generally offset by continued deposit margin compression in an expected low interest rate environment. T6 Net interest income and core banking margin(1) ($ billions, except percentage amounts) Total average assets and net interest income Less: total assets in Capital Markets(1) Banking margin on average total assets Less: non-earning assets and customers’ liability under acceptances Average balance $ 913.8 259.4 $ 654.4 56.6 2016 Interest $ 14.3 – $ 14.3 Average rate Average balance $ 860.6 258.1 2015 Interest $ 13.1 – Average rate Average balance $ 795.6 232.5 2.18% $ 602.5 $ 13.1 2.18% $ 563.1 2014 Interest $ 12.3 – $ 12.3 Average rate 2.19% 54.4 48.0 Core banking assets and margin $ 597.8 $ 14.3 2.38% $ 548.1 $ 13.1 2.39% $ 515.1 $ 12.3 2.39% (1) Net interest income from Capital Markets trading assets is recorded in trading revenues in non-interest income. 18 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L P E R F O R M A N C E 2016 Average balance Interest Average rate Average balance 2015 Interest Average rate Average balance 2014 Interest Average rate $ 67.8 107.2 $ 99.8 67.8 218.6 96.8 161.4 (4.6) $ 472.2 $ 814.8 11.4 87.6 0.4 0.2 0.1 1.1 7.4 7.3 5.5 0.58% $ 0.16% 71.1 111.2 $ 0.16% 1.57% 3.37% 7.57% 3.41% 99.9 43.7 214.4 87.5 142.2 (4.0) 0.3 0.2 0.2 0.7 7.5 6.6 4.6 0.41% $ 0.17% 60.1 113.3 $ 0.16% 1.69% 3.51% 7.52% 3.25% 91.1 41.2 210.9 79.6 128.5 (3.6) 0.3 0.1 0.2 0.8 7.6 6.1 4.3 $ 20.2 $ 22.0 4.28% $ 440.1 2.70% $ 766.0 $ 18.7 $ 20.1 4.26% $ 415.4 2.63% $ 721.1 $ 18.0 $ 19.4 11.4 83.2 10.4 64.1 0.44% 0.12% 0.20% 1.91% 3.60% 7.61% 3.39% 4.34% 2.69% $ 913.8 $ 22.0 2.41% $ 860.6 $ 20.1 2.34% $ 795.6 $ 19.4 2.43% T7 Average balance sheet(1) and net interest income For the fiscal years ($ billions) Assets Deposits with financial institutions Trading assets Securities purchased under resale agreements and securities borrowed Investment securities Loans: Residential mortgages Personal and credit cards Business and government Allowance for credit losses Total loans Total earning assets Customers’ liability under acceptances Other assets Total assets Liabilities and equity Deposits: Personal Business and government Financial institutions Total deposits $ 195.1 384.7 42.8 $ 622.6 $ $ 2.4 3.9 0.4 6.7 0.2 0.2 0.6 7.7 Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Other interest-bearing liabilities 99.1 7.5 54.9 Total interest-bearing liabilities $ 784.1 $ Other liabilities including acceptances Equity(2) Total liabilities and equity Net interest income 74.4 55.3 $ 913.8 $ 7.7 $ 14.3 (1) Average of daily balances. (2) Includes non-controlling interests of $1.5 in 2016, $1.3 in 2015 and $1.2 in 2014. 1.22% $ 181.4 368.1 1.01% 37.3 1.03% 1.08% $ 586.8 $ $ 0.19% 3.10% 1.04% 90.7 5.6 50.1 0.98% $ 733.2 $ 2.3 3.4 0.3 6.0 0.2 0.2 0.6 7.0 75.9 51.5 0.84% $ 860.6 $ 7.0 $ 13.1 1.27% $ 172.6 339.7 0.91% 38.4 0.85% 1.02% $ 550.7 $ $ 0.26% 3.33% 1.20% 87.3 5.3 50.2 0.96% $ 693.5 $ 2.4 3.5 0.3 6.2 0.3 0.2 0.4 7.1 54.4 47.7 0.81% $ 795.6 $ 7.1 $ 12.3 1.42% 1.02% 0.77% 1.13% 0.32% 3.84% 0.72% 1.02% 0.89% 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 19 MANAGEMENT’S DISCUSSION AND ANALYSIS T8 Non-interest income For the fiscal years ($ millions) 2016 2015 2014 2016 versus 2015 Banking Card revenues Deposit and payment services Deposit services Other payment services Credit fees Commitment and other credit fees Acceptance fees Other Banking fee related expenses $ 1,359 $ 1,089 $ 933 25% 949 330 928 307 901 282 $ 1,279 $ 1,235 $ 1,183 870 284 787 266 778 236 $ 1,154 $ 1,053 $ 1,014 436 559 406 423 379 339 C3 Sources of non-interest income 21% 11% 10% 10% 14% Underwriting and other advisory fees Non-trading foreign exchange fees Trading revenues Other non-interest income 12% 4% 5% 5% 8% Card revenues Deposit and payment services and other banking fees Credit fees Mutual funds Brokerage fees Investment management and trust Total banking revenues $ 3,669 $ 3,360 $ 3,170 Wealth management Mutual funds Brokerage fees Investment management and trust Investment management and custody Personal and corporate trust Total wealth management revenues Underwriting and other advisory Non-trading foreign exchange Trading revenues Net gain on investment securities Net income from investments in associated corporations Insurance underwriting income, net of claims Other $ 1,624 1,010 $ 1,619 1,006 $ 1,468 942 $ $ 443 205 648 3,282 594 540 1,403 534 414 603 1,019 $ $ 440 204 644 3,269 525 492 1,185 639 405 556 526 $ $ 419 194 613 3,023 712 420 1,114 741 428 474 1,217 2 7 4% 11 7 10% 7 32 9% –% – 1 – 1 –% 13% 10 18 (16) 2 8 94 Total non-interest income $ 12,058 $ 10,957 $ 11,299 10% Non-Interest Income Non-interest income was $12,058 million, up $1,101 million or 10%, primarily from growth in banking and trading revenues and higher underwriting and advisory fees. The positive impact of acquisitions, foreign currency translation and hedging activities, and gain from the sale of a non-core lease finance business also contributed to the increase. Gains on sales of real estate were generally offset by lower net gains on investment securities. Banking revenues, excluding related expenses, grew $445 million or 12% to $4,228 million reflecting strong growth in card revenues of 25% due to higher fee income and the impact from acquisitions in Canadian Banking and International Banking. Credit fees were up $101 million or 10% mainly from growth in Global Banking and Markets, as well as contributions from Canadian Banking and International Banking. Banking fee related expenses rose $136 million or 32%, primarily due to card expenses in Canadian Banking and International Banking, reflecting higher transaction volumes as well as acquisitions. Underwriting and other advisory fees were up $69 million or 13%, mainly due to higher new issue activity and investment advisory fees in Global Banking and Markets. Non-trading foreign exchange revenues rose $48 million or 10% to $540 million, primarily in Latin America and the Caribbean. Trading revenues of $1,403 million were higher by $218 million or 18% (refer to T9) from the prior year mainly related to fixed income. Higher commodities and foreign exchange trading revenues were offset by lower equity trading revenues. Insurance underwriting income was up $47 million or 8%, mostly from strong premium growth in Canada and the Caribbean. Other income increased significantly by $493 million to $1,019 million primarily due to the gain on sale of a non-core lease financing business, the impact of acquisitions, and gains on sale of real estate. Outlook Non-interest income is expected to reflect continued growth in 2017 benefiting from higher card revenues, mutual fund management fees and brokerage revenues. Gains on investment securities, primarily recorded in the Other segment, are expected to be lower than 2016. 20 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T T9 Trading revenues For the fiscal years ($ millions) By trading products: Interest rate and credit Equities Commodities Foreign exchange Other Total trading revenues % of total revenues 2016 2015 2014 $ 613 101 376 262 51 $ 400 177 345 201 62 $ 415 92 359 208 40 1,403 1,185 1,114 5.3% 4.9% 4.7% Provision for Credit Losses The total provision for credit losses was $2,412 million, up $470 million from last year net of acquisition-related benefits of $152 million. The provision for credit losses ratio was 50 basis points compared to 43 basis points in the prior year. In Canadian Banking, the provision for credit losses was $832 million, an increase of $145 million. The provision for credit losses was higher due to growth in retail portfolios, primarily in credit cards and auto loans, with additional increases from commercial provisions. The provision for credit losses ratio was 28 basis points, up five basis points from the prior year. The provision for credit losses in International Banking increased $153 million to $1,281 million. Retail provisions were flat compared to 2015. Increases from acquisitions and higher provisions for credit losses in Latin America from strong retail loan growth were offset by favourable foreign currency translation. In the commercial portfolio, provisions were higher in Colombia, primarily the energy sector, and in Puerto Rico. Overall, the provision for credit losses ratio was 126 basis points, up two basis points from last year. The provision for credit losses in Global Banking and Markets was $249 million, an increase of $182 million from last year due to higher provisions in the United States and Europe, primarily in the energy sector, and also in Asia. The provision for credit losses ratio was up 20 basis points to 30 basis points. Outlook The quality of the Bank’s credit portfolio is expected to remain strong given its broad global diversification. The total provision for credit losses ratio is expected to reduce in 2017. In Canadian Banking, the retail provision for credit losses ratio is expected to increase from changes in the business mix while the commercial ratio is expected to normalize in relation to historical experience. In International Banking, the retail provision for credit losses ratio is expected to be in line with last year after accounting for the integration of prior acquisitions while the commercial ratio should improve. In Global Banking and Markets, the provision for credit losses ratio is expected to decline driven by lower energy related issues. Overall, provision levels in 2017 will be within the Bank’s risk appetite and aligned with strategy. T10 Provisions against impaired loans by business line M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L P E R F O R M A N C E For the fiscal years ($ millions) Canadian Banking Retail Commercial International Banking Caribbean and Central America Latin America Mexico Peru Chile Colombia Other Latin America Total Latin America Global Banking and Markets Canada U.S. Asia and Europe Total 2016 2015 2014 $ $ $ 770 62 832 250 224 317 112 320 58 1,031 $ $ $ 642 45 687 184 260 265 108 247 64 944 $ $ $ 607 56 663 248 240 267 74 146 49 776 $ 1,281 $ 1,128 $ 1,024 $ 43 113 93 $ 249 $ $ 42 4 21 67 $ $ 3 2 11 16 $ 2,362 $ 1,882 $ 1,703 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 21 MANAGEMENT’S DISCUSSION AND ANALYSIS T11 Provision for credit losses as a percentage of average net loans and acceptances For the fiscal years (%) Canadian Banking Retail Commercial International Banking Retail Commercial Global Banking and Markets Provisions against impaired loans Provisions against performing loans Total T12 Net charge-offs(1) as a percentage of average loans and acceptances For the fiscal years (%) Canadian Banking Retail Commercial International Banking Retail Commercial Global Banking and Markets Total (1) Write-offs net of recoveries. 2016 2015 2014 0.29% 0.15 0.28 0.25% 0.12 0.23 0.24% 0.17 0.23 2.08 0.52 1.26 0.30 0.49 0.01 2.33 0.26 1.24 0.10 0.42 0.01 2.13 0.51 1.27 0.03 0.40 0.00 0.50% 0.43% 0.40% 2016 2015 2014 0.26% 0.16 0.24 1.90 0.31 1.06 0.21 0.26% 0.20 0.25 1.99 0.30 1.10 0.01 0.21% 0.24 0.21 1.66 0.14 0.70 0.11 0.41% 0.39% 0.33% 22 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T T13 Non-interest expenses and productivity For the fiscal years ($ millions) 2016 2015 2014 2016 versus 2015 Salaries and employee benefits Salaries Performance-based compensation Share-based payments Other employee benefits Premises and technology Premises Net rent Property taxes Other premises costs Technology Depreciation and amortization Depreciation Amortization of intangible assets Communications Advertising and business development Professional Business and capital taxes Business taxes Capital taxes $ 4,071 1,538 243 1,173 $ 4,019 1,438 220 1,004 $ 3,680 1,473 270 1,124 $ 7,025 $ 6,681 $ 6,547 428 89 431 948 1,290 2,238 325 359 684 442 617 693 356 47 403 $ $ $ $ $ $ $ $ 433 89 421 943 1,143 2,086 303 281 584 434 592 548 319 42 361 $ $ $ $ $ $ $ $ 392 82 415 889 1,047 1,936 297 229 526 417 571 471 276 38 314 $ $ $ $ $ $ $ $ Other $ 2,438 $ 1,755 $ 1,819 1% 7 10 17 5% (1) – 2 1% 13% 7% 7 28 17% 2% 4% 27% 12 12 12% 39% Total non-interest expenses $ 14,540 $ 13,041 $ 12,601 11% Productivity ratio 55.2% 54.2% 53.4% Non-interest expenses $ millions C4 16000 14000 12000 10000 8000 6000 4000 2000 14 15 16 Salaries & employee benefits Premises & technology Depreciation and amortization Communications & advertising Professional & taxes Other Direct and indirect taxes $ millions 14 15 16 Provision for income taxes Total other taxes C5 3000 2500 2000 1500 1000 500 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L P E R F O R M A N C E 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 23 MANAGEMENT’S DISCUSSION AND ANALYSIS Non-Interest Expenses Non-interest expenses were $14,540 million, an increase of $1,499 million or 11% from the prior year. The Bank took a restructuring charge this year of $378 million (refer T1). The restructuring will enable the Bank to enhance its customer experience, drive a digital transformation and improve its productivity. The restructuring charge, recorded in the Other segment, arises from a structural cost reduction program that relates primarily to changes in Canadian Banking and organization-wide structural changes. These strategic efforts will better position the Bank for long-term growth. Adjusting for the restructuring charge, the increase was $1,121 million or 9%. The increase was driven by acquisitions, higher performance-based compensation, as well as initiative and volume-driven growth in technology, software amortization, professional fees, and deposit insurance. There were also higher employee pension and benefit expenses as last year benefited from lower pension benefit costs related to modifications made to the Bank’s main pension plan. These were partly offset by net savings of $55 million realized from structural cost reduction initiatives related to this year’s restructuring charge, as well as the reorganization cost incurred in 2015. The productivity ratio was 55.2%, or 53.7% on an adjusted basis (refer T1), compared to 54.2% in 2015. Operating leverage was negative 1.9%. Adjusting for the restructuring charge, it was positive 1.0% (refer T1). Outlook Non-interest expenses are expected to rise in 2017, after adjusting for the 2016 restructuring charge. This is driven by business growth, ongoing strategic and technology investments as well as higher pension and benefit expenses. The growth will be partly offset by savings from structural cost reduction initiatives. Income Taxes The provision for income taxes was $2,030 million, an increase from $1,853 million last year. The Bank’s overall effective tax rate for the year was 21.6% compared to 20.4% for 2015. The increase in the effective tax rate was due primarily to lower tax-exempt income and higher taxes in foreign jurisdictions this year. Outlook The Bank’s consolidated effective tax rate is expected to be in the range of 22% to 25% in 2017. 24 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Financial Results Review: 2015 vs. 2014 In order to identify key business trends between 2015 and 2014, commentary and the related financial results are below. Net income The Bank had net income of $7,213 million in 2015, compared to $7,298 million in 2014 and diluted earnings per share (EPS) of $5.67 compared to $5.66 in 2014. Return on equity was 14.6% compared to 16.1% in 2014. The 2015 net income was positively impacted by an increase in net interest income, the favourable impact of foreign currency translation and lower income taxes. Mostly offsetting these positive impacts were higher provision for credit losses and higher non-interest expenses. The 2015 net income included the following, largely offsetting items, comprised of a reduction in the pension benefit accrual related to modifications made to the Bank’s main pension plan of $204 million pre-tax ($151 million after tax; approximately 3% of the pension liability), an increase to the collective allowance against performing loans of $60 million pre-tax ($44 million after tax) to support the growing loan portfolio, and reorganization costs related to the consolidation of Canadian shared services operations of $61 million pre-tax ($45 million after tax). These items were recorded in the Other segment. The 2014 net income was impacted by several notable items (refer T15) totaling a net benefit of $301 million pre-tax or $290 million after tax, or approximately 23 cents per share. Net interest income Net interest income increased $787 million or 6% to $13,092 million in 2015, primarily from growth in core banking assets and the favourable impact of foreign currency translation. The core banking margin was stable at 2.39%. Non-interest income Non-interest income was $10,957 million, a decrease of $342 million from $11,299 million. The 2014 non-interest income was positively impacted by notable items of $566 million (refer T15). In 2015, increases in wealth management and banking revenues and the positive impact of foreign currency translation were partly offset by lower underwriting and advisory fees and lower net gains on investment securities. Provision for credit losses The total provision for credit losses was $1,942 million in 2015, up $239 million from 2014. This was primarily from increased provisions in the Canadian and International retail portfolios, as well as higher Global Banking and Markets corporate loan provisions in Canada and Europe. These higher provisions were partially offset by lower commercial provisions in Canadian Banking. The 2015 provision also included a $60 million increase in the collective allowance against performing loans. The 2014 provision included a notable item of $62 million related to a change in write-off policy on unsecured bankrupt retail accounts in Canada. Non-interest expenses Non-interest expenses were $13,041 million in 2015, an increase of $440 million or 3% over 2014. The increase reflects higher technology, business development and reorganization costs and the negative impact of foreign currency translation. These were partly offset by lower pension benefit costs. The 2014 non-interest expenses included notable items of $203 million (refer T15). Operating leverage was negative 1.5% on a reported basis, or negative 0.7% after adjusting for the 2014 notable items. Provision for income taxes The provision for income taxes was $1,853 million, a decrease of $149 million from 2014. The Bank’s overall effective tax rate for 2015 was 20.4% compared to 21.5% in 2014. The decrease in the effective tax rate was due primarily to higher tax-exempt income and lower earnings in higher tax jurisdictions, partially offset by a lower tax rate on the notable gain in the prior year. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L P E R F O R M A N C E T14 Financial Results Review For the year ended October 31, 2015 ($ millions)(1) Net interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income tax expense Net income Canadian Banking International Banking Global Banking and Markets Other(2) Total $ 6,415 4,832 $ 11,247 687 6,014 1,202 $ 5,706 3,137 $ 8,843 1,128 5,095 568 $ 1,071 2,953 $ 4,024 67 1,846 558 $ (100) 35 $ (65) 60 86 (475) $ 13,092 10,957 $ 24,049 1,942 13,041 1,853 $ 3,344 $ 2,052 $ 1,553 $ 264 $ 7,213 Net income attributable to non-controlling interests – 199 – – 199 Net income attributable to equity holders of the Bank $ 3,344 $ 1,853 $ 1,553 $ 264 $ 7,014 (1) Taxable equivalent basis. Refer to Glossary. (2) Includes all other smaller operating segments, including Group Treasury, and corporate adjustments, such as the elimination of the tax-exempt income gross-up reported in net interest income, non-interest income and provision for income taxes for the year ended October 31, 2015 – $390 to arrive at the amounts reported in Consolidated Statement of income, and differences in the actual amount of costs incurred and charged to the operating segments. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 25 MANAGEMENT’S DISCUSSION AND ANALYSIS For the year ended October 31, 2014 ($ millions)(1) Net interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income tax expense Net income Net income attributable to non-controlling interests Canadian Banking $ 5,996 5,263 $ 11,259 663 5,799 1,113 $ 3,684 1 International Banking Global Banking and Markets $ 5,155 2,945 $ 8,100 1,024 4,690 544 $ 1,842 226 $ 1,064 3,167 $ 4,231 16 1,880 665 $ 1,670 – Other(2) Total $ $ 90 (76) 14 – 232 (320) $ 12,305 11,299 $ 23,604 1,703 12,601 2,002 $ 102 $ 7,298 – 227 Net income attributable to equity holders of the Bank $ 3,683 $ 1,616 $ 1,670 $ 102 $ 7,071 (1) Taxable equivalent basis. Refer to Glossary. (2) Includes all other smaller operating segments, including Group Treasury and corporate adjustments, such as the elimination of the tax-exempt income gross-up reported in net interest income, non-interest income and provision for income taxes for the year ended October 31, 2014 – $354 million to arrive at the amounts reported in Consolidated Statement of Income, and differences in the actual amount of costs incurred and charged to the operating segments. 2014 Notable Items There were several notable items in 2014 totaling a net benefit of $290 million ($301 million pre-tax), or approximately 23 cents per share as outlined in the table below. T15 2014 Notable items For the year ended October 31 ($ millions, except EPS) Gain on sale Sale of holdings in CI Financial Corp. Provision for credit losses Unsecured bankrupt retail accounts in Canada Valuation adjustments Funding valuation adjustment Revaluation of monetary assets in Venezuela Legal provisions Sub-total Restructuring charges Total By Business line Canadian Banking International Banking Global Banking and Markets Other Total By Consolidated Statement of Income line Trading revenues Other income Non-interest income Provision for credit losses Non-interest expenses Total Notes Q3 2014 items (1) Sale of majority of Bank’s holding in CI Financial Corp. 2014 Notes Pre-tax After-tax EPS Impact 1 2 3 4 5 6 $ 643 $ 555 $ 0.45 (62) (30) (47) (55) 449 (148) (46) (22) (47) (40) 400 (110) (0.04) (0.02) (0.04) (0.03) 0.32 (0.09) $ 301 $ 290 $ 0.23 $ 506 (81) (38) (86) $ 301 $ (30) 596 566 (62) (203) $ 453 (74) (27) (62) $ 290 $ (22) 508 486 (46) (150) $ 0.23 $ 301 $ 290 $ 0.23 The Bank sold a majority of its holding in CI Financial Corp. resulting in a $643 million pre-tax gain ($555 million after tax), or 45 cents per share. This included an unrealized gain of $174 million pre-tax, or $152 million after tax, on the reclassification of the Bank’s remaining investment to available-for-sale securities. Q4 2014 items (2) Provision for credit losses The Bank changed its write-off policy on unsecured bankrupt retail accounts in Canada in order to accelerate write-offs upon notification of a bankruptcy filing. As a result, a charge of $62 million ($46 million after tax) was recorded. (3) Funding valuation adjustment The Bank enhanced the fair value methodology and recognized a funding valuation adjustment (FVA) charge of $30 million ($22 million after tax), to reflect the implied funding cost on uncollateralized derivative instruments. (4) Venezuela Venezuela was designated as hyper-inflationary and measures of exchange controls have been imposed by the Venezuelan government. These restrictions have limited the Bank’s ability to repatriate cash and dividends out of Venezuela. The Bank’s Venezuelan Bolivar (VEF) exposures include its investment in Banco del Caribe, and unremitted dividends and other cash amounts (“monetary assets”) in Venezuela. As at October 31, 2014, the Bank remeasured its net investment and monetary assets at the SICAD II rate (1 USD to 50 VEF). As a result, the Bank recorded a charge of $47 million in the Consolidated Statement of Income representing the revaluation impact on the monetary assets and a reduction in carrying value of the net investment of $129 million has been charged to Other Comprehensive Income. (5) Legal provision The Bank recorded a legal provision of approximately $55 million ($40 million after tax) related to certain ongoing legal claims. (6) Restructuring charges The Bank recorded a restructuring charge of $148 million ($110 million after tax), the majority relating to employee severance charges. These charges will drive greater operational efficiencies. In Canada, the charges relate to recent initiatives to centralize and automate several mid-office branch functions, as well as reductions in required wealth management operational support. In International Banking, the charges are primarily for closing or downsizing approximately 120 branches, which will allow us to focus on high-growth markets, minimize branch overlap, and realize synergies resulting from recent acquisitions. The Bank also made a series of changes to simplify its leadership structure and operating model, recorded in the Other segment. 26 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L P E R F O R M A N C E Fourth Quarter Review T16 Fourth Quarter Financial Results ($ millions) Net Interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income tax expense Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Preferred shareholders Common shareholders Q4 2016 vs. Q4 2015 For the three months ended October 31 2016 July 31 2016 October 31 2015 $ 3,653 3,098 $ 3,602 3,038 $ 3,371 2,754 6,751 550 3,650 540 6,640 571 3,505 605 6,125 551 3,286 445 $ 2,011 $ 1,959 $ 1,843 $ 72 $ 62 $ 60 $ 1,939 31 $ 1,908 $ 1,897 37 $ 1,860 $ 1,783 29 $ 1,754 Net income Net income was $2,011 million, an increase of $168 million or 9%. Strong asset growth and higher capital markets revenues were partly offset by higher non-interest expenses and income taxes. Net interest income Net interest income was $3,653 million, an increase of $282 million or 8%. The increase was attributable primarily to growth in retail and commercial loans in International Banking, credit cards, automotive loans and residential mortgages in Canadian Banking, and corporate loans in Global Banking and Markets. The core banking margin was 2.40%, up five basis points driven by higher margins across all business lines, partially offset by lower contribution from asset/liability management activities in the Other segment. Non-interest income Non-interest income of $3,098 million was up $344 million or 12%. This was driven by higher banking fees, wealth management and trading revenues, underwriting and other advisory fees and net income from investments in associated corporations. Gains on sale of real estate were largely offset by lower net gains on investment securities. Provision for credit losses The provision for credit losses was $550 million, down $1 million. Last year’s increase in collective allowance against performing loans of $60 million was mostly offset by higher provisions in Canadian Banking and International Banking. Non-interest expenses Non-interest expenses increased by $364 million or 11% to $3,650 million. Last year benefited from lower pension benefit costs, partly offset by the reorganization costs relating to Canadian shared services. The increase was primarily due to higher performance and stock-based compensation, acquisitions and continued investments in the business, including technology and professional expenses. This was partly offset by the favourable impact of foreign currency translation and savings from structural cost reduction initiatives. The productivity ratio was 54.1%, compared to 53.6%. Income taxes The tax rate was 21.2% compared to 19.4%, due primarily to lower tax-exempt income. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 27 MANAGEMENT’S DISCUSSION AND ANALYSIS Q4 2016 vs. Q3 2016 Net income Net income was $2,011 million, an increase of $52 million or 3% over the prior quarter. Higher revenues, lower provision for credit losses and lower income taxes, were partly offset by higher non-interest expenses. Net interest income Net interest income was $3,653 million, an increase of $51 million or 1%. The increase was attributable to asset growth primarily in residential mortgages and automotive loans in Canadian Banking, and retail loans in International Banking. The core-banking margin was 2.40%, up two basis points, mostly from higher margins in Canadian Banking and Global Banking and Markets. Non-interest income Non-interest income was $3,098 million, up $60 million or 2%. Higher banking and wealth management revenues and contributions from associated corporations were partly offset by lower underwriting and advisory fees. Gains on sale of real estate were offset by lower net gains on investment securities. Provision for credit losses The provision for credit losses was $550 million, a decline from $571 million, due primarily to lower provisions in International Banking. Non-interest expenses and productivity Non-interest expenses were up $145 million or 4%. This was mainly due to continued investments in the business, including technology and professional fees, and higher seasonal marketing expenses. The productivity ratio was 54.1% compared to 52.8%. Income taxes The effective tax rate was 21.2% compared to 23.6%, due primarily to higher taxes in certain foreign jurisdictions in the previous quarter. 28 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L P E R F O R M A N C E Trending Analysis T17 Quarterly financial highlights ($ millions) Net interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income tax expense Net income Basic earnings per share ($) Diluted earnings per share ($) Net income For the three months ended October 31 2016 July 31 2016 April 30 2016 January 31 2016 October 31 2015 July 31 2015 April 30 2015 January 31 2015 $ 3,653 3,098 $ 6,751 550 3,650 540 $ 3,602 3,038 $ 6,640 571 3,505 605 $ 3,518 3,076 $ 6,594 752 3,817 441 $ 3,519 2,846 $ 6,365 539 3,568 444 $ 3,371 2,754 $ 6,125 551 3,286 445 $ 3,354 2,770 $ 6,124 480 3,334 463 $ 3,198 2,739 $ 5,937 448 3,224 468 $ 3,169 2,694 $ 5,863 463 3,197 477 $ 2,011 $ 1,959 $ 1,584 $ 1,814 $ 1,843 $ 1,847 $ 1,797 $ 1,726 1.58 1.57 1.55 1.54 1.24 1.23 1.44 1.43 1.46 1.45 1.46 1.45 1.43 1.42 1.36 1.35 The Bank recorded strong net income over the past eight quarters. The second quarter of 2016 was impacted by a restructuring charge of $378 million pre-tax, or $278 million after tax. Net interest income Net interest income rose throughout the year. Core banking assets increased steadily during 2016 from continuing growth in Latin America, and retail loan growth in Canadian Banking, corporate loan growth in Global Banking and Markets, as well as the benefit from the impact of foreign currency translation. The average balance of low-spread deposits with banks has declined since the fourth quarter of last year. The core banking margin for the year was 2.38%, a one basis point decrease from last year. The margin was stable for the first three quarters, and increased by five basis points in the fourth quarter. Canadian Banking’s margin improved during the year mainly from growth in higher spread products, including credit cards and consumer automotive. International Banking’s margin increased in each of the first three quarters, but declined slightly in the fourth quarter due to lower spreads in Chile, Peru and the Caribbean. The banking margin in Global Banking and Markets increased each quarter during the year mainly due to higher deposit interest and loan amortization fees, partly offset by lower spreads in the U.S. and Asia corporate loan portfolios. Lower contributions from asset/ liability management activities and higher funding costs in the Other segment had a dampening effect on the margin. Non-interest income Non-interest revenues grew during the first two quarters, declined in the third and rebounded in the fourth quarter. Banking revenues trended upward during the year with strong growth in card fees in Canadian and International Banking. Mutual fund fees and retail brokerage fees were strong in the first quarter, but dropped back in the second before climbing steadily through the second half of the year. Trading revenues recovered in the last three quarters of the year, from the low levels experienced at the end of last year and the first quarter of the current year. The level of net gains on investment securities reflected market opportunities. Provision for credit losses Provision for credit losses peaked in the second quarter, primarily in the energy sector, with declines in the third and fourth quarters. Loan loss ratios in Canadian Banking increased slightly in the first three quarters, and declined by one basis point in the last quarter of the year. Overall provisions were up slightly from last year due mainly to an increased mix of consumer loan and credit card volumes. International Banking provisions peaked in the second quarter, and then declined in both the third and fourth quarters. The provision for credit losses in Global Banking and Markets was impacted by softness in the energy sector, with increases in both the first and second quarters, before returning to more normalized levels in the second half of the year. Non-interest expenses Non-interest expenses increased during the year. This was in part due to the impact of acquisitions, continued investment in growth initiatives, and volume-related technology expenses. The restructuring charge taken in the second quarter and timing-related expenses, such as share and performance-based compensation as well as advertising and business development costs, contributed to the quarterly fluctuations. Income taxes The effective tax rate ranged between 19.4% and 23.6% reflecting different levels of income earned in lower tax jurisdictions, as well as the fluctuation of tax-exempt dividend income. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 29 MANAGEMENT’S DISCUSSION AND ANALYSIS GROUP FINANCIAL CONDITION T18 Condensed statement of financial position As at October 31 ($ billions) 2016 2015 2014 Assets Cash, deposits with financial institutions and precious metals Trading assets Securities purchased under resale agreements and securities borrowed Investment securities Loans Other Total assets Liabilities Deposits Obligations related to securities sold under repurchase agreements and securities lent Other liabilities Subordinated debentures Total liabilities Equity Common equity Preferred shares Non-controlling interests in subsidiaries Total equity $ 54.8 108.6 $ 84.5 99.1 $ 64.0 113.2 92.1 72.9 480.2 87.7 87.3 43.2 458.6 83.8 93.9 38.7 424.3 71.6 $ 896.3 $ 856.5 $ 805.7 $ 611.9 $ 600.9 $ 554.0 97.1 121.8 7.6 77.0 118.9 6.2 89.0 108.6 4.9 $ 838.4 $ 803.0 $ 756.5 52.7 3.6 1.6 49.1 2.9 1.5 45.0 2.9 1.3 $ 57.9 $ 53.5 $ 49.2 Total liabilities and shareholders’ equity $ 896.3 $ 856.5 $ 805.7 Statement of Financial Position Assets C6 Loan portfolio loans & acceptances, $ billions, as at October 31 480 400 320 240 160 80 14 15 16 Business & government Personal & credit cards Residential mortgages C7 Deposits $ billions, as at October 31 600 500 400 300 200 100 14 15 16 Banks Business & government Personal The Bank’s total assets as at October 31, 2016 were $896 billion, up $40 billion or 5% from October 31, 2015. This growth was primarily in loans and trading assets, while higher investment securities were offset by lower deposits with financial institutions. Cash and deposits with financial institutions decreased $28 billion due primarily to lower balances with the U.S. Federal Reserve. Securities purchased under resale agreements and securities borrowed increased $5 billion. Trading assets increased $9 billion or 10% from October 31, 2015, due primarily to an increase in trading securities from higher holdings of Canadian and U.S. government debt and common equities. Investment securities increased $30 billion or 69% from October 31, 2015, due primarily to an increase in held-to-maturity securities. As of October 31, 2016, the unrealized gain on available-for-sale securities, after the impact of qualifying hedges, decreased $241 million to $26 million due mainly to realized gains on disposals. Loans increased $22 billion or 5% from October 31, 2015. Residential mortgages increased $5 billion, mainly in Canada and Latin America. Personal and credit card loans rose $8 billion, due mainly to organic growth in Canada and Latin America and the acquisition of the Canadian credit card portfolio from JPMorgan Chase Bank. Business and government loans were up $9 billion across all business lines. 30 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N Liabilities Total liabilities were $838 billion as at October 31, 2016, up $35 billion or 4% from October 31, 2015. Total deposits increased $11 billion. Personal deposits grew by $9 billion mainly in Canada and Latin America. Obligations related to securities sold under repurchase agreements and securities lent increased by $20 billion, mostly in line with higher trading securities and securities purchased under resale agreements. Equity Total shareholders’ equity increased $4,342 million from October 31, 2015. This increase was driven by current year earnings of $7,368 million, the issuance of common shares of $391 million mainly through the Dividend Reinvestment Plan and the exercise of options, and a net increase in preferred shares of $660 million. This was partially offset by dividends paid of $3,598 million, distributions to non-controlling interests of $116 million, other comprehensive loss of $229 million due primarily to an increase in the net pension obligation from a lower rate environment, as well as, the repurchase and cancellation of approximately 1.5 million common shares for $80 million under the Normal Course Issuer Bid program. Outlook Assets and deposits are expected to continue to grow in 2017 across all business lines. In Canada, while growth in residential mortgages is expected to remain moderate, other retail and commercial lending should continue to have good growth. Internationally, lending assets and personal deposits are expected to grow with stronger growth in the Pacific Alliance countries. Capital Management Overview Scotiabank is committed to maintaining a strong capital base to support the risks associated with its diversified businesses. Strong capital levels contribute to safety for the Bank’s customers, foster investor confidence and support strong credit ratings. It also allows the Bank to take advantage of growth opportunities as they arise and enhance shareholder returns through increased dividends. The Bank’s capital management framework includes a comprehensive internal capital adequacy assessment process (ICAAP), aimed at ensuring that the Bank’s capital is adequate to meet current and future risks and achieve its strategic objectives. Key components of the Bank’s ICAAP include sound corporate governance; creating a comprehensive risk appetite for the Bank; managing and monitoring capital, both currently and prospectively; and utilizing appropriate financial metrics which relate risk to capital, including internal capital and regulatory capital measures. Governance and oversight The Bank has a sound capital management framework to measure, deploy and monitor its available capital and assess its adequacy. Capital is managed in accordance with the Board-approved Capital Management Policy. In addition, the Board reviews and approves the Bank’s annual capital plan. The Asset-Liability Committee and senior executive management provide governance over the capital management process. The Bank’s Finance, Treasury and Global Risk Management groups take a coordinated approach to implementing the Bank’s capital plan. Risk appetite The risk appetite framework that establishes enterprise wide risk tolerances in addition to capital targets are detailed in the Risk Management section “Risk appetite framework”. The framework encompasses medium term targets with respect to regulatory capital thresholds, earnings and other risk- based parameters. These targets ensure the Bank achieves the following overall objectives: exceed regulatory and internal capital targets, manage capital levels commensurate with the risk profile of the Bank, maintain strong credit ratings and provide the Bank’s shareholders with acceptable returns. Regulatory capital Effective November 1, 2012, Canadian banks are subject to the revised capital adequacy requirements as published by the Basel Committee on Banking Supervision (BCBS) and commonly referred to as Basel III. Basel III builds on the “International Convergence of Capital Measurement and Capital Standards: A Revised Framework” (Basel II). Under Basel III, there are three primary risk-based regulatory capital ratios used to assess capital adequacy; Common Equity Tier 1 (CET1), Tier 1 and Total capital ratios, which are determined by dividing those capital components by risk-weighted assets. Basel III also provides guidance on non-viability contingent capital (NVCC). The guidance stipulates that in order to qualify as regulatory capital, non-common share capital instruments must be convertible into common equity upon a trigger event as defined within the guidance. All non- common share capital instruments issued after December 31, 2012, are required to meet these NVCC requirements to qualify as regulatory capital. To enable banks to meet the new standards, the BCBS Basel III rules contain transitional arrangements commencing January 1, 2013, through January 1, 2019. Transitional requirements result in a five year phase-in of new deductions and additional components to common equity. Non- qualifying non-common capital instruments are being phased-out over 10 years and the capital conservation buffer is being phased-in over four years. As of January 2019, banks will be required to meet new minimum requirements related to risk-weighted assets of: CET1 ratio of 4.5% plus a capital conservation buffer of 2.5%, collectively 7%, minimum Tier 1 ratio of 8.5%, and Total capital ratio of 10.5%. The Office of the Superintendent of Financial Institutions, Canada (OSFI) has issued guidelines, reporting requirements and disclosure guidance which are consistent with the Basel III reforms, except for its deferral of the Basel III credit valuation adjustment (CVA) related capital charges, requiring they be phased-in over a five year period, beginning January 2014. In accordance with OSFI’s requirements, during 2016, the scalars for CVA risk-weighted assets of 0.64, 0.71 and 0.77 were used to compute the CET1, Tier 1 and Total capital ratios, respectively (October 31, 2015 – scalars of 0.64, 0.71 and 0.77, respectively). The scalars will increase to 0.72, 0.77 and 0.81, respectively, effective in the first quarter of 2017. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 31 MANAGEMENT’S DISCUSSION AND ANALYSIS Commencing the first quarter of 2013, OSFI required Canadian deposit-taking institutions to fully implement the 2019 Basel III reforms, without the transitional phase-in provisions for capital deductions (referred to as ‘all-in’) and achieve minimums of 7%, 8.5% and 10.5% for CET1, Tier 1 and Total Capital ratios, respectively. OSFI has also designated the Bank a domestic systemically important bank (D-SIB), increasing its minimum capital ratio requirements by 1% across all tiers of capital effective January 1, 2016, in line with the requirements for global systemically important banks. Regulatory developments related to capital In addition to risk-based capital requirements, the Basel III reforms introduced a simpler, non risk-based Leverage ratio requirement to act as a supplementary measure to its risk-based capital requirements. The Leverage ratio is defined as a ratio of Basel III Tier 1 capital to a leverage exposure measure which includes on-balance sheet assets and off-balance sheet commitments, derivatives and securities financing transactions, as defined within the requirements. In January 2014, the BCBS issued revisions to the Basel III Leverage ratio framework noting that the final calibration of the Leverage ratio will be completed by 2017. In 2014, OSFI released its Basel III Leverage Ratio Requirements Guideline and Public Disclosure Requirements which outlines the application and disclosure of the Basel III Leverage ratio in Canada and the replacement of the former Assets-to-Capital Multiple (ACM), effective the first quarter of 2015. Institutions are expected to maintain a material operating buffer above the 3% minimum. In April 2016, OSFI published a consultative paper proposing updates to the capital requirements for residential mortgage loans in response to evolving risks, such as risks associated with elevated house prices in certain markets, and increasing levels of household debt. The proposed changes include a risk sensitive floor for loss given default (LGD) that will be tied to increases in local property prices and/or to house prices that are high relative to borrower income. This will apply to banks using the advanced internal ratings-based approach to determining risk-weighted assets for residential real estate secured lending. The proposed changes are published as draft requirements and are expected to be implemented in the first quarter of 2017. New mortgage originations, refinances and mortgage renewals will be subject to the new rules on a go-forward basis. Planning, managing and monitoring capital Capital is managed and monitored based on planned changes in the Bank’s strategy, identified changes in its operating environment or changes in its risk profile. As part of the Bank’s comprehensive ICAAP, sources and uses of capital are continuously measured and monitored through financial metrics, including regulatory thresholds, and internal capital. These results are used in capital planning and strategic decision-making. The Bank’s assessment of capital adequacy is in the context of its current position and its expected future risk profile and position relative to its internal targets while considering the potential impact of various stress scenarios. Specific scenarios are selected based on the current economic conditions and business events facing the Bank. In addition, the Bank’s forward looking capital adequacy assessment includes a consideration of the results of more severe multi-risk scenarios within its enterprise-wide stress testing. This testing is used to determine the extent to which severe, but plausible events, impact the Bank’s capital. The Bank sets internal regulatory capital targets to ensure the Bank’s available capital is sufficient within the context of its risk appetite. The Bank’s internal target includes an adequate buffer over the regulatory minimum ensuring sufficient flexibility for future capital deployment and in consideration of the Bank’s risk appetite, the volatility of planning assumptions, the results from stress testing and contingency planning. The Bank has a comprehensive risk management framework to ensure that the risks taken while conducting its business activities are consistent with its risk appetite, its impact on capital relative to internal targets, and that there is an appropriate balance between risk and return. Refer to the Risk Management section on page 60 for further discussion on the Bank’s risk management framework. In managing the Bank’s capital base, close attention is paid to the cost and availability of the various types of capital, desired leverage, changes in the assets and risk-weighted assets, and the opportunities to profitably deploy capital. The amount of capital required for the business risks being assumed, and to meet regulatory requirements, is balanced against the goal of generating an appropriate return for the Bank’s shareholders. Capital generation Capital is generated internally through net earnings after dividend payments. As well, capital is generated by the issuance of common shares, preferred shares, and subordinated debentures, net of redemptions. Capital utilization The Bank deploys capital to support sustainable, long-term revenue and net income growth. The growth can be through existing businesses by attracting new customers, increasing cross-selling activities to existing customers, adding new products and enhancing sales productivity, or through acquisitions. All major initiatives to deploy capital are subject to rigorous analysis, validation of business case assumptions and evaluation of expected benefits. Key financial criteria include impact on earnings per share, capital ratios, return on invested capital, expected payback period and internal rate of return based on discounted cash flows. Any potential business acquisitions, investments or strategic initiatives are reviewed and approved by the Bank’s Strategic Transaction Executive Committee, to ensure effective deployment of capital. Regulatory capital ratios The Bank continues to maintain strong, high quality capital levels which positions it well for future business growth. The Basel III all-in Common Equity Tier 1 (CET1) ratio as at October 31, 2016 was 11.0%. Increases in the CET1 ratio from 2015 were primarily from strong internal capital generation and the prudent management of asset growth during the year. The Bank’s Basel III all-in Tier 1 and Total Capital ratios were 12.4% and 14.6%, respectively, as at October 31, 2016. Tier 1 and Total Capital also benefited from capital issuances during the year. The Bank’s capital ratios continue to be well in excess of OSFI’s minimum capital ratio requirements for 2016 (including the 1% D-SIB surcharge) of 8%, 9.5% and 11.5% for CET1, Tier 1 and Total Capital, respectively. Outlook The Bank will continue to have a strong capital position in 2017. Capital will be prudently managed to support: organic growth initiatives; selective acquisitions that enhance shareholder returns; and higher capital requirements from evolving accounting and regulatory changes. 32 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T T19 Regulatory capital(1) As at October 31 ($ millions) Common Equity Tier 1 capital Total Common Equity Qualifying non-controlling interest in common equity of subsidiaries Goodwill and non-qualifying intangibles, net of deferred tax liabilities(2) Threshold related deductions Net deferred tax assets (excluding those arising from temporary differences) Other Common Equity Tier 1 capital deductions(3) Common Equity Tier 1 Preferred shares(4) Capital instrument liabilities – trust securities(4) Other Tier 1 capital adjustments(5) Net Tier 1 capital Tier 2 capital Subordinated debentures, net of amortization(4) Eligible collective allowance for inclusion in Tier 2 and excess allowance (re: IRB approach) Qualifying non-controlling interest in Tier 2 capital of subsidiaries Other Tier 2 capital adjustments Tier 2 capital Total regulatory capital Risk-weighted assets ($ billions) Credit risk Market risk Operational risk CET1 risk-weighted assets(6) Capital ratios(7) Common Equity Tier 1 Tier 1 Total Leverage: Leverage exposures(8) Leverage ratio(8) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N Basel III All-in 2016 2015 2014 $ 52,657 597 (11,589) $ 49,085 557 (11,018) $ 44,965 514 (10,482) (435) (484) (757) (664) (539) (456) (305) (620) (330) 39,989 36,965 33,742 3,594 1,400 83 2,934 1,400 67 2,934 1,400 (3) 45,066 41,366 38,073 7,633 528 103 – 8,264 6,182 486 196 – 6,864 4,871 468 180 – 5,519 53,330 48,230 43,592 314.8 10.6 38.6 308.0 14.4 35.6 261.9 17.3 33.3 $ 364.0 $ 358.0 $ 312.5 11.0% 12.4% 14.6% 10.3% 11.5% 13.4% $ 1,010,987 $ 980,212 4.5% 4.2% 10.8% 12.2% 13.9% N/A N/A (1) Effective November 1, 2012, regulatory capital ratios are determined in accordance with Basel III rules on an all-in basis (refer to page 31). Prior period amounts have not been restated for new and amended IFRS standards as they represent the actual amounts reported in that period for regulatory purposes. (2) Reported amounts are based on OSFI’s requirements that goodwill relating to investments in associates be classified as goodwill for regulatory reporting purposes beginning Q3 2014. (3) Other CET1 capital deductions under Basel III all-in include gains/losses due to changes in own credit risk on fair valued liabilities, pension plan assets and other items. (4) Non-qualifying Tier 1 and Tier 2 capital instruments are subject to a phase-out period of 10 years. (5) Other Tier 1 capital adjustments under the all-in approach include eligible non-controlling interests in subsidiaries. (6) As at October 31, 2016, CVA risk-weighted assets were calculated using scalars of 0.64, 0.71, and 0.77 to compute CET1 , Tier 1 and Total capital ratios, respectively, (scalars of 0.64, 0.71, and 0.77 in 2015). (7) OSFI designated the Bank as a domestic systemically important bank (D-SIB), increasing its minimum capital ratio requirements by 1% for the identified D-SIBs. This 1% surcharge was applicable to all minimum capital ratio requirements for CET1, Tier 1 and Total Capital, by January 1, 2016, in line with the requirements for global systemically important banks. (8) Effective November 1, 2014, the leverage ratio replaced the assets-to-capital multiple. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 33 MANAGEMENT’S DISCUSSION AND ANALYSIS T20 Changes in regulatory capital(1) For the fiscal years ($ millions) Total capital, beginning of year Changes in Common Equity Tier 1 Net income attributable to common equity holders of the Bank Dividends paid to equity holders of the Bank Shares issued Shares repurchased/redeemed Gains/losses due to changes in own credit risk on fair valued liabilities Movements in accumulated other comprehensive income, excluding cash flow hedges Change in non-controlling interest in common equity of subsidiaries Change in goodwill and other intangible assets (net of related tax liability)(2) Other changes including regulatory adjustments below: – Deferred tax assets that rely on future profitability (excluding those arising from temporary differences) – Significant investments in the common equity of other financial institutions (amount above 10% threshold) – Other capital deductions – Other Changes in Common Equity Tier 1 Changes in Additional Tier 1 Capital Issued Redeemed Other changes including regulatory adjustments and phase-out of non-qualifying instruments Changes in Additional Tier 1 Capital Changes in Tier 2 Capital Issued Redeemed Collective allowances eligible for inclusion in Tier 2 and Excess Allowance under AIRB Other changes including regulatory adjustments and phase-out of non-qualifying instruments Changes in Tier 2 Capital Total capital generated (used) Total capital, end of year Basel III All-in 2016 2015 2014 $ 48,230 $ 43,592 $ 38,841 6,987 (3,468) 391 (80) (2) (472) 40 (571) 199 55 61 126 (43) 6,897 (3,289) 104 (955) (158) 1,451 43 (535) (335) 81 (317) 44 (143) 6,916 (3,110) 771 (320) 410 35 (710) 3,391 132 2,583 941 (265) $ 3,024 $ 3,223 $ 7,383 1,350 (690) 16 $ 676 $ 2,502 (1,035) 42 (109) – – 70 70 1,250 – 17 78 – (1,150) (74) $ (1,224) – (970) (502) 64 $ $ 1,400 5,100 $ $ 1,345 4,638 $ (1,408) $ 4,751 $ 53,330 $ 48,230 $ 43,592 (1) Effective November 1, 2012, regulatory capital ratios are determined in accordance with Basel III rules on an all-in basis (refer to page 31). Prior period amounts have not been restated for new and amended IFRS standards as they represent the actual amounts reported in that period for regulatory capital. (2) Reported amounts are based on OSFI’s requirements that goodwill relating to investments in associates be classified as goodwill for regulatory reporting purposes beginning Q3 2014. 34 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T CET1 capital %, as at October 31 C8 14 12 10 8 6 4 2 14 15 16 C9 Dividend growth dollars per share 3 2 1 06 08 10 12 14 16 C10 Internally generated capital $ billions, for years ended October 31 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 14 15 16 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N Regulatory capital components The Bank’s regulatory capital is divided into three components – Common Equity Tier 1 (CET1), Tier 1 capital and Tier 2 capital, depending on their degree of permanency and loss absorbency. All components of capital provide support for banking operations and protect depositors. CET1 consists primarily of common shareholders’ equity, a proration of non-controlling interests, and regulatory deductions. These regulatory deductions include goodwill, intangible assets (net of deferred tax liabilities), deferred tax assets that rely on future profitability, defined-benefit pension fund net assets, shortfall of allowance for credit losses to expected losses and significant investments in the common equity of other financial institutions. Additional Tier 1 capital consists primarily of qualifying non-cumulative preferred shares or non- qualifying preferred shares and innovative Tier 1 instruments subject to phase-out. Tier 2 capital consists mainly of qualifying or non-qualifying subordinated debentures subject to phase-out and the eligible allowances for credit losses. The Bank’s Common Equity Tier 1 capital was $40.0 billion as at October 31, 2016, an increase of $3.0 billion from the prior year primarily from: (cid:129) $3.5 billion growth from internal capital generation; (cid:129) $0.3 billion from net common share issuances under the Bank’s dividend reinvestment, employee share purchase, and stock option plans; and, (cid:129) $0.2 billion from decreases in other regulatory capital adjustments, including capital deductions. Partly offset by: (cid:129) $0.6 billion increases in goodwill and intangibles (net of related tax liability) including the impacts from the acquisition of JP Morgan Canadian Credit Card Business, Citibank Costa Rica and Panama Retail Banking Operations. (cid:129) $0.5 billion decrease from movements in Accumulated Other Comprehensive Income, excluding cash flow hedges, primarily from employee benefits and available-for-sale securities partly offset by impacts from foreign currency translation. The Bank’s Tier 1 and Total capital ratios were also impacted by the above changes and the issuances of $1.35 billion of NVCC preferred shares, partly offset by the redemption of $690 million of non-NVCC preferred shares during the year. In addition, Total capital increased mainly due to the issuance of approximately $2.5 billion of NVCC subordinated debentures, partly offset by the $1.0 billion redemption of non-NVCC subordinated debentures during the year. Dividends The strong earnings and capital position allowed the Bank to increase its dividends twice in 2016. The annual dividend in 2016 was $2.88, compared to $2.72 in 2015, an increase of 6%. The dividend payout ratio was 49.6% in line with the Bank’s Board approved target dividend payout ratio of 40-50%. T21 Selected capital management activity For the fiscal years ($ millions) 2016 2015 2014 Dividends Common Preferred Common shares issued(1)(2) Common shares repurchased for cancellation under the Normal Course Issuer Bid(2) Preferred shares issued Preferred shares redeemed Subordinated debentures issued Maturity, redemption and repurchase of subordinated debentures $ 3,468 130 391 $ 3,289 117 104 $ 3,110 155 771 80 1,350 690 2,502 1,035 955 – – 1,250 20 320 – 1,150 – 1,000 (1) Represents primarily cash received for stock options exercised during the year, common shares issued pursuant to the Dividend and Share Purchase Plan and shares issued for acquisitions. (2) Represents reduction to Common shares and Retained earnings (refer to the Consolidated Statement of Changes in Equity). Prior period amounts have been restated to conform with current period presentation. Normal Course Issuer Bid During the year ended October 31, 2016, under normal course issuer bids, the Bank repurchased and cancelled approximately 1.5 million common shares (2015 –15.5 million) at an average price of $52.34 per share (2015 – $61.64) for a total amount of approximately $80 million (2015 – $955 million). On May 31, 2016, the Bank announced that OSFI and the Toronto Stock Exchange (TSX) approved a normal course issuer bid pursuant to which it may repurchase for cancellation up to 12 million of the Bank’s common shares, which represented approximately 1% of the Bank’s common shares issued and outstanding as of May 26, 2016. Purchases under the new bid commenced on June 2, 2016, and will end on the earlier of June 1, 2017, or the date on which the Bank completes its purchases. On a quarterly basis, the Bank will consult with OSFI prior to making purchases. Under this bid, the Bank has not repurchased any common shares. On May 29, 2015, the Bank announced that OSFI and the TSX approved its normal course issuer bid pursuant to which it may repurchase for cancellation up to 24 million of the Bank’s common shares, which represented approximately 2% of the Bank’s common shares issued and outstanding as of May 25, 2015. The bid ended on June 1, 2016. Under this bid, the Bank repurchased and cancelled approximately 9.5 million common shares at an average price of $58.94 per share. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 35 MANAGEMENT’S DISCUSSION AND ANALYSIS Share data and other capital instruments The Bank’s common and preferred share data, as well as other capital instruments, are shown in T22. Further details, including exchangeability features, are discussed in Note 20 and Note 23 of the Consolidated Financial Statements. T22 Shares and other instruments As at October 31, 2016 Share data Common shares(1) Preferred shares Preferred shares Series 16(2) Preferred shares Series 17(2) Preferred shares Series 18(2)(3)(4) Preferred shares Series 19(2)(3)(5) Preferred shares Series 20(2)(3)(6) Preferred shares Series 21(2)(3)(7) Preferred shares Series 22(2)(3)(8) Preferred shares Series 23(2)(3)(9) Preferred shares Series 30(2)(3)(10) Preferred shares Series 31(2)(3)(11) Preferred shares Series 32(2)(3)(12) Preferred shares Series 33(2)(3)(13) Preferred shares Series 34(2)(3)(14)(15) Preferred shares Series 36(2)(3)(14)(16) Preferred shares Series 38(2)(3)(14)(17) Trust securities Scotiabank Trust Securities – Series 2006-1 issued by Scotiabank Capital Trust(18a,c,d) Scotiabank Tier 1 Securities – Series 2009-1 issued by Scotiabank Tier 1 Trust(18b,c,d) NVCC subordinated debentures Subordinated debentures due March 2027 Subordinated debentures due December 2025(19) Subordinated debentures due December 2025(20) Options Outstanding options granted under the Stock Option Plans to purchase common shares(1)(21) Amount ($ millions) Dividends declared per share Number outstanding (000s) $ 15,513 $ 2.88 1,207,894 345 230 187 158 201 149 234 66 154 111 279 130 350 500 500 1.312500 1.400000 0.837500 0.628938 0.902500 0.541438 0.957500 0.586438 0.455000 0.366438 0.638235 0.334959 1.184800 0.852350 – Amount ($ millions) $ 750 650 Distribution Yield (%) 28.25 39.01 5.650 7.802 Amount ($ millions) $ US$ 1,250 750 1,250 13,800 9,200 7,498 6,302 8,039 5,961 9,377 2,623 6,143 4,457 11,162 5,184 14,000 20,000 20,000 Number outstanding (000s) 750 650 Interest Rate (%) 2.58 3.37 4.50 Number outstanding (000s) 19,852 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) Dividends on common shares are paid quarterly, if and when declared. As at November 18, 2016, the number of outstanding common shares and options was 1,208,151 thousand and 19,594 thousand, respectively. These preferred shares are entitled to non-cumulative preferential cash dividends payable quarterly. These preferred shares have conversion features (refer to Note 23 of the Consolidated Financial Statements for further details). Subsequent to the initial five-year fixed rate period which ended on April 25, 2013, and resetting every five years thereafter, the dividends, if and when declared, will be determined by the sum of the five-year Government of Canada Yield plus 2.05%, multiplied by $25.00. Dividends, if and when declared, are determined by the sum of the three-month Government of Canada Treasury Bill Yield plus 2.05%, multiplied by $25.00, which will be reset quarterly. Subsequent to the initial five-year fixed rate period which ended on October 25, 2013, and resetting every five years thereafter, the dividends, if and when declared, will be determined by the sum of the five-year Government of Canada Yield plus 1.70%, multiplied by $25.00. Dividends, if and when declared, are determined by the sum of the three-month Government of Canada Treasury Bill Yield plus 1.70%, multiplied by $25.00, which will be reset quarterly. Subsequent to the initial five-year fixed rate period which ended on January 25, 2014, and resetting every five years thereafter, the dividends, if and when declared, will be determined by the sum of the five-year Government of Canada Yield plus 1.88%, multiplied by $25.00. Dividends, if and when declared, are determined by the sum of the three-month Government of Canada Treasury Bill Yield plus 1.88%, multiplied by $25.00, which will be reset quarterly. Subsequent to the initial five-year fixed rate period which ended on April 25, 2015, and resetting every five years thereafter, the dividends, if and when declared, will be determined by the sum of the five-year Government of Canada Yield plus 1.00%, multiplied by $25.00. Dividends, if and when declared, are determined by the sum of the three-month Government of Canada Treasury Bill Yield plus 1.00%, multiplied by $25.00, which will be reset quarterly. Subsequent to the initial five-year fixed rate period which ended on February 1, 2016, and resetting every five years thereafter, the dividends, if and when declared, will be determined by the sum of the five-year Government of Canada Yield plus 1.34%, multiplied by $25.00. Dividends, if and when declared, are determined by the sum of the three-month Government of Canada Treasury Bill Yield plus 1.34%, multiplied by $25.00, which will be reset quarterly. These preferred shares contain Non-Viability Contingent Capital (NVCC) provisions necessary for the shares to qualify as Tier 1 regulatory capital under Basel III. Refer to Note 23 of the Consolidated Financial Statements. (13) (14) (15) On December 17, 2015, the Bank issued 14,000 thousand Non-cumulative 5-Year Rate Reset Preferred Shares Series 34 (NVCC) for $350 million. Dividends, if and when declared, are for the initial five-year period ending on April 25, 2021. Subsequent to the initial five-year fixed rate period, and resetting every five years thereafter, the dividends will be determined by the sum of the five-year Government of Canada Yield plus 4.51%, multiplied by $25.00. (16) On March 14, 2016, the Bank issued 20,000 thousand Non-cumulative 5-Year Rate Reset Preferred Shares Series 36 (NVCC) for $500 million. Dividends, if and when declared, are for the initial five-year period ending on July 25, 2021. Subsequent to the initial five-year fixed rate period, and resetting every five years thereafter, the dividends will be determined by the sum of the five-year Government of Canada Yield plus 4.72%, multiplied by $25.00. (17) On September 16, 2016, the Bank issued 20,000 thousand Non-cumulative 5-Year Rate Reset Preferred Shares Series 38 (NVCC) for $500 million. The initial dividend, if and when declared, will be payable on January 27, 2017. Dividends, if and when declared are for the initial five-year period ending on January 26, 2022. Subsequent to the initial five-year fixed rate period, and resetting every five years thereafter, the dividends will be determined by the sum of the five-year Government of Canada Yield plus 4.19%, multiplied by $25.00. (18)(a) On September 28, 2006, Scotiabank Capital Trust issued 750,000 Scotiabank Trust Securities – Series 2006-1 (Scotia BaTS II Series 2006-1). The holders of Scotia BaTS II Series 2006-1 are entitled to receive non-cumulative fixed cash distributions payable semi-annually in an amount of $28.25 per security. With regulatory approval, these securities may be redeemed in whole upon the occurrence of certain tax or regulatory capital changes, or in whole or in part on December 30, 2011 and on any distribution date thereafter at the option of Scotiabank Capital Trust. The holder has the right at any time to exchange their security into Non-cumulative Preferred Shares Series S of the Bank. The Series S shares will be entitled to cash dividends payable semi-annually in an amount of $0.4875 per $25.00 share [refer to Note 23 – Restrictions on dividend payments]. Under the circumstances outlined in 18(c) below, the Scotia BaTS II Series 2006-1 would be automatically exchanged without the consent of the holder, into Non-cumulative Preferred Shares Series T of the Bank. The Series T shares will be entitled to non-cumulative cash dividends payable semi-annually in an amount of $0.625 per $25.00 share. If there is an automatic exchange of the Scotia BaTS II Series 2006-1 into Preferred Shares Series T of the Bank, then the Bank would become the sole beneficiary of the Trust. (18)(b) On May 7, 2009, Scotiabank Tier 1 Trust issued 650,000 Scotiabank Tier 1 Securities Series 2009-1 (Scotia BaTS III Series 2009-1). Interest is payable semi-annually in an amount of $39.01 per Scotia BaTS III Series 2009-1 on the last day of June and December until June 30, 2019. After June 30, 2019 and on every fifth anniversary thereafter until June 30, 2104, the interest rate on the Scotia BaTS III Series 2009-1 will be reset at an interest rate per annum equal to the then prevailing 5-year Government of Canada Yield plus 7.05%. On or after June 30, 2014, the Trust may, at its option redeem the Scotia BaTS III Series 2009-1, in whole or in part, subject to regulatory approval. Under the circumstances outlined in 18(c) below, the Scotia BaTS III Series 2009-1, including accrued and unpaid interest thereon, would be exchanged automatically without the consent of the holder, into newly issued Non-cumulative Preferred Shares Series R of the Bank. In addition, in certain circumstances, holders of Scotia BaTS III Series 2009-1 may be required to invest interest paid on the Scotia BaTS III Series 2009-1 in a series of newly-issued preferred shares of the Bank with non-cumulative dividends (each such series is referred to as Bank Deferral Preferred Shares). If there is an automatic exchange of the Scotia BaTS Preferred Shares, then the Bank would become the sole beneficiary of the Trust. 36 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T (18)(c) The Scotia BaTS II Series 2006-1 and Scotia BaTS III Series 2009-1 may be automatically exchanged, without the consent of the holder, into Non-cumulative Preferred Shares of the Bank in the following circumstances: (i) proceedings are commenced for the winding-up of the Bank; (ii) the Superintendent takes control of the Bank or its assets; (iii) the Bank has a Tier 1 Capital ratio of less than 5% or a Total Capital ratio of less than 8%; or (iv) the Superintendent has directed the Bank to increase its capital or provide additional liquidity and the Bank elects such automatic exchange or the Bank fails to comply with such direction. (18)(d) No cash distributions will be payable on the Scotia BaTS II Series 2006-1 and Scotia BaTS III Series 2009-1 in the event that the regular dividend is not declared on the Bank’s preferred shares and, if no preferred shares are outstanding, the Bank’s common shares. In such a circumstance the net distributable funds of the Trust will be payable to the Bank as the holder of the residual interest in the Trust. Should the Trust fail to pay the semi-annual distributions on the Scotia BaTS II Series 2006-1 and Scotia BaTS III Series 2009-1 in full, the Bank will not declare dividends of any kind on any of its preferred or common shares for a specified period of time [refer to Note 23 – Restrictions on dividend payments]. (19) On December 8, 2015, the Bank issued $750 million subordinated debentures (NVCC) due December 8, 2025. (20) On December 16, 2015, the Bank issued US$1.25 billion subordinated debentures (NVCC) due December 16, 2025. (21) Included are 57,800 stock options with tandem stock appreciation rights (Tandem SAR) features. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 37 MANAGEMENT’S DISCUSSION AND ANALYSIS Credit ratings Credit ratings are one of the factors that affect the Bank’s access to capital markets and borrowing costs, as well as the terms on which the Bank can conduct derivatives and hedging transactions and obtain related borrowings. The credit ratings and outlook that the rating agencies assign to the Bank are based on their own views and methodologies. The Bank continues to have strong credit ratings and is rated AA by DBRS, Aa3 by Moody’s, AA- by Fitch and A+ by Standard and Poor’s (S&P). On December 11, 2015, S&P affirmed the Bank’s A+ rating for deposits and senior debt, as well as the A-1 rating for short-term instruments. The Bank’s outlook was changed to stable from negative. The outlook change was predicated on S&P’s belief that the potential negative ratings impact from the proposed bail-in regime has subsided, with a view that the implementation timetable could be two years or more to 2018 or later. On January 25, 2016, Moody’s downgraded the Bank’s long-term ratings by one notch to Aa3 from Aa2, while affirming the Bank’s short-term deposit rating of P-1. On August 22, 2016, DBRS confirmed the Bank’s long and short-term rating of AA and R-1 (high), respectively. On October 27, 2016, Fitch affirmed the Bank’s long and short-term rating of AA- and F1+, respectively. Fitch and S&P have a stable outlook on the Bank. Meanwhile, DBRS and Moody’s continue to maintain their negative outlook for all Canadian banks citing the uncertainty around the federal government’s proposed new bail-in regime for senior unsecured debt, to reflect the greater likelihood that such debt may incur losses in the unlikely event of a distress scenario. Risk-weighted assets Regulatory capital requirements are based on OSFI’s target minimum percentage of risk-weighted assets (RWA). RWA represent the Bank’s exposure to credit, market and operational risk and are computed by applying a combination of the OSFI approved Bank’s internal risk models and OSFI prescribed risk-weights to on- and off-balance sheet exposures. Common Equity Tier 1 (CET1), Tier 1 and Total Capital RWA were $364.0, $364.5 and $364.9 billion, respectively at year end, representing increases from 2015 of approximately $6.0 billion. The increases are due to higher credit risk RWA of approximately $6.8 billion (including the impact of foreign currency translation of $2.7 billion) and operational risk RWA of $3.0 billion, partly offset by lower market risk RWA of $3.8 billion. CET1 Credit risk-weighted assets As shown in T23, CET1 credit risk-weighted assets increased by $6.8 billion to $314.8 billion primarily due to the following components: (cid:129) Book quality changes increased RWA by $10.5 billion. (cid:129) The implementation of the Internal Modeling Method for the determination of counterparty credit risk and credit valuation adjustment RWA decreased RWA by $3.2 billion. (cid:129) Implementation of methodology and policy changes during the year decreased RWA by $2.8 billion. (cid:129) Higher RWA from acquisitions, net of divestitures, of $1.7 billion were mainly due to the acquisitions of JP Morgan Canadian Credit Card Business, Citibank Costa Rica and Panama Retail Banking Operations. (cid:129) The impact of foreign exchange translation increased RWA by $2.7 billion. T23 Flow statement for Basel III All-in credit risk-weighted assets ($ millions) Credit risk-weighted assets movement by key driver(1) ($ millions) CET1 Credit risk-weighted assets as at beginning of year Book size(2) Book quality(3) Model updates(4) Methodology and policy(5) Acquisitions and disposals Foreign exchange movements Other CET1 Credit risk-weighted assets as at end of year(6) Tier 1 CVA scalar Tier 1 Credit risk-weighted assets as at end of year(6) Total CVA scalar Total Credit risk-weighted assets as at end of year(6) 2016 2015 Credit risk $ 308,035 1,781 10,542 (3,214) (2,849) 1,672 2,731 (3,876) $ 314,822 456 315,278 390 $ 315,668 Of which counterparty credit risk $ 22,940 (4,082) 740 (3,214) – – 48 – $ 16,432 456 16,888 390 $ 17,278 Credit risk $ 261,887 24,339 3,575 843 892 1,340 15,159 – $ 308,035 785 308,820 673 $ 309,493 Of which counterparty credit risk $ 17,935 1,988 181 – 892 – 1,944 – $ 22,940 785 23,725 673 $ 24,398 Includes counterparty credit risk. (1) (2) Book size is defined as organic changes in book size and composition (including new business and maturing loans). (3) Book quality is defined as quality of book changes caused by experience such as underlying customer behaviour or demographics, including changes through model calibrations/realignments. (4) Model updates are defined as model implementation, change in model scope or any change to address model enhancement. (5) Methodology and policy is defined as methodology changes to the calculations driven by regulatory policy changes, such as new regulation (e.g. Basel III). (6) As at October 31, 2016, risk-weighted assets were calculated using scalars of 0.64, 0.71, and 0.77 to compute CET1, Tier 1, and Total capital ratios, respectively, (scalars of 0.64, 0.71, and 0.77 in 2015). 38 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N T24 Internal rating scale(1) and mapping to external rating agencies Equivalent Rating External Rating – S&P External Rating – Moody’s External Rating – DBRS Grade IG Code PD Range(2) AAA to AA+ AA to A+ A to A- BBB+ BBB BBB- BB+ BB BB- B+ B to B- CCC+ CCC CCC- to CC – Default Aaa to Aa1 Aa2 to A1 A2 to A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 to B3 Caa1 Caa2 Caa3 to Ca – AAA to AA (high) AA to A (high) A to A (low) BBB (high) BBB BBB (low) BB (high) BB BB (low) B (high) B to B (low) – – – – Investment grade Non-Investment grade Watch list Default 99-98 95 90 87 85 83 80 77 75 73 70 65 60 40 30 27-21 0.0000% – 0.0510% 0.0510% – 0.1321% 0.0618% – 0.1517% 0.0969% – 0.2429% 0.1381% – 0.3383% 0.1969% – 0.4714% 0.3059% – 0.5239% 0.4751% – 0.5822% 0.5822% – 0.7380% 0.7380% – 1.4180% 1.4180% – 2.7248% 2.7248% – 9.9903% 9.9903% – 19.0626% 19.0626% – 35.9847% 35.9847% – 59.9872% 100% (1) Applies to non-retail portfolio. (2) PD ranges overlap across IG codes as the Bank utilizes two risk rating systems for its AIRB portfolios, and each risk rating system has its own separate IG to PD mapping. T25 Non-retail AIRB portfolio exposure by internal rating grade(1)(2) As at October 31 ($ millions) 2016 2015 Grade IG Code ($)(4) Exposure at default PD (%)(5)(8) LGD (%)(6)(8) RW (%)(7)(8) Exposure at default ($)(4) Investment grade(3) Non-Investment grade Watch list 99-98 95 90 87 85 83 80 77 75 73 70 65 60 40 30 Default(9) 27-21 Total, excluding residential mortgages Government guaranteed residential mortgages Total RWA ($) 878 6,458 8,540 10,326 14,189 16,704 20,502 14,955 11,830 6,063 4,682 2,078 2,447 4,901 178 8,106 66,127 45,031 52,357 42,398 40,162 37,926 36,135 23,941 15,941 7,307 4,692 1,297 1,221 2,465 100 2,520 379,620 132,837 100,869 – 480,489 132,837 0.01 0.06 0.07 0.13 0.18 0.25 0.36 0.51 0.74 1.42 2.73 9.99 19.05 28.77 59.28 100 1.20 – 0.95 18 30 37 37 41 44 46 43 46 40 43 41 40 37 43 42 36 25 34 1 14 16 24 35 44 57 62 74 83 100 160 200 199 178 322 35 – 28 RWA ($) 423 7,673 9,144 10,137 12,819 20,036 18,735 14,158 14,102 7,414 3,855 1,679 2,287 3,267 5 3,786 80,227 40,068 48,131 43,056 33,413 38,499 33,036 20,340 19,589 8,737 4,804 991 1,101 1,454 3 1,093 374,542 129,520 86,832 – 461,374 129,520 PD (%)(5)(8) LGD (%)(6)(8) RW (%)(7)(8) 0.00 0.07 0.08 0.14 0.19 0.31 0.41 0.55 0.80 1.54 2.97 10.55 19.42 30.14 69.10 100 0.76 – 0.62 16 37 37 36 42 46 44 45 41 40 34 44 40 43 45 52 35 15 31 1 19 19 24 38 52 57 70 72 85 80 169 208 225 167 346 35 – 28 (1) Refer to the Bank’s Supplementary Regulatory Capital Disclosures for a more detailed breakdown by asset class, exposure at default, probability at default, loss given default and risk weighting. (2) Excludes securitization exposures. (3) Excludes government guaranteed residential mortgages of $100.9 billion ($86.8 billion in 2015). (4) After credit risk mitigation. (5) PD – Probability of Default. (6) LGD – Loss Given Default. (7) RW – Risk Weight. (8) Exposure at default used as basis for estimated weightings. (9) Gross defaulted exposures, before any related allowances. Credit risk-weighted assets – non-retail Credit risk measures the risk that a borrower or counterparty will fail to honour its financial or contractual obligations to the Bank. The Bank uses the Advanced Internal Ratings Based (AIRB) approach under Basel III to determine minimum regulatory capital requirements for its domestic, U.S. and European credit portfolios, and certain international non-retail portfolios. The remaining credit portfolios are subject to the Standardized approach, which relies on the external credit ratings of borrowers, if available, to compute regulatory capital for credit risk. For AIRB portfolios, the key risk measures used in the quantification of regulatory capital for credit risk include probability of default (PD), loss given default (LGD) and exposure at default (EAD). (cid:129) Probability of default (PD) measures the likelihood that a borrower, with an assigned Internal Grade (IG) code, will default within a one-year time horizon. IG codes are a component of the Bank’s risk rating system. Each of the Bank’s internal borrower IG codes is mapped to a PD estimate. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 39 MANAGEMENT’S DISCUSSION AND ANALYSIS (cid:129) Loss given default (LGD) measures the severity of loss on a facility in the event of a borrower’s default. The Bank’s internal LGD grades are mapped to ranges of LGD estimates. LGD grades are assigned based on facility characteristics such as seniority, collateral type, collateral coverage and other structural elements. LGD for a defaulted exposure is based on the concept of economic loss and is calculated using the present value of repayments, recoveries and related direct and indirect expenses. (cid:129) Exposure at default (EAD) measures the expected exposure on a facility at the time of default. All three risk measures are estimated using the Bank’s historical data, as well as available external benchmarks, and are updated on a regular basis. The historical data used for estimating these risk measures exceeds the minimum five-year AIRB requirement for PD estimates and the minimum seven-year AIRB requirement for LGD and EAD estimates. Further analytical adjustments, as required under the Basel III Framework and OSFI’s requirements set out in its Domestic Implementation Notes, are applied to average estimates obtained from historical data. These analytical adjustments incorporate the regulatory requirements pertaining to: (cid:129) Long-run estimation of PD, which requires that PD estimates capture average default experience over a reasonable mix of high-default and low- default years of the economic cycle; (cid:129) Downturn estimation for LGD, which requires that LGD estimates appropriately reflect conditions observed during periods where credit losses are substantially higher than average; and (cid:129) Downturn estimation for EAD, which requires that EAD estimates appropriately reflect conditions observed during periods of economic downturn; and (cid:129) The addition of a margin of conservatism, which is related to the likely range of errors based on the identification and quantification of the various sources of uncertainty inherent in historical estimates. These risk measures are used in the calculation of regulatory capital requirements based on formulas specified by the Basel framework. The credit quality distribution of the Bank’s AIRB non-retail portfolio is shown in T25. The risk measures are subject to a rigorous back-testing framework which uses the Bank’s historical data to ensure that they are appropriately calibrated. Based on results obtained from the back-testing process, risk measures are reviewed, re-calibrated and independently validated on at least an annual basis to ensure that they reflect the implications of new data, technical advances and other relevant information. (cid:129) As PD estimates represent long-run parameters, back-testing is performed using historical data spanning at least one full economic cycle. Realized PDs are back-tested using pre-defined confidence intervals, and the results are then aggregated to provide an overall assessment of the appropriateness of each PD estimate; (cid:129) The back-testing for LGD and EAD estimates is conducted from both long-run and downturn perspectives, in order to ensure that these estimates are adequately conservative to reflect both long-run and downturn conditions. Portfolio-level back-testing results, based on a comparison of estimated and realized parameters for the four-quarter period ended at July 31, 2016, are shown in T26. T26 Portfolio-level comparison of estimated and actual non-retail percentages Average PD Average LGD Average CCF(2) Estimated(1) Actual 0.85 41.26 49.94 0.69 24.63 16.08 (1) Estimated parameters are based on portfolio averages at Q3/15, whereas actual parameters are based on averages of realized parameters during the subsequent four quarters. (2) EAD back-testing is performed through Credit Conversion Factor (CCF) back-testing, as EAD is computed using the sum of the drawn exposure and the committed undrawn exposure multiplied by the estimated CCF. Credit risk-weighted assets – Canadian retail The AIRB approach is used to determine minimum regulatory capital requirements for the retail credit portfolio. The retail portfolio is comprised of the following Basel-based pools: (cid:129) Residential real estate secured exposures consists of conventional and high ratio residential mortgages and all other products opened under the Scotia Total Equity Plan (STEP), such as loans, credit cards and secured lines of credit; (cid:129) Qualifying revolving retail exposures consists of all unsecured credit cards and lines of credit; (cid:129) Other retail consists of term loans (secured and unsecured), as well as credit cards and lines of credit which are secured by assets other than real estate. For the AIRB portfolios, the following models and parameters are estimated: (cid:129) Probability of default (PD) is the likelihood that the facility will default within the next 12 months. (cid:129) Loss Given Default (LGD) measures the economic loss as a proportion of the defaulted balance. (cid:129) Exposure at Default (EAD) is the portion of expected exposures at time of default. The data observation period used for PD/EAD/LGD estimates meets the five year minimum. Various statistical techniques including predictive modeling and decision trees were used to develop models. The models assign accounts into homogenous segments using internal and external borrower/facility- level credit experience. Every month, exposures are automatically re-rated based on risk and loss characteristics. PD, LGD and EAD estimates are then assigned to each of these segments incorporating the following regulatory requirements: (cid:129) PD incorporates the average long run default experience over an economic cycle. This long run average includes a mix of high and low default years. (cid:129) LGD is adjusted to appropriately reflect economic downturn conditions. (cid:129) EAD may also be adjusted to reflect downturn conditions when PD and EAD are highly correlated. (cid:129) Sources of uncertainty are reviewed regularly to ensure uncertainties are identified, quantified and included in calculations so that all parameter estimates reflect appropriate levels of conservatism. 40 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N The table below summarizes the credit quality distribution of the Bank’s AIRB retail portfolio as at October 31, 2016. T27 Retail AIRB portfolio exposure by PD range(1)(2) As at October 31 ($ millions) 2016 2015 Category PD Range Exceptionally low 0.0000% – 0.0499% 0.0500% – 0.1999% Very low 0.2000% – 0.9999% Low Medium low Medium 1.0000% – 2.9999% 3.0000% – 9.9999% High Extremely high 10.0000% – 19.9999% 20.0000% – 99.9999% Default(7) Total 100% Exposure at default ($)(2) 44,356 59,509 52,261 20,851 6,265 1,997 2,312 677 RWA ($) 964 4,417 12,483 10,961 6,028 2,926 3,682 PD (%)(3)(6) LGD (%)(4)(6) RW (%)(5)(6) Exposure at default ($)(2) PD (%)(3)(6) LGD (%)(4)(6) RW (%)(5)(6) 0.04 0.15 0.54 1.75 5.34 10.77 35.12 30 31 42 53 61 67 56 74 38 2 7 24 53 96 147 159 – 22 49,414 59,484 53,094 21,545 5,551 2,213 2,521 611 RWA ($) 1,154 4,064 12,507 11,558 5,533 3,261 3,914 0.04 0.14 0.54 1.80 5.69 11.36 35.28 28 28 41 53 65 63 52 72 36 2 7 24 54 100 147 155 – 22 – 100.00 – 100.00 188,228 41,461 1.48 194,433 41,991 1.46 (1) Refer to the Bank’s Supplementary Regulatory Capital Disclosures for a more detailed breakdown by asset class, exposure at default, probability at default, loss given default and risk-weighting. (2) After credit risk mitigation. (3) PD – Probability of Default. (4) LGD – Loss Given Default. (5) RW – Risk Weight. (6) Exposure at default used as basis for estimated weightings. (7) Gross defaulted exposures, before any related allowances. All AIRB models and parameters are monitored on a quarterly basis and independently validated annually by the Global Risk Management group. These models are tested to ensure rank ordering and back testing of parameters is appropriate. Comparison of estimated and actual loss parameters for the period ended July 31, 2016 are shown in Table T28. During this period the actual experience was significantly better than the estimated risk parameters. T28 Estimated and actual loss parameters(1) ($ millions) Residential real estate secured Residential mortgages Insured mortgages(8) Uninsured mortgages Secured lines of credit Qualifying revolving retail exposures Other retail Average estimated PD (%)(2)(7) Actual default rate (%)(2)(5) Average estimated LGD (%)(3)(7) Actual LGD (%)(3)(6) Estimated EAD Actual EAD ($)(4)(7) ($)(4)(5) 1.01 0.54 0.77 2.02 1.95 0.46 0.25 0.25 1.78 1.32 – 19.37 29.53 77.74 58.88 – 11.54 20.47 65.66 49.85 – – 89 656 6 – – 79 573 5 (1) Estimates and Actual Values are restated to align with new models implemented during the period. (2) Account weighted aggregation. (3) Default weighted aggregation. (4) EAD is estimated for revolving products only. (5) Actual based on accounts not at default as at four quarters prior to reporting date. (6) Actual LGD calculated based on 24 month recovery period after default and therefore excludes any recoveries received after the 24 month period. (7) Estimates are based on the four quarters prior to the reporting date. (8) Actual and Estimated LGD for insured mortgages are not shown. Actual LGD includes the insurance benefit, whereas estimated LGD may not. Credit risk-weighted assets – International retail International retail credit portfolios follow the Standardized approach and consist of the following components: (cid:129) Residential real estate secured lending; (cid:129) Qualifying revolving retail exposures consisting of all credit cards and lines of credit; (cid:129) Other retail consisting of term loans. Under the standardized approach, in general, residential real estate secured lending products are risk-weighted 35% and other retail products receive a 75% risk-weight. Market risk Market risk is the risk of loss from changes in market prices including interest rates, credit spreads, equity prices, foreign exchange rates, and commodity prices, the correlations between them, and their levels of volatility. For all material trading portfolios, the Bank applies its internal models to calculate the market risk capital charge. OSFI has approved the Bank’s internal VaR, Stressed VaR, Incremental Risk Charge and Comprehensive Risk Measure models for the determination of market risk capital. The attributes and parameters of these models are described in the Risk Measurement Summary. For some non-material trading portfolios, the Bank applies the Standardized Approach for calculating market risk capital. The standardized method uses a “building block” approach, with the capital charge for each risk category calculated separately. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 41 MANAGEMENT’S DISCUSSION AND ANALYSIS Below are the market risk requirements as at October 31, 2016 and 2015: T29 Total market risk capital ($ millions) All-Bank VaR All-Bank stressed VaR Incremental risk charge Comprehensive risk measure Standardized approach Total market risk capital(1) (1) Equates to $10,571 of market risk-weighted assets (2015 – $14,350). T30 Risk-weighted assets movement by key drivers ($ millions) RWA as at beginning of the year Movement in risk levels(1) Model updates(2) Methodology and policy(3) RWA as at end of the year 2016 $ 105 209 407 77 48 $ 846 $ 2015 141 246 488 201 72 $ 1,148 Market risk 2016 2015 $ 14,350 (5,018) 1,239 – $ 17,251 2,004 (2,723) (2,182) $ 10,571 $ 14,350 (1) Movement in risk levels are defined as changes in risk due to position changes and market movements. Foreign exchange movements are imbedded within Movement in risk levels. (2) Model updates are defined as updates to the model to reflect recent experience, change in model scope. (3) Methodology and policy is defined as methodology changes to the calculations driven by regulatory policy changes (eg. Basel III). Market risk-weighted assets decreased by $3.8 billion to $10.6 billion as shown in T30 primarily due to movements in risk levels. Operational risk Operational risk is the risk of loss, whether direct or indirect, to which the Bank is exposed due to external events, human error, or the inadequacy or failure of processes, procedures, systems or controls. The Bank currently applies the Standardized Approach for calculating operational risk capital as per applicable Basel Standards. Total capital is determined as the sum of capital for each of eight Basel defined business activities. The capital for each activity is the product of the relevant risk factor, as defined by Basel, applied to the gross income of each respective business activity. The Bank has received approval from OSFI to use the Advanced Measurement Approach (AMA) commencing the first quarter of 2017. Under AMA, regulatory capital measurement will more directly reflect the Bank’s operational risk environment through the use of a loss distribution approach model which will use internal loss events, external loss events, scenario analysis and other adjustments to arrive at a final operational risk regulatory capital calculation. No significant capital increase is expected under AMA. Operational risk-weighted assets increased by $3.0 billion during the year to $38.6 billion primarily due to organic growth in gross income and acquisitions which closed during the year. Internal capital The Bank utilizes economic capital methodologies and measures to calculate internal capital. Internal capital is a measure of the unexpected losses inherent in the Bank’s business activities. The calculation of internal capital relies on models that are subject to independent vetting and validation as required by the Bank’s Model Risk Management Policy. Management assesses its risk profile to determine those risks for which the Bank should attribute internal capital. The major risk categories included in internal capital are: (cid:129) Credit risk measurement is based on the Bank’s internal credit risk ratings for derivatives, corporate and commercial loans, and credit scoring for retail loans. It is also based on the Bank’s actual experience with recoveries and takes into account differences in term to maturity, probabilities of default, expected severity of loss in the event of default, and the diversification benefits of certain portfolios. (cid:129) Market risk for internal capital incorporates models consistent with the regulatory basis, with some exclusions, and calibrated to a higher 99.95% confidence interval, and models of other market risks, mainly structural interest rate and foreign exchange risks. (cid:129) Operational risk for internal capital is based on a model incorporating actual losses, adjusted for an add-on for regulatory capital. (cid:129) Other risks include additional risks for which internal capital is attributed, such as business risk, significant investments, insurance risk and real estate risk. In addition, the Bank’s measure of internal capital includes a diversification benefit which recognizes that all of the above risks will not occur simultaneously. The Bank also includes the full amount of goodwill and intangible assets in the internal capital amount. For further discussion on risk management and details on credit, market and operational risks, refer to the Risk Management section. Off-Balance Sheet Arrangements In the normal course of business, the Bank enters into contractual arrangements with entities that are either consolidated or not required to be consolidated in its financial statements, but could have a current or future impact on the Bank’s financial performance or financial condition. These arrangements can be classified into the following categories: structured entities, securitizations, guarantees and other commitments. Structured entities Arrangements with structured entities include structured entities that are used to provide a wide range of services to customers, such as structured entities established to allow clients to securitize their financial assets while facilitating cost-efficient financing, and to provide certain investment opportunities. The Bank creates, administers and manages personal and corporate trusts on behalf of its customers. The Bank also sponsors and actively manages certain structured entities (see discussion on other unconsolidated structured entities on page 44). 42 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T All structured entities are subject to a rigorous review and approval process to ensure that all significant risks are properly identified and addressed. For many of the structured entities that are used to provide services to customers, the Bank does not guarantee the performance of the structured entities’ underlying assets, and does not absorb any related losses. For other structured entities, such as securitization and investment vehicles, the Bank may be exposed to credit, market, liquidity or operational risks. The Bank earns fees based on the nature of its association with a structured entity. Consolidated structured entities The Bank controls its U.S.-based multi-seller conduit and certain funding and other vehicles, and consolidates these structured entities in the Bank’s consolidated financial statements. As at October 31, 2016, total assets of consolidated structured entities were $59 billion, compared to $47 billion at the end of 2015. The change was primarily due to asset purchases by Scotiabank Covered Bond Guarantor Limited Partnership. More details of the Bank’s consolidated structured entities are provided in Note 14(a) to the consolidated financial statements. Unconsolidated structured entities There are two primary types of association the Bank has with unconsolidated structured entities: (cid:129) Canadian multi-seller conduits administered by the Bank, and (cid:129) Structured finance entities. The Bank earned total fees of $23 million in 2016 (October 31, 2015 – $18 million) from certain structured entities in which it had a significant interest at the end of the year but did not consolidate. More information with respect to the Bank’s involvement with these unconsolidated structured entities, including details of liquidity facilities and maximum loss exposure by category is provided below and in Note 14(b) to the consolidated financial statements. Canadian multi-seller conduits administered by the Bank The Bank sponsors two Canadian-based multi-seller conduits that are not consolidated. The Bank earned commercial paper issuance fees, program management fees, liquidity fees and other fees from these multi-seller conduits, which totaled $22 million in 2016, compared to $17 million in 2015. These multi-seller conduits purchase high-quality financial assets and finance these assets through the issuance of highly-rated commercial paper. As further described below, the Bank’s exposure to these off-balance sheet conduits primarily consists of liquidity support and temporary holdings of commercial paper. Although the Bank has power over the relevant activities of the conduits, it has limited exposure to variability in returns, which results in the Bank not consolidating the two Canadian conduits. The Bank has a process to monitor these exposures and significant events impacting the conduits to ensure there is no change in control, which could require the Bank to consolidate the assets and liabilities of the conduits at fair value. A significant portion of the conduits’ assets have been structured to receive credit enhancements from the sellers, including overcollateralization protection and cash reserve accounts. Each asset purchased by the conduits is supported by a backstop liquidity facility provided by the Bank in the form of a liquidity asset purchase agreement (LAPA). The primary purpose of the backstop liquidity facility is to provide an alternative source of financing in the event the conduits are unable to access the commercial paper market. Under the terms of the LAPA, in most cases, the Bank is not obliged to purchase defaulted assets. The Bank’s primary exposure to the Canadian-based conduits is the liquidity support provided, with total liquidity facilities of $5.8 billion as at October 31, 2016 (October 31, 2015 – $3.9 billion). The year-over-year increase was due to normal business operations. As at October 31, 2016, total commercial paper outstanding for the Canadian-based conduits was $4.4 billion (October 31, 2015 – $2.5 billion) and the Bank held less than 0.1% of the total commercial paper issued by these conduits. Table T31 presents a summary of assets purchased and held by the Bank’s two Canadian multi-seller conduits as at October 31, 2016 and 2015, by underlying exposure. All of the funded assets have at least an equivalent rating of AA– or higher based on the Bank’s internal rating program. Assets held in these conduits were investment grade as at October 31, 2016. Approximately 75% of the funded assets have final maturities falling within four years, and the weighted-average repayment period, based on cash flows, approximates 1.8 years. T31 Assets held by Scotiabank-sponsored Canadian-based multi-seller conduits M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N As at October 31 ($ millions) Auto loans/leases Trade receivables Canadian residential mortgages Equipment loans/leases Total(3) Funded assets are reflected at original cost, which approximates estimated fair value. (1) (2) Exposure to the Bank is through global-style liquidity facilities. (3) These assets are substantially sourced from Canada. 2016 2015 Funded assets(1) Unfunded commitments Total exposure(2) Funded assets(1) Unfunded commitments Total exposure(2) $ 3,168 131 1,081 21 $ 4,401 $ 601 618 194 – $ 3,769 749 1,275 21 $ 1,200 131 1,082 78 $ 573 614 193 2 $ 1,773 745 1,275 80 $ 1,413 $ 5,814 $ 2,491 $ 1,382 $ 3,873 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 43 MANAGEMENT’S DISCUSSION AND ANALYSIS Structured finance entities The Bank has interests in structured finance entities used to assist corporate clients in accessing cost-efficient financing through their securitization structures. The Bank’s maximum exposure to loss from structured finance entities was $2,326 million as at October 31, 2016, (October 31, 2015 – $2,330 million). Other unconsolidated structured entities The Bank sponsors unconsolidated structured entities in which it has insignificant or no interest at the reporting date. The Bank is a sponsor when it is significantly involved in the design and formation at inception of the structured entity, and the Bank’s name is used by the structured entity to create an awareness of the instruments being backed by the Bank’s reputation and obligation. The Bank also considers other factors, such as its continuing involvement and obligations to determine if, in substance, the Bank is a sponsor. The Bank earned $1,968 million income from its involvement with the unconsolidated Bank-sponsored structured entities for the year ended October 31, 2016 (for the year ended October 31, 2015 – $1,977 million). Securitizations The Bank securitizes fully insured residential mortgage loans, Bank originated and others, through the creation of mortgage backed securities (MBS) that are sold to Canada Housing Trust (CHT) and/or third party investors. The sale of such mortgages does not qualify for derecognition with the exception of social housing mortgage pools. The outstanding amount of off-balance sheet securitized social housing pools was $1,237 million as at October 31, 2016, compared to $1,366 million last year. The transferred mortgages sold to CHT and/or third party investors continue to be recognized on balance sheet along with the proceeds from sale treated as secured borrowings. More details have been provided in Note 13 to the consolidated financial statements on page 173. The Bank securitizes a portion of its Canadian lines of credit and credit card receivables (receivables) through two Bank-sponsored structured entities. The receivables are comprised of unsecured personal lines of credit, securitized through Hollis Receivables Term Trust II (Hollis), and personal and small business credit card receivables, securitized through Trillium Credit Card Trust II (Trillium). Hollis and Trillium issue Class A notes to third-party investors and subordinated notes to the Bank, and the proceeds of such issuances are used to purchase co-ownership interests in the respective receivables originated by the Bank. The sale of such co-ownership interests does not qualify for derecognition and therefore the receivables continue to be recognized on the Consolidated Statement of Financial Position. Recourse of the note holders is limited to the purchased co-ownership interests. During the year, no receivables were securitized through Hollis (2015 – $1,145 million) and $1,242 million were securitized through Trillium. The subordinated notes issued by Hollis of $297 million (2015 – $399 million) and Trillium of $99 million, both held by the Bank, are eliminated on consolidation. The Bank securitizes a portion of its Canadian auto loan receivables (receivables) through Securitized Term Auto Receivables Trust 2016-1 (START), a Bank-sponsored structured entity. START issues multiple series of Class A notes to third-party investors and subordinated notes to the Bank, and the proceeds of such issuances are used to purchase a discrete pool of retail indirect auto loan receivables from the Bank on a fully serviced basis. The sale of such pool does not qualify for derecognition and therefore the receivables continue to be recognized on the Consolidated Statement of Financial Position. Recourse of the note holders is limited to the receivables. During the year, $740 million of assets were securitized through START. The subordinated notes issued by START of $45 million, held by the Bank, are eliminated on consolidation. Guarantees and other commitments Guarantees and other commitments are fee-based products that the Bank provides to its customers. These products can be categorized as follows: (cid:129) Standby letters of credit and letters of guarantee. As at October 31, 2016, these amounted to $35 billion, compared to $31 billion last year. These instruments are issued at the request of a Bank customer to secure the customer’s payment or performance obligations to a third party. The year- over-year increase reflects a general increase in customer activity and the impact of foreign currency translation; (cid:129) Liquidity facilities. These generally provide an alternate source of funding to asset-backed commercial paper conduits in the event a general market disruption prevents the conduits from issuing commercial paper or, in some cases, when certain specified conditions or performance measures are not met; (cid:129) Indemnification contracts. In the ordinary course of business, the Bank enters into many contracts where it may indemnify contract counterparties for certain aspects of its operations that are dependent on other parties’ performance, or if certain events occur. The Bank cannot estimate, in all cases, the maximum potential future amount that may be payable, nor the amount of collateral or assets available under recourse provisions that would mitigate any such payments. Historically, the Bank has not made any significant payments under these indemnities; (cid:129) Loan commitments. The Bank has commitments to extend credit, subject to specific conditions, which represent undertakings to make credit available in the form of loans or other financings for specific amounts and maturities. As at October 31, 2016, these commitments amounted to $174 billion, compared to $166 billion last year. The year-over-year increase primarily reflects an increase in foreign currency denominated business activity. These guarantees and loan commitments may expose the Bank to credit or liquidity risks, and are subject to the Bank’s standard review and approval processes. For the guaranteed products, the dollar amounts represent the maximum risk of loss in the event of a total default by the guaranteed parties, and are stated before any reduction for recoveries under recourse provisions, insurance policies or collateral held or pledged. Fees from the Bank’s guarantees and loan commitment arrangements, recorded as credit fees in other income in the Consolidated Statement of Income, were $574 million in 2016, compared to $489 million in the prior year. Detailed information on guarantees and loan commitments is disclosed in Note 35 to the consolidated financial statements. 44 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Financial Instruments Given the nature of the Bank’s main business activities, financial instruments make up a substantial portion of the Bank’s financial position and are integral to the Bank’s business. Assets that are financial instruments include cash resources, securities, securities purchased under resale agreements, loans and customers’ liability under acceptances. Financial instrument liabilities include deposits, acceptances, obligations related to securities sold under repurchase agreements, obligations related to securities sold short, subordinated debentures and capital instrument liabilities. In addition, the Bank uses derivative financial instruments for both trading and hedging purposes. Financial instruments are generally carried at fair value, except for non-trading loans and receivables, certain securities and most financial liabilities, which are carried at amortized cost unless designated as fair value through profit or loss at inception. Unrealized gains and losses on the following items are recorded in other comprehensive income: (cid:129) available-for-sale securities, net of related hedges, (cid:129) derivatives designated as cash flow hedges, and (cid:129) net investment hedges. Gains and losses on available-for-sale securities are recorded in the Consolidated Statement of Income when realized. Gains and losses on cash flow hedges and net investment hedges are recorded in the Consolidated Statement of Income when the hedged item affects income. All changes in the fair value of derivatives, including embedded derivatives that must be separately accounted for, are recorded in the Consolidated Statement of Income, other than those designated as cash flow and net investment hedges which flow through other comprehensive income. The Bank’s accounting policies for derivatives and hedging activities are further described in Note 3 to the consolidated financial statements. Interest income and expense on non-trading interest-bearing financial instruments are recorded in the Consolidated Statement of Income as part of net interest income. Credit losses resulting from loans are recorded in the provision for credit losses. Interest income and expense, as well as gains and losses, on trading securities and trading loans are recorded in other operating income – trading revenues. Realized gains and losses and write-downs for impairment on available-for-sale debt or equity instruments are recorded in net gain on investment securities within other operating income. Several risks arise from transacting financial instruments, including credit risk, liquidity risk, operational risk and market risk. The Bank manages these risks using extensive risk management policies and practices, including various Board-approved risk management limits. A discussion of the Bank’s risk management policies and practices can be found in the Risk Management section on pages 60 to 98. In addition, Note 35 to the consolidated financial statements presents the Bank’s exposure to credit risk, liquidity risk and market risks arising from financial instruments as well as the Bank’s corresponding risk management policies and procedures. There are various measures that reflect the level of risk associated with the Bank’s portfolio of financial instruments. For example, the interest rate risk arising from the Bank’s financial instruments can be estimated by calculating the impact of a 100 basis point increase or decrease in interest rates on annual income, and the economic value of shareholders’ equity, as described on page 83. For trading activities, T50 discloses the average one-day Value at Risk by risk factor. For derivatives, based on the Bank’s maturity profile of derivative instruments, only 16% (2015 – 14%) had a term to maturity greater than five years. Note 9 to the consolidated financial statements provides details about derivatives used in trading and hedging activities, including notional amounts, remaining term to maturity, credit risk and fair values. The fair value of the Bank’s financial instruments is provided in Note 6 to the consolidated financial statements along with a description of how these amounts were determined. The fair value of the Bank’s financial instruments was favourable when compared to their carrying value by $2,148 million as at October 31, 2016 (October 31, 2015 – favourable $2,410 million). This difference relates mainly to loan assets, deposit liabilities, subordinated debentures and other liabilities. The year-over-year change in the fair value over carrying value arose mainly from changes in interest rates since origination. Fair value estimates are based on market conditions as at October 31, 2016, and may not be reflective of future fair values. Further information on how fair values are estimated is contained in the section on critical accounting estimates on page 99. Disclosures specific to certain financial instruments designated at fair value through profit or loss can be found in Note 8 to the consolidated financial statements. These designations were made primarily to significantly reduce accounting mismatches. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G R O U P F I N A N C I A L C O N D I T I O N 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 45 MANAGEMENT’S DISCUSSION AND ANALYSIS Selected Credit Instruments – Publically Known Risk Items Mortgage-backed securities Total mortgage-backed securities held in the non-trading and trading portfolios are shown in T32. T32 Mortgage-backed securities As at October 31 Carrying value ($ millions) Canadian NHA mortgage-backed securities(1) Commercial mortgage-backed securities Other residential mortgage-backed securities Total 2016 2015 Non-trading portfolio Trading portfolio Non-trading portfolio Trading portfolio $ 1,591 – 521 $ 1,546 57 – $ 137 2 206 $ 1,335 113 3 $ 2,112 $ 1,603 $ 345 $ 1,451 (1) Canada Mortgage and Housing Corporation provides a guarantee of timely payment to NHA mortgage-backed security investors. Collateralized debt obligations and collateralized loan obligations Non-trading portfolio The Bank has collateralized loan obligation (CLO) investments in its non-trading portfolio. CLOs generally achieve their structured credit exposure by investing and holding corporate loans or bonds. Cash-based CLOs are classified as loans and are carried at amortized cost. These are assessed for impairment like all other loans. As at October 31, 2016, the carrying value of cash-based CLOs reported as loans on the Consolidated Statement of Financial Position was $14 million (October 31, 2015 – $34 million). The fair value was $7 million (October 31, 2015 – $28 million). The year-over-year decline was due to paydowns. None of these cash-based CLOs are classified as impaired loans. Substantially all of the referenced assets of the Bank’s CLOs are corporate exposures, without any U.S. mortgage-backed securities. Trading portfolio The Bank also holds synthetic CDOs in its trading portfolio as a result of structuring and managing transactions with clients and other financial institutions. To hedge its trading exposure, the Bank purchases or sells CDOs to other financial institutions, along with purchasing and/or selling index tranches or single name credit default swaps (CDSs). The main driver of the value of CDOs and CDSs is changes in credit spreads. Total CDOs purchased and sold in the trading portfolio are shown in T33 below. T33 Collateralized debt obligations (CDOs) As at October 31 Outstanding ($ millions) CDOs – sold protection CDOs – purchased protection 2016 2015 Notional Amount $ 142 – $ Positive/ (negative) fair value $ 4 $ – Notional Amount $ 1,977 $ 1,776 Positive/ (negative) fair value $ 24 $ (8) The change in the notional amount and fair value of CDOs were due mainly to trades that matured or were unwound during the year. The change in fair value of CDOs was due to the reduction of probability of deals experiencing defaults as they approach maturity. Based on positions held at October 31, 2016, a 50 basis point widening of relevant credit spreads in this portfolio would result in a pre-tax decrease of approximately $2.0 million in net income. The referenced assets underlying the trading book CDOs are substantially all corporate exposures, with no mortgage-backed securities. Other As at October 31, 2016, the Bank has insignificant exposure to highly leveraged loans awaiting syndication, auction-rate securities, Alt-A type loans, monoline insurance and investments in structured investment vehicles. 46 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T BUSINESS LINE OVERVIEW Business line results are presented on a taxable equivalent basis, adjusting for the following: (cid:129) The Bank analyzes revenue on a taxable equivalent basis (TEB) for business lines. This methodology grosses up tax-exempt income earned on certain securities reported in either net interest income or non-interest income to an equivalent before tax basis. A corresponding increase is made to the provision for income taxes; hence, there is no impact on net income. Management believes that this basis for measurement provides a uniform comparability of net interest income and non-interest income arising from both taxable and non-taxable sources and facilitates a consistent basis of measurement. While other banks also use TEB, their methodology may not be comparable to the Bank’s methodology. A segment’s revenue and provision for income taxes are grossed up by the taxable equivalent amount. The elimination of the TEB gross up is recorded in the Other segment. (cid:129) For business line performance assessment and reporting, net income from associated corporations, which is an after-tax number, is adjusted to normalize for income taxes. The tax normalization adjustment grosses up the amount of net income from associated corporations and normalizes the effective tax rate in the business lines to better present the contribution of the associated corporations to the business line results. Below are the results of the Bank’s three business operating segments for 2016: CANADIAN BANKING Canadian Banking reported net income to equity holders of $3,736 million, up 12% from last year. Solid asset and deposit growth, along with increasing margin driven by credit cards and deposits, gain on sale of a non-core lease financing business and higher non-interest income contributed to this increase. This was partially offset by higher provision for credit losses and non-interest expenses. Return on equity was 22.0% compared to 21.0% last year. INTERNATIONAL BANKING International Banking had net income attributable to equity holders of $2,079 million, up $226 million or 12% from last year. Results benefited from strong asset and fee growth and the positive impact of foreign currency translation. This was partly offset by higher provision for credit losses. Return on equity was 12.8%, compared to 13.0% last year. GLOBAL BANKING AND MARKETS Global Banking and Markets reported net income attributable to equity holders of $1,571 million, an increase of $18 million from last year. Strong revenue performances in the fixed income, corporate lending and commodities businesses, were mainly offset by higher provision for credit losses and lower results in equities. Return on equity was 12.6% compared to 13.0% last year. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | B U S I N E S S L I N E S 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 47 MANAGEMENT’S DISCUSSION AND ANALYSIS KEY PERFORMANCE INDICATORS FOR ALL BUSINESS LINES Management uses a number of key metrics to monitor business line performance: (cid:129) Net income (cid:129) Return on equity (cid:129) Productivity ratio (cid:129) Provision for credit losses ratio (cid:129) Employee engagement T34 2016 Financial performance ($ millions) Net interest income(2) Non-interest income(2) Total revenue(2) Provision for credit losses Non-interest expenses Income tax expense(2) Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Return on equity (%)(3) Average assets ($ billions) Average liabilities ($ billions) Canadian Banking International Banking Global Banking and Markets Other(1) Total $ 7,024 5,164 12,188 832 6,324 1,296 $ 3,736 – 3,736 22.0% 309 232 $ $ $ $ 6,359 3,482 9,841 1,281 5,523 707 $ 2,330 251 $ 2,079 12.8% 143 109 $ $ $ 1,293 3,139 4,432 249 2,040 572 $ 1,571 – $ (384) 273 (111) 50 653 (545) $ (269) – $ 1,571 $ (269) 12.6% 351 270 $ $ –% $ 111 $ 247 $ $ $ $ 14,292 12,058 26,350 2,412 14,540 2,030 $ 7,368 251 7,117 13.8% 914 858 (1) The Other category represents smaller operating segments, including Group Treasury, and other corporate adjustments that are not allocated to an operating segment. Corporate adjustments include the net residual in matched maturity transfer pricing, the elimination of the tax-exempt income gross-up reported in net interest income, non-interest income and provision for income taxes, changes in the collective allowance on performing loans, and differences in the actual amount of costs incurred and charged to the operating segments. (2) Taxable equivalent basis. (3) Refer to Glossary. 48 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C A N A D I A N B A N K I N G Canadian Banking Canadian Banking provides a full suite of financial advice and banking solutions, supported by an excellent customer experience, to retail, small business, commercial and wealth management customers in Canada. 2016 Achievements (cid:129) Delivered an industry-leading customer experience across our businesses and channels. (cid:129) (cid:129) (cid:129) Launched two new customer-focused branch formats – Scotiabank Express in Guelph and Montreal and Scotiabank Solutions in Guelph and Kitchener. Also, launched the Network Transformation Wave Pilot to improve the customer and employee experience. Scotiabank received a record nine awards in the 2016 Ipsos Best Banking Awards, placing 2nd among the Big Five Banks for Overall Service Quality. Tangerine earned the highest ranking in customer satisfaction among mid-sized banks for the fifth straight year in the 2016 J.D. Power Canadian Retail Banking Customer Satisfaction Study. For the eleventh year in a row, Tangerine was recognized as a customer service leader in the Ipsos Best Banking Awards. (cid:129) (cid:129) Contact centres for Scotiabank (Halifax) and ScotiaLife Financial both received Contact Centre World Class First Call Resolution (FCR) Certification from the Service Quality Management (SQM) Group. (cid:129) Delivered industry-leading solutions to enhance the customer experience, including best-in-class processes for mortgage, credit (cid:129) card, small business loan applications and branch onboarding. Launched new Scotia Wealth Management brand – “Enriched Thinking” – one unified voice, one strong brand, and one integrated approach to serving client needs. (cid:129) HollisWealth ranking moved up from fourth place in 2015 to secure third place in the J.D. Power 2016 Canadian Full Service Investor Satisfaction Study. (cid:129) Further optimized our business mix by growing our higher margin assets, building sticky core deposits, and earning higher fee income. (cid:129) Two popular co-brand credit cards from Scotiabank – the Scotiabank GM Visa Infinite card and the Scotiabank SCENE Visa card – were recognized with highest honours in the 2015 MoneySense Annual Credit Cards Ranking. Launched the Scotiabank More Rewards Visa in partnership with Western Canada based grocer Overwaitea Food Group. Successfully completed the acquisition of the JPMorgan Chase MasterCard portfolio. (cid:129) (cid:129) (cid:129) Completed the sale of Roynat’s non-core lease financing business. (cid:129) (cid:129) (cid:129) Record year for life insurance revenue driven by Private Banking, Private Investment Counsel, and stronger partnership with Financial Tangerine won the 2016 Product of the Year award for the Tangerine Money-Back Credit Card. Scotiabank iTRADE selected by MoneySense Magazine as a Top 3 pick in best online brokerages in Canada. Planning specialists. (cid:129) Dynamic Funds won five Fundata FundGrade A+ Awards. (cid:129) Made significant investments to become a digital banking leader. (cid:129) Named the 2016 World’s Best Consumer Digital Bank in Canada by Global Finance Magazine. (cid:129) (cid:129) (cid:129) Tied for highest overall score in the 2016 Canadian Mobile Banking Functionality Benchmark by Forrester Research. Tied for third place overall in the 2016 Global Mobile Banking Functionality Benchmark by Forrester Research. Tangerine named the industry leader in Canadian Mobile Banking Services according to Surviscor’s 2015 Mobile Banking scorecard Review. Scotiabank came in at #2. Launched Apple Pay. All Scotiabank customers can now use mobile payments through Apple Pay (for iPhone) and My Mobile Wallet (for Android and Blackberry). (cid:129) Business Profile Canadian Banking provides a full suite of financial advice and banking solutions, supported by an excellent customer experience, to over 10 million Retail, Small Business, Commercial Banking, and Wealth Management customers. It serves these customers through its network of 980 branches and more than 3,500 automated banking machines (ABMs), as well as internet, mobile and telephone banking and specialized sales teams. Canadian Banking also provides an alternative self-directed banking solution to over two million Tangerine Bank customers. Canadian Banking is comprised of the following areas: (cid:129) Retail and Small Business Banking provides financial advice and solutions and day-to-day banking products, including debit cards, chequing accounts, credit cards, investments, mortgages, loans and related creditor insurance products, to individuals and small businesses. Tangerine Bank provides day-to-day banking products, including chequing and saving accounts, credit cards, and investments to self-directed customers. (cid:129) Commercial Banking delivers advice and a full suite of lending, deposit, cash management and trade finance solutions to medium and large businesses, including automotive dealers and their customers to whom we provide retail automotive financing solutions. (cid:129) Wealth Management provides a suite of investment and wealth management advice, services, products and solutions to customers, as well as advisors. The asset management business is focused on developing investment solutions for both retail and institutional investors. The customer- facing wealth businesses, including private customer, online brokerage, full-service brokerage, pensions, institutional customer services and an independent advisor channel, are focused on providing a full suite of wealth management solutions to our customers. Strategy Canadian Banking continues to execute on a long term strategy to deliver a best-in-class customer experience, grow its primary banking relationships, and outperform competitors in earnings growth through customer experience, business mix, operational improvements and digital transformation. 2017 Priorities (cid:129) Customer experience: Deliver an excellent customer experience across our businesses and channels. (cid:129) Business mix: Optimize our business mix by growing higher margin assets, building core deposits, and earning higher fee income. (cid:129) Operational improvement: Reduce structural costs to build the capacity to invest in our businesses and technology. (cid:129) Digital transformation: Enhance our digital offering and e-commerce capabilities to drive digital sales and engagement. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 49 MANAGEMENT’S DISCUSSION AND ANALYSIS T35 Canadian Banking financial performance ($ millions) Net interest income(1) Non-interest income(1)(2) Total revenue(1) Provision for credit losses Non-interest expenses Income tax expense(1) Net income Net income attributable to non-controlling interests Net income attributable to equity holders of the Bank Key ratios Return on equity(3) Productivity(1) Net interest margin(4) Provision for credit losses as a percentage of loans and acceptances Selected Consolidated Statement of Financial Position data (average balances) Earning assets Total assets Deposits Total liabilities Other ($ billions) as at October 31 Assets under administration Assets under management (1) Taxable equivalent basis. (2) Includes net income from investments in associated corporations of $78 (2015 – $66; 2014 – $157). (3) Refer to Glossary. (4) Net interest income (TEB) as % of average earning assets excluding bankers acceptances. 2016 7,024 5,164 12,188 832 6,324 1,296 3,736 – 3,736 $ $ $ 2015 6,415 4,832 11,247 687 6,014 1,202 3,344 – 3,344 $ $ $ 2014 5,996 5,263 11,259 663 5,799 1,113 3,684 1 3,683 $ $ $ 22.0% 51.9% 2.38% 0.28% 21.0% 53.5% 2.23% 0.23% 22.8% 51.5% 2.14% 0.23% $ 302,648 309,232 224,006 232,498 $ 293,460 299,929 210,241 217,753 $ 284,966 291,549 202,088 208,354 $ $ 318 145 $ $ 310 135 $ $ 296 124 50 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Financial Performance Canadian Banking’s net income attributable to equity holders was $3,736 million in 2016, an increase of $392 million or 12%. The gain on the sale of a non-core lease financing business (“the gain on sale”) of $116 million pre-tax or $100 million after tax contributed 3% growth to net income. Strong performance from retail and small business banking, commercial banking and wealth management, as well as the impact of the credit card portfolio acquired from JPMorgan Chase Bank (“the acquisition”) contributed to the growth. Assets and liabilities Average assets rose $9 billion or 3% to $309 billion. Adjusting for the impact of the Tangerine broker-originated and white-label mortgage run-off portfolios, assets increased $14 billion or 5%. The growth reflected $6 billion or 8% in personal loans primarily in consumer automotive lending and credit cards, $5 billion or 3% in residential mortgages, as well as $3 billion or 9% in business loans and acceptances. Average liabilities rose $14 billion or 7% to $232 billion. Retail banking experienced solid growth in chequing accounts of $2 billion or 9% and savings deposits of $8 billion or 14%. There was also growth of $2 billion or 4% in small business and commercial banking business operating accounts and $4 billion or 25% in wealth management deposits. Partially offsetting was a decline in lower spread GICs of $2 billion or 2%. Assets under management (AUM) and assets under administration (AUA) AUM of $145 billion increased $10 billion or 7% driven by market appreciation and net sales. AUA increased $8 billion or 3% to $318 billion driven by market appreciation. Revenues Canadian Banking reported total revenues of $12,188 million in 2016, up $941 million from last year, including the gain on sale. Net interest income increased $609 million or 9% to $7,024 million. The increase was driven by a 15 basis point increase in the margin to 2.38%, strong growth in assets and deposits, and the impact of the acquisition. The increase in margin was primarily driven by growth in higher margin credit cards, margin expansion in deposits, the run-off of lower spread Tangerine mortgages, and the acquisition. Non-interest income increased $332 million or 7% to $5,164 million. The increase was driven by strong growth in credit cards, retail and commercial banking, insurance and wealth management businesses and includes gains on sale of real estate and the non-core lease financing business. Retail & Small Business Banking Total retail and small business banking revenues were $6,843 million, up $607 million or 10%. Net interest income grew $428 million or 9%, primarily driven by a 16 basis point improvement in the margin and solid growth in credit card products and deposits. Non-interest income increased $179 million or 11%, primarily due to growth in credit card revenues, deposit payment service fees and insurance revenues. Commercial Banking Total commercial banking revenues increased $274 million or 15% to $2,133 million, including the gain on sale. Net interest income rose $135 million or 9% due mainly to growth in loans and business operating accounts and a margin expansion of six basis points. Non-interest income increased $139 million or 33% mainly driven by the gain on sale and higher acceptance fees. Wealth Management Total wealth management revenues were $3,212 million, an increase of $60 million or 2%. Net interest income rose $46 million or 15% mainly due to growth in deposits and loans. Non- interest revenues increased $13 million from higher investment management fees and growth in mutual funds revenues as a result of net sales and market appreciation. Partly offsetting these increases was lower transaction based brokerage fees. Non-interest expenses Non-interest expenses were $6,324 million, an increase of $310 million or 5%, primarily reflecting the impact of the acquisition, technology and project spending, partially offset by benefits realized from cost reduction initiatives. Operating leverage was positive 3.2%, or 2.2% adjusting for the gain on sale. Provision for credit losses The provision for credit losses in Canadian Banking was $832 million, an increase of $145 million. The provision for credit losses was higher due to growth in retail portfolios, primarily in credit cards and auto loans, with additional increases from commercial provisions, partly offset by acquisition-related benefits. The provision for credit losses ratio was 28 basis points, compared to 23 basis points in the prior year due to growth in higher margin products. Provision for income taxes The effective tax rate decreased to 25.8%, compared to 26.4% in the previous year. Outlook Canadian Banking’s growth in 2017 will be driven in part by an improving economic outlook for Canada. Assets are projected to grow across retail mortgages, automotive, commercial loans and credit cards. Deposits are also expected to grow across retail chequing and savings, small business and commercial deposits. Margins are expected to be stable to slightly increasing during 2017. Provisions for credit losses will rise reflecting primarily a changing asset mix. Wealth management is expected to see continued growth in 2017. Expense management continues to be a focus that will lead to further improvements in productivity. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C A N A D I A N B A N K I N G C11 Total revenue $ millions 26% 18% 56% Retail & Small Business Banking Commercial Banking Wealth Management C12 Total revenue by sub-segment $ millions 12000 10000 8000 6000 4000 2000 14 15 16 Wealth Management Commercial Banking Retail & Small Business Banking C13 Average loans and acceptances $ billions 300 250 200 150 100 50 14 15 16 Commercial loans/acceptances Retail loans (except mortgages) Residential mortgages C14 Canadian wealth management assets $ billions, as at October 31 350 300 250 200 150 100 50 175 150 125 100 75 50 25 14 15 16 Assets under administration (left scale) Assets under management (right scale) 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 51 MANAGEMENT’S DISCUSSION AND ANALYSIS International Banking International Banking provides a full range of financial products, solutions and advice to retail and commercial customers in select regions outside of Canada. 2016 Achievements (cid:129) Improved customer experience across our businesses and channels. (cid:129) Developed 4 new retail branch prototypes in Mexico City to focus on improving customer experience. (cid:129) (cid:129) Named Scotiabank “World’s Best Emerging Market Bank 2016” in the Bahamas, Barbados, Costa Rica, Trinidad & Tobago, Turks & Caicos and Launched the Net Promoter System (NPS) to build customer advocacy across the Pacific Alliance and Canada. The U.S. Virgin Islands by Global Finance Magazine. (cid:129) Achieved Service Quality Measurement World Class Certification and recognition at the 2015 SQM Conference Awards for our contact centres in Mexico, Jamaica and the Dominican Republic. (cid:129) Further optimized our business mix by growing high-yielding assets, building sticky core deposits, and earning higher fee income. Introduced new Premium Banking Model in eight branches in Peru. (cid:129) (cid:129) Achieved leading bookrunner by volume in Latin America (Thomson Reuters). (cid:129) Renewed partnership with Cencosud in Colombia to target new credit card customers. (cid:129) Extended ATM alliance to Mifel and Actiniver (regional financial services providers) in Mexico to provide customers with access to a broader self- service network. (cid:129) Made significant investments to become a digital banking leader. (cid:129) (cid:129) Launched the Global Digital Banking Organization including stand-alone Digital Banking Units in Mexico, Peru, Chile and Colombia. Launched significant enhancements to Online and Mobile Banking platforms in Mexico. (cid:129) Redeployed new Online and Mobile Banking platforms in the Caribbean. (cid:129) Recognized as the #1 Global Bank with the Best Digital Strategy for 2016 by Retail Banker International. (cid:129) Named the “World’s Best Consumer Digital Bank 2016” in Latin America, the Caribbean and Canada for 2016 by Global Finance magazine. (cid:129) Launched fintech partnership with Kabbage in Mexico and Canada to provide customers with real-time credit adjudication. Business Profile International Banking (IB) has a well-established, diversified franchise that serves more than 14 million Retail, Corporate, and Commercial customers across our footprint. These customers are supported by over 50,000 employees, 1,800+ branches, and a network of contact and business support centres. IB is focused on Latin America, including the Pacific Alliance countries of Mexico, Peru, Chile and Colombia, and the Caribbean and Central America. We believe the Pacific Alliance countries offer excellent opportunities for growth with young demographics, low banking penetration, growing economies, low consumer indebtedness and stable banking systems. The Caribbean and Central American markets are more mature and have lower growth, but are still very profitable. Strategy International Banking continues to pursue: (i) a growth strategy in the Pacific Alliance countries and (ii) an optimization strategy in the Caribbean and Central American countries. Our strategy is organized around five key areas: (cid:129) Customer focus – Increase the number of primary customers in target segments by creating a simpler and more compelling digital customer experience, and a systematic approach to gathering and acting upon customer feedback. (cid:129) Digital transformation – Drive digital adoption and sales for customers through digital customer-facing and internal processes and increase our operational efficiency. (cid:129) Business mix alignment – Optimize the business mix by growing core deposits, targeting more profitable products, balancing portfolio growth, and closely managing our usage of wholesale funding. (cid:129) Structural costs transformation – Optimize the operating model and footprint to lower structural costs, reduce complexity, digitize processes, leverage scale and ultimately improve productivity. (cid:129) Leadership – Make leadership a competitive advantage by actively acquiring, developing and engaging a diverse pool of leaders to deepen bench strength and reflect our growth markets. 2017 Priorities Aligned to our strategy and in addition to the growth in our core business, our primary focus is on the following key growth initiatives over the next 3-5 years: 1. Customer focus: Launch Net Promoter System (NPS) across Peru, Chile, Colombia and Mexico to provide our employees and leadership with timely and specific customer feedback. 2. Digital transformation: Establish digital banking organizations within our Pacific Alliance operations to drive greater digital adoption and sales. 3. Business mix: Enhance business mix by growing core deposits to reduce funding costs along with growing in targeted profitable segments/ products. 4. Structural costs transformation: Continue cost reduction programs to lower expenses and use the savings to fund strategic initiatives, make investments in technology, and improve productivity. 52 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T T36 International Banking financial performance ($ millions) Net interest income(1) Non-interest income(1)(2) Total revenue(1) Provision for credit losses Non-interest expenses Income tax expense(1) Net income Net income attributable to non-controlling interests Net income attributable to equity holders of the Bank Key ratios Return on equity(3) Productivity(1) Net interest margin(4) Provision for credit losses as a percentage of loans and acceptances Selected Consolidated Statement of Financial Position data (average balances) Earning assets Total assets Deposits Total liabilities Other ($ millions as at October 31) Assets under administration Assets under management Includes net income from investments in associated corporations of $473 (2015 – $476; 2014 – $411). (1) Taxable equivalent basis. (2) (3) Refer to Glossary. (4) Net interest income (TEB) as % of average earning assets excluding bankers acceptances. 2016 6,359 3,482 9,841 1,281 5,523 707 2,330 251 2,079 $ $ $ 2015 5,706 3,137 8,843 1,128 5,095 568 2,052 199 1,853 $ $ $ 2014 5,155 2,945 8,100 1,024 4,690 544 1,842 226 1,616 $ $ $ 12.8% 56.1% 4.71% 1.26% 13.0% 57.6% 4.71% 1.24% 11.7% 57.9% 4.75% 1.27% $ 135,167 142,582 87,508 109,302 $ 121,130 128,248 73,946 94,340 $ 108,717 114,996 65,025 84,969 $ $ 85,888 47,287 $ $ 80,606 43,560 $ $ 71,587 41,125 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | I N T E R N A T I O N A L B A N K I N G 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 53 MANAGEMENT’S DISCUSSION AND ANALYSIS Financial Performance Net income attributable to equity holders was $2,079 million, an increase of $226 million or 12%. Earnings from strong asset and fee growth, including the positive impact of foreign currency translation, were partly offset by higher provision for credit losses. Strong underlying asset and fee growth in Latin America and a solid contribution from Caribbean & Central America, were complemented by earnings in Asia. Assets and Liabilities Average assets of $143 billion increased $14 billion or 11%, driven by strong retail and commercial loan growth of 11% and 12% respectively. Latin America primarily drove the growth in lending assets with retail and commercial assets increasing 11% and 14%, respectively. Caribbean and Central America saw retail assets increase by 12% with commercial assets up 6%. Average liabilities increased $15 billion or 16% to $109 billion largely due to 18% growth in deposits, including demand and savings deposits up 16%, partly offset by lower securities sold under repurchase agreements down 20%. Revenues Total revenues of $9,841 million increased $998 million or 11%. Net interest income increased 11% driven by strong loan growth and recent acquisitions. The net interest margin was stable at 4.71%. Non-interest income increased $345 million or 11%. This increase was largely driven by higher net fee and commission revenues which increased 10% to $2,579 million with higher banking and wealth management fees across Latin America and the Caribbean. Other operating income rose by $104 million or 14% due mainly to foreign exchange hedge related gains, higher acquisition benefits, and insurance revenues, partly offset by lower net gains on investment securities. Latin America Total revenues of $6,455 million increased 10% from last year, or 16% adjusting for the negative impact of foreign currency translation. Non-interest income was up $191 million or 10%. Net interest income increased $418 million or 11%, reflecting the impact of strong asset growth and a stable net interest margin. Net fee and commission revenues increased by $174 million or 10% largely driven by higher transaction, credit card fees, wealth management fees, and foreign exchange fees. Other non-interest income increased by $17 million, due mainly to foreign exchange hedge related gains, higher acquisition-related benefits, and trading revenues, partly offset lower net gains on investment securities. Caribbean and Central America Total revenues were $2,967 million, up 14% versus last year or 7% adjusting for the positive impact of foreign currency translation. Net interest income increased $234 million or 13%, driven by positive foreign currency translation and acquisitions of Citi Central America. Non-interest income including net fees and commissions was up 16%, or 7% adjusting for foreign currency translation, as a result of strong growth in banking, credit card and foreign exchange fees, and higher insurance revenues, and hedge gains vs losses last year. Asia Total revenues were $419 million, up 6% versus last year, or down 3% adjusting for the positive impact of foreign currency translation. This was primarily driven by a lower contribution from Thanachart Bank, partly offset by a higher contribution from Bank of Xi’an. Non-interest expenses Non-interest expenses of $5,523 million increased $428 million or 8% from last year. The increase reflected the impact of acquisitions, business volume growth and inflationary increases, partly offset by the positive impact of foreign currency translation. Operating leverage was a positive 2.9%. Provision for credit losses The provision for credit losses increased $153 million or 14% to $1,281 million. Retail provisions were flat compared to 2015. Increases from acquisitions and higher provisions for credit losses in Latin America from strong retail growth were offset by favourable foreign currency translation. Commercial provisions for credit losses increased mainly in Colombia, primarily the energy sector, and Puerto Rico. Overall, the provision for credit losses ratio was stable, up two basis points to 1.26% relative to last year. Provision for income taxes The effective tax rate was 23.3% compared to 21.7% last year due primarily to lower tax benefits in Mexico and the Caribbean. Outlook International Banking’s growth in 2017 will be achieved through leveraging its diversified footprint, with particular focus on the Pacific Alliance countries. Despite moderation of economic growth in the Pacific Alliance countries, we expect to continue to deliver low double digit loan growth in this region. Margins and credit quality are expected to remain stable. Expense management and delivering positive operating leverage remains a key business priority, with strategic investments in optimizing the business structure and delivering a stronger customer experience being funded through internal structural cost reduction programs. While the primary business focus is on organic growth, acquisition opportunities will continue to be considered that are strategically aligned and complement current operations within the existing footprint. 54 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C15 Total revenue 4.3% 30.2% 65.5% Caribbean and Central America Latin America Asia C16 Total revenue by region $ millions 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 14 15 16 Asia Caribbean and Central America Latin America C17 Average loans and acceptances $ billions 100 80 60 40 20 14 15 16 Residential mortgages Retail loans (except mortgages) Business loans/acceptances C18 Average earning assets(1) by region $ billions 140 120 100 80 60 40 14 15 16 Asia Caribbean and Central America Latin America (1) Average earning assets excluding bankers acceptances M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G L O B A L B A N K I N G A N D M A R K E T S Global Banking and Markets Global Banking and Markets (GBM) provides clients with corporate banking, investment banking, capital markets and transaction banking solutions. GBM’s products and services are offered to corporate, government and institutional clients in Canada, the U.S., Latin America, Europe, Asia and Australia. 2016 Achievements (cid:129) Enhanced customer focus and leveraged our global footprint and our core sector expertise to deliver value-added solutions and superior service to clients. Examples include: (cid:129) US$11.8 billion acquisition by Fortis Inc. of ITC Holdings Corp. Scotiabank acted as financial advisor and provided financing to Fortis. This transaction made Fortis one of the top 15 North American public utilities by enterprise value. Scotiabank was also exclusive financial advisor to Fortis on its US$1.2 billion sale of a 19.9% equity interest in ITC to GIC Private Limited, Singapore’s sovereign wealth fund. (cid:129) $3.2 billion sale of RONA Inc. to Lowe’s Companies Inc. Scotiabank acted as exclusive financial advisor to RONA. Together, RONA and Lowe’s Canada stores created Canada’s leading home improvement retailer. (cid:129) Mandated lead arranger, underwriter, book-runner and swaps provider on the three largest debt transactions in Australia over the past year: A$12.8 billion debt facility for the acquisition of the Ausgrid electricity network; A$5.9 billion debt facility for the acquisition of the TransGrid electricity network; and A$4.2 billion debt facility for the acquisition of the Port of Melbourne. The Ausgrid financing was the largest ever AUD corporate loan transaction. (cid:129) US$900 million sale by Glencore plc of silver production from the Antamina mine in Peru to Silver Wheaton Corp., and US$500 million sale of gold and silver production from its Antapaccay mine in Peru to Franco-Nevada Corp. Scotiabank was sole financial advisor to Glencore, one of the world’s largest diversified natural resource companies. Joint book-runner on a US$920 million bought deal by Franco-Nevada, largely aimed for the acquisition from Glencore. Franco-Nevada is the leading precious metals royalty and streaming company by both gold revenue and number of precious metal assets. (cid:129) US$525 million acquisition by Gran Tierra Energy Inc. of PetroLatina Energy Ltd. Scotiabank acted as lead financial advisor, sole lead arranger for a US$130 million bridge credit facility and top left book-runner in two equity offerings for a total of US$303 million. Gran Tierra is an oil and gas exploration and production company based in Canada with operations in South America, mainly Colombia. (cid:129) $1.9 billion inaugural Scotiabank lead bond underwriting for the Province of Alberta on its September 2021 offering, the largest Canadian bond underwriting for a province in history. (cid:129) JPY 6 billion 30-year bond deal for the Province of Manitoba, Scotiabank’s inaugural JPY transaction for a Canadian province. Scotiabank was joint lead underwriter and sole hedge provider on this deal, named as the 2016 Deal of the Year for Asia-Pacific from mtn-i awards. (cid:129) Scotiabank’s Equity Research team earned eleven #1 industry rankings and 17 top-tier sector rankings in the 2016 Canadian Equity Investors Study by Greenwich Associates. Additionally, the team ranked joint second overall in the 2016 Thomson Reuters Analyst Awards for Canada, recognizing analysts’ performance based on their stock picking ability and accuracy of their earnings estimates. (cid:129) Implemented a new client segmentation and coverage model to improve customer experience and better align our resources and capabilities to meet our clients’ needs. (cid:129) First Canadian bank to offer Bulk Interac e-Transfer, making it easier for businesses to send refunds or payments to customers online. (cid:129) Further optimized our business mix, including growing our Latin America business and repositioning our business in Asia and Australia. (cid:129) Obtained all licenses required to operate as a branch of The Bank of Nova Scotia in Australia. This allows Scotiabank to extend our offerings to Australian-based customers and better serve Canadian and international customers with business interests in Australia. (cid:129) Named Best Foreign Exchange Provider in Canada, Peru and Costa Rica, Global Finance (2016). (cid:129) Hired new staff to support our Investment Banking coverage in the Pacific Alliance. (cid:129) Strengthened our customer data and analytics capabilities by enhancing our customer relationship management system and data quality and by introducing new client planning tools. (cid:129) Following the creation of the GBM Diversity & Inclusion (D&I) Office in late 2015, we have made good progress towards making GBM a more diverse and inclusive workplace, including creating steering committees in each region in which we operate to advance our D&I initiatives globally. Business Profile Global Banking and Markets (GBM) conducts the Bank’s wholesale banking and capital markets business with corporate, government and institutional investor clients. GBM is a full-service wholesale bank and investment dealer in Canada and Mexico, and offers a range of products and services in the U.S., Latin America (excluding Mexico), and in select markets in Europe, Asia and Australia. More specifically, GBM provides clients with: corporate lending; transaction banking (including trade finance and cash management); investment banking (including corporate finance and mergers & acquisitions); fixed income and equity underwriting, sales, trading and research; prime services (prime brokerage and stock lending); foreign exchange sales and trading; commodity derivatives; precious and base metals sales, trading, financing and physical services; and collateral management. Scotiabank took steps to refocus its Asia business this year. This included the establishment of a fully-licensed branch in Australia, the closing of our representative offices in Vietnam and Thailand, and the closing of our branches in Taiwan and Dubai. Strategy GBM aims to be a leading wholesale bank in Canada and the Pacific Alliance and maintain a focused presence in other regions to support multi- regional customers and leverage GBM’s strengths in its core markets and sectors. We will achieve this objective by: (cid:129) Enhancing our customer focus to strengthen customer relationships; (cid:129) Making the required investments in our platform and technology; 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 55 MANAGEMENT’S DISCUSSION AND ANALYSIS (cid:129) Executing on cost control strategies; and (cid:129) Directing capital and resources to businesses which optimize profitability and align with our customer-focused strategies. 2017 Priorities (cid:129) Improve customer focus – Improve our customer coverage and deepen relationships with our most important customers. Increase our emphasis on investment banking and other fee-based activities that strengthen customer relationships. Leverage our global platforms to serve the strategic and financial objectives of our customers. (cid:129) Align business mix – Shift our business mix to more closely align with our customer-focused strategy and other priorities by: (i) increasing fee- based revenue as a percentage of total revenue; (ii) improving sector diversification; and (iii) shifting more focus and resources to our Pacific Alliance operations. (cid:129) Improve resource productivity – Improve productivity and achieve cost efficiencies through: (i) structural cost management and the re-purposing of our cost base; (ii) further reduction in costs and risks through enhanced client on-boarding processes; and (iii) re-alignment of global wholesale operations. (cid:129) Further digital transformation – Improve automation and embrace disruptive technologies to improve the customer experience and reduce costs. Invest in advanced analytics to drive revenues and optimize the use of capital and funding. T37 Global Banking and Markets financial performance ($ millions) Net interest income(1) Non-interest income(1) Total revenue(1) Provision for credit losses Non-interest expenses Income tax expense(1) Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Key ratios Return on equity(2) Productivity(1) Net interest margin(3) Provision for credit losses as a percentage of loans and acceptances Selected Consolidated Statement of Financial Position data (average balances) Trading assets Loans and acceptances Earning assets Total assets Deposits Total liabilities (1) Taxable equivalent basis. (2) Refer to Glossary. (3) Net interest income (TEB) as % of average earning assets excluding bankers’ acceptances. 2016 1,293 3,139 4,432 249 2,040 572 1,571 – 1,571 $ $ $ 2015 1,071 2,953 4,024 67 1,846 558 1,553 – 1,553 $ $ $ 2014 1,064 3,167 4,231 16 1,880 665 1,670 – 1,670 $ $ $ 12.6% 46.0% 1.67% 0.30% 13.0% 45.9% 1.65% 0.10% 15.2% 44.4% 1.69% 0.03% $ 103,316 81,662 298,664 350,627 77,261 269,755 $ 108,137 70,103 290,482 342,389 63,308 239,628 $ 110,869 63,818 274,386 311,021 59,273 217,408 56 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Financial Performance Global Banking and Markets reported net income attributable to equity holders of $1,571 million in 2016, an increase of $18 million or 1% from last year. Stronger results in the fixed income, corporate lending and commodities businesses, as well as the positive impact of foreign currency translation, were mainly offset by higher provision for credit losses and lower results in equities. Average assets Average assets increased by $9 billion or 3% to $351 billion this year. Adjusting for the positive impact of foreign currency translation, average assets decreased by $4 billion or 1%, due primarily to a decrease of $7 billion in trading assets and $3 billion in securities purchased under resale agreements. This was partly offset by growth of $6 billion in corporate loans and acceptances. Average liabilities Average liabilities increased by $30 billion or 13% to $270 billion this year. Adjusting for the impact of foreign currency translation, the increase was $19 billion or 8%, mainly due to growth of $12 billion in deposits and $6 billion in securities sold under repurchase agreements. Net interest income Net interest income increased by 21% to $1,293 million, mainly due to higher lending volumes and loan origination fees in Canada, U.S. and Europe, and the positive impact of foreign currency translation. The net interest margin was 1.67%, which was two basis points higher than 2015. Non-interest income Non-interest income of $3,139 million increased by $186 million or 6%. Stronger fixed income and commodities trading revenues, higher underwriting and advisory fees and higher banking fees all contributed to the growth. This was partly offset by lower revenues in equities. Non-interest expenses Non-interest expenses increased by $194 million or 11% to $2,040 million in 2016. This was due to higher performance-related and share-based compensation, higher technology, compliance and regulatory costs, volume-driven securities expenses, and the negative impact of foreign currency translation. Operating leverage was negative 0.4%. Provision for credit losses The provision for credit losses was $249 million, up $182 million from last year, due to higher provisions in the U.S., Europe and Asia, primarily in the energy sector. The provision for credit losses ratio was up 20 basis points to 30 basis points. Provision for income taxes The effective tax rate of 26.7% was 0.3% higher than the prior year. Outlook Global Banking and Markets expects business conditions and financial results to continue to moderately improve in 2017, as volatility driven by political (US election, Brexit) and monetary (Fed policy) events influence investor and business confidence. Improved focus client revenues, growth in deposits, improved Corporate Banking results and strong performance from Investment Banking will be partly offset by lower other capital markets’ activities. Expense management is expected to provide benefits in 2017 with expenses down from 2016 from benefits from the recent structural cost initiatives, partly offset by higher technology costs. Provisions for credit losses are expected to moderate to longer term average levels. The U.S. and Canada are expected to drive the bulk of growth in 2017 as Europe suffers from Brexit uncertainty and high regulatory costs, and Asia begins to grow from a lower asset base after recent repositioning. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | G L O B A L B A N K I N G A N D M A R K E T S C19 Total revenue 53% 47% Business Banking Capital Markets C20 Business banking revenue $ millions 2500 2000 1500 1000 500 14 15 16 Metals Lending C21 Capital markets revenue by business line $ millions 2500 2000 1500 1000 500 14 15 16 Global Investment Banking Global Equities Fixed Income & Commodities C22 Composition of average earning assets $ billions 400 350 300 250 200 150 100 50 14 15 16 Other Securities purchased under resale agreement Trading assets Corporate loans and acceptances C23 Trading loss days 14 12 10 8 6 4 2 14 15 16 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 57 MANAGEMENT’S DISCUSSION AND ANALYSIS Other The Other segment includes Group Treasury, smaller operating segments, business line elimination items and other corporate items which are not allocated to a business line. Financial Performance Net interest income, non-interest income, and income taxes in each period include the elimination of tax-exempt income gross-up. This amount is included in the operating segments, which are reported on a taxable equivalent basis. The elimination was $299 million in 2016, compared to $390 million in 2015. Net income from investments in associated corporations and the provision for income taxes in each period include the tax normalization adjustments related to the gross-up of income from associated corporations. This adjustment normalizes the effective tax rate in the divisions to better present the contribution of the associated corporations to the divisional results. The Other segment had a net loss attributable to equity holders of $269 million in 2016. Adjusting for the restructuring charge of $378 million ($278 million after tax; refer T1), net income was $9 million this year. The prior year included a number of largely offsetting items, comprised of a reduction in pension benefit accrual related to modifications made to the Bank’s main pension plan of $204 million pre-tax ($151 million after tax), an increase to the collective allowance for credit losses against performing loans due to the increase in the loan portfolio of $60 million pre-tax ($44 million after tax), and reorganization costs related to Canadian Banking’s shared services operations of $61 million pre-tax ($45 million after tax). Revenues Revenues declined by $46 million mainly due to lower contributions from asset/liability management activities. Partly offsetting were lower taxable equivalent basis offsets and the positive impact of foreign currency translation. Gains on sale of real estate were largely offset by lower net gains on investment securities. Provision for credit losses The increase in collective allowance for credit losses on performing loans was $50 million this year compared to $60 million last year. Non-interest expenses Non-interest expenses increased by $567 million to $653 million. The increase was largely due to the restructuring charge of $378 million and increased costs relating to strategic and technology initiatives. There were also higher employee pension and benefit expenses in 2016 as last year included lower pension expenses from a reduction in pension benefit accrual, partially offset by reorganization costs related to Canadian Banking’s shared service operations in the prior year. T38 Other financial performance ($ millions) Net interest income(1) Non-interest income(1)(2) Total revenue(1) Provision for credit losses Non-interest expenses Income tax expense(1) Net income Net income attributable to equity holders of the bank 2016 2015 2014 $ (384) 273 $ (100) 35 $ (111) 50 653 (545) (65) 60 86 (475) 90 (76) 14 – 232 (320) $ (269) $ 264 $ 102 $ (269) $ 264 $ 102 (1) (2) Includes the net residual in matched maturity transfer pricing and the elimination of the tax-exempt income gross-up reported in net interest income, non-interest income and provision for income taxes in the business segments. Includes net income from investments in associated corporations of $(137) in 2016; (2015 – $(137); 2014 – $(140)). 58 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Financial Performance of Business Lines: 2015 vs. 2014 Canadian Banking Canadian Banking’s net income attributable to equity holders was $3,344 million in 2015, a decrease of $339 million or 9% primarily from changes in the Canadian tax legislation and the gain on sale of the Bank’s investment in CI Financial Corp. in 2014 (refer T15). Retail and small business banking and wealth management generated strong performances. This year’s results were positively impacted by good asset and deposit growth and an eight basis point increase in the margin to 2.23%. Also contributing was the full year impact of the Bank’s investment in Canadian Tire Financial Services. Return on equity was 21.0% versus 22.8% in 2014. International Banking Net income attributable to equity holders was $1,853 million in 2015, an increase of $237 million or 15% resulting from the favourable impact of foreign currency translation, strong asset and fee growth, and acquisitions partly offset by lower securities gains and higher provisions for credit losses. The 2014 results were negatively impacted by the revaluation of monetary assets in Venezuela and the restructuring charge, totaling $74 million (refer T15), which also contributed to the year-over-year increase. Return on equity was 13.0%, up from 11.7% in 2014. Global Banking and Markets Global Banking and Markets reported net income attributable to equity holders of $1,553 million in 2015, a decrease of $117 million from 2014. Lower results in investment banking, Asia lending and precious metals, as well as lower securities gains in U.S. were only partly offset by growth in other businesses. The 2014 results were also impacted primarily by the restructuring charge (refer T15). Return on equity decreased to 13.0% from 15.2% in 2014. Other The Other segment had net income attributable to equity holders of $264 million in 2015, up $162 million from last year. The 2015 net income included the following largely offsetting items, comprised of a reduction in the pension benefit accrual related to modifications made to the Bank’s main pension plan of $204 million pre-tax ($151 million after tax), an increase to the collective allowance against performing loans due to the relative increase in the loan portfolio of $60 million pre-tax ($44 million after tax), and reorganization costs related to the consolidation of Canadian shared services of $61 million pre-tax ($45 million after tax). Included in the 2014 results were additional legal provisions and a restructuring charge (refer T15), totaling $62 million. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | O T H E R 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 59 MANAGEMENT’S DISCUSSION AND ANALYSIS RISK MANAGEMENT Effective risk management is fundamental to the success of the Bank, and is recognized as a core deliverable in the Bank’s overall approach to strategy management. Scotiabank has a strong, disciplined risk management culture where risk management is a responsibility shared by all of the Bank’s employees. Risk Management Framework The primary goals of risk management are to ensure that the outcomes of risk-taking activities are consistent with the Bank’s strategies and risk appetite, and that there is an appropriate balance between risk and reward in order to maximize shareholder value. Scotiabank’s Enterprise- Wide Risk Management Framework (the Framework) articulates the foundation for achieving these goals. This Framework is subject to constant evaluation to ensure that it meets the challenges and requirements of the global markets in which the Bank operates, including regulatory standards and industry best practices. The risk management programs of the Bank’s subsidiaries conform in all material respects to the Bank’s risk management framework, although the actual execution of their programs may be different. Risk Governance Risk Appetite Risk Capacity Risk Appetite Statement Key Risk Appetite Measures Risk Management Tools Policies & Limits Guidelines Processes & Standards Measuring Monitoring & Reporting Stress Testing Risks Credit Market Liquidity Operational Reputational Strategic Insurance Environmental Strong Risk Culture The Bank’s risk management framework is applied on an enterprise- wide basis and consists of five key elements: 1. Risk Governance, 2. Risk Appetite, 3. Risk Management Tools, 4. Risk Identification and Assessment, and 5. Risk Culture. The Types of Risk The Bank ensures that risk-taking activities are consistent with the Bank’s strategies and risk appetite by favouring businesses that generate sustainable, consistent and predictable earnings over the business cycle. In order to mitigate risk, the Bank seeks to avoid excessive risk concentrations through a diversified mix of businesses, products, geographies, currencies and customers. The Framework provides an overview of each principal risk type that can materially impact the Bank and how each principal risk type is managed. Scotiabank’s principal risk types include: Credit, Market, Liquidity, Operational, Reputational, Strategic, Insurance and Environmental. Risk Management Principles Risk-taking and risk management activities across the enterprise are guided by the following principles: Risk and reward – business decisions are consistent with strategies and risk appetite, and there is an appropriate balance between risk and reward in order to maximize shareholder value. Understand the risks – the Bank limits its risk taking activities to those that are well understood, and where there is sufficient expertise, resources and infrastructure to effectively measure and manage the risks – all material risks are identified, measured and managed. Forward thinking – forward thinking and the use of stress testing are utilized to proactively identify emerging risks and potential vulnerabilities. Everyone is a risk manager – within the Bank’s risk governance structure, it is the shared responsibility of every employee to manage risk. Protect our brand – all risk taking activities must be in line with the Bank’s risk appetite, Scotiabank’s Code of Conduct, Values and policy principles which are established to guide risk taking behaviors and protect the Bank’s brand. Compensation – compensation plan design and decisions are aligned with the Bank’s strategy and risk culture and support appropriate risk behaviors. Risk Governance Effective risk management begins with effective risk governance. The Bank has a well-established risk governance structure, with an active and engaged Board of Directors supported by an experienced executive management team. Decision-making is highly centralized through a number of senior and executive risk management committees. The Bank’s risk management framework is predicated on the three-lines-of-defence model. Within this model, the First Line of Defence (typically comprised of the business lines and most corporate functions) incur and own the risks, while the Second Line of Defence (typically comprised of control functions such as Global Risk Management, Compliance, and Finance) provide independent oversight and objective challenge to the First Line of Defence, as well as monitoring and control of risk. Internal Audit Department (the Third Line of Defence) provides enterprise-wide independent assurance over the design and operation of the Bank’s internal control, risk management and governance processes throughout the first and second lines of defence. In this risk governance structure, employees in every area of the organization are responsible for risk management. 60 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T BOARD OF DIRECTORS Board of Directors Committees President and Chief Executive Officer Executive Management Team and Executive & Senior Management Committees THREE LINES OF DEFENCE 1A Risk Owners 1B Risk Owners’ Support 2 Risk Owner’s Oversight 3 Independent Assurance (cid:129) Own the risks generated by their activities, which may be financial (e.g. credit, market) or nonfinancial (e.g. operational, reputational) (cid:129) Design and execute internal controls (cid:129) Ensure the risks generated are identified, assessed, managed and monitored, are within risk appetite, and are in compliance with relevant policies, guidelines and limits (cid:129) Assist Risk Owners in identifying, assessing, monitoring, reporting, and responding to risks (cid:129) Assist Risk Owners in implementing risk management initiatives, and establishing risk governance, internal controls, and reporting frameworks (cid:129) Establish risk appetite, risk limits, policies and frameworks, in accordance with best practice and regulatory requirements (cid:129) Measure, monitor and report on risks taken in relation to limits and risk appetite, and on emerging risks (cid:129) Must be independent of the first line to be able to perform its function in an objective manner (cid:129) Provide reasonable assurance to senior management and the Board that the first and second lines of defence are effectively managing and controlling risks (cid:129) Focus on governance framework and control systems Important Note: All employees are, for some of their activities, Risk Owners (1A), as all employees are capable of generating reputational and operational risks in their day to day activities, and must be held accountable for owning and managing these risks. The Board of Directors: as the top of the Bank’s risk management governance structure, provides oversight, either directly or through its committees, to satisfy itself that decision making is aligned with the Bank’s strategies and risk appetite. The Board receives regular updates on the key risks of the Bank – including a quarterly comprehensive summary of the Bank’s risk profile and performance of the portfolio against defined limits – and approves key risk policies, limits, the Risk Appetite Framework and the Credit Risk Appetite. The Risk Committee of the Board: assists the Board by providing oversight to the risk management function at the Bank. This includes periodically reviewing and approving the Bank’s key risk management policies, frameworks and limits and satisfying itself that management is operating within the Bank’s Risk Appetite Framework. The Committee also oversees the risk management function’s independence from the Business Lines and oversees the effectiveness of the Chief Risk Officer and risk management function. The Audit and Conduct Review Committee of the Board: assists the Board by providing oversight on the effectiveness of the Bank’s system of internal controls. The Committee oversees the integrity of the Bank’s consolidated financial statements and related quarterly results. The Committee oversees the Bank’s compliance with legal and regulatory requirements and oversees the Compliance, Finance, Audit, and Anti-Money Laundering/Anti- Terrorist Financing functions at the Bank. Human Resources Committee of the Board: in conjunction with the Risk Committee of the Board, satisfies itself that adequate procedures are in place to identify, assess and manage the risks associated with the Bank’s material compensation programs and that such procedures are consistent with the Bank’s risk management programs. The Committee has further responsibilities relating to leadership, succession planning and total rewards. Corporate Governance Committee of the Board: acts in an advisory capacity to the Board to enhance the Bank’s corporate governance through a continuing assessment of the Bank’s approach to corporate governance and makes policy recommendations. President and Chief Executive Officer (CEO): reports directly to the Board and is responsible for defining, communicating and implementing the strategic direction, goals and core values for Scotiabank that maximize long term shareholder value. The CEO oversees the establishment of the Bank’s risk appetite, in collaboration with the CRO and CFO, which is consistent with the Bank’s short and long term strategy, business and capital plans, as well as compensation programs. Chief Risk Officer (CRO): is responsible for the overall management of Global Risk Management. The CRO has unfettered access to the Risk Committee of the Board to ensure independence of GRM. As a senior member of the Bank’s executive management team, the CRO participates in strategic decisions related to where and how the Bank will deploy its various resources sources of capital to meet the performance targets of the business lines and the Bank’s Balanced Scorecard. The CRO reports directly to the CEO and the Risk Committee of the Board. Executive Committees: Operating Committee: serves as a forum for the President and Chief Executive Officer (the “CEO”) to discuss key strategic issues and the long-term direction of the Bank with senior executives. Through the Operating Committee, the CEO may solicit views and advice and counsel from senior 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 61 MANAGEMENT’S DISCUSSION AND ANALYSIS executives on issues pertinent to the CEO and the direction of the Bank. Meetings of the Operating Committee also consider “tone from the top” matters, enabling its members to shape, reinforce and role-model the Bank’s desired operating style and organizational culture. The Operating Committee may discuss topics including: setting the Bank’s key strategies and, upon approval by the Board, directing the execution of those strategies and the execution of the Bank’s overall risk strategy; and monitoring and evaluating how risks are managed across the Bank. Asset-Liability Committee (ALCO): is chaired by the CEO and consists of the executive and senior management of the Bank, including members from Group Treasury, Finance, Global Banking & Markets, Canadian Banking, International Banking and GRM. The purpose of the committee is to provide high level oversight and strategic direction for the management of funding, foreign exchange risk, hedging stock based compensation, and economic forecasts. This committee also reviews monthly economic updates and the performance of the key topics discussed. Additionally, the Committee reviews balance sheet management topics, such as: deposits, liquidity, net interest margin, and capital management topics. The committee’s focus is on business line activity (i.e. mortgages and deposits) as well as funding aspects. The committee reviews high level strategies, monitors progress and discusses various trends and key issues. As well, the committee reviews quarterly capital plans, capital allocation and capital risk indicators. Strategic Transaction Investment Committee (STIC): is chaired by the CEO and provides advice, counsel and decisions on effective allocation and prioritization of resources with respect to the Bank’s portfolio of businesses, strategic investments including mergers and acquisitions (M&A), and divestitures. The committee’s objectives include review and approval of the Bank’s business mix guidelines, review of the Bank’s portfolio of businesses and post-acquisition assessments at 12 and 24-36 month benchmarks. Risk Policy Committee (RPC): is chaired by the CEO and includes the CRO and the heads of the business lines, Group Treasury and GRM. It is responsible for policies, limits, proposals, and other issues covering credit, market, reputational, legal and operational risk, as well as adjudicating on issues referred by the senior management committees. The committee’s accountabilities include reviewing and adjudicating on the mandates of its subcommittees. Human Capital Committee (HCC): is chaired by the Group Head & Chief Human Resources Officer and includes the President and CEO, the CRO, and the heads of the business lines, among others. The committee reviews and approves all major new and changing Bank-wide Human Resources objectives, strategies, policies and programs including all compensation matters. As well, the committee reviews and approves all senior management appointments and the staffing of key positions. Systems Planning and Policy Committee (SPPC): is chaired by the CEO and consists of the executive and senior management of the Bank, including Canadian Banking, Global Banking & Markets, International Banking, and GRM. This committee reviews and approves major business initiatives involving human and computing facilities, and reviews and adjudicates on submissions in excess of designated executive approval limits. Senior Management Committees: Stress Testing Committee (STC): is chaired by the Senior Vice President & Chief Market Risk Officer. It consists of senior management from GRM, Executive Offices (E.O.) Audit, E.O. Finance, Group Treasury, Economics, Enterprise Strategy, and the Group Head and Chief Financial Officers (CFO) of the business lines. The purpose of the committee is to provide high level oversight of stress testing; serve as the most senior point of management that establishes and enhances policies to develop, review, challenge and communicate stress testing results; and promote consistent, collaborative application of the stress testing program Bank-wide. Senior Credit Committees (SCCs): consist of three non-retail Senior Credit Committees (Corporate, Commercial, and International) which are chaired by the Executive Vice President & Chief Credit Officer (with the Chief Risk Officer as alternate chair), and two Senior Credit Committees (Canadian Banking and International) for Retail, Small Business and Wealth Management which is chaired by the Chief Risk Officer (with the Executive Vice President & Chief Credit Officer as the alternate chair). The Senior Vice President & Chief Market Risk Officer is also an alternate for Corporate SCC. Other voting members of each committee include the Senior Vice Presidents of the relevant credit units, and the Managing Director and Heads of the relevant business lines. A quorum must include the chair or alternate chair, and a member from the relevant business line. Market Risk Management and Policy Committee (MRMPC): is chaired by the Senior Vice President & Chief Market Risk Officer. It consists of executive and senior management of the Bank including representatives from GRM (Chief Risk Officer and Executive Vice President & Chief Credit Officer), Group Treasury, International Banking and Global Banking & Markets. The MRMPC is responsible for overseeing and establishing standards for market, liquidity and insurance risk management processes within the Bank. For subsidiaries, the MRMPC provides advice and counsel to ensure that their limits are consistent with the overall objectives and strategic direction of the Bank. The MRMPC may delegate in writing the authority to approve specified types of transactions and changes to approved limits to staff in GRM and other departments (Delegated Authorities). Reputational Risk Committee (RRC): is chaired by the Executive Vice President, General Counsel. It consists of senior management from Audit, Finance, GRM, Group Treasury, Global Compliance, Legal and Public Corporate & Government Affairs as well as senior management from Canadian Banking, International Banking and Global Banking & Markets. The mandate of the RRC is to promote conduct consistent with high ethical standards and protect the reputation of the Bank, by recommending reputational risk policies and procedures as may be necessary to the Board; overseeing the implementation of Board-approved reputational risk policies and procedures; approving additions or exceptions to policies and procedures as may be reserved to the RRC; and upon referral to the RRC from the various business line divisions, risk committees or sub-committees, reviewing business activities, initiatives, products, services, transactions or processes which the sponsor believes may embody a degree of reputational risk, and recommending either for or against proceeding or proceeding subject to conditions, based on an assessment of the reputational risk involved. Operational Risk Committee (ORC): is chaired by the Chief Risk Officer. It consists of executive and senior management, including the CFO, and the heads of the business lines and key functional areas. The committee provides high level oversight of operational risk, and promotes an enterprise-wide operational risk framework to ensure risks are understood, communicated, and appropriate actions are taken to mitigate related losses. In particular, the committee reviews the Bank’s top operational risks, including those arising in new products and initiatives and in existing products and programs where the risk profile may be changing due to internal or external factors. Risk Rating Governance Committee (RRGC): provides oversight of the Bank’s Non-retail credit risk rating system, including policies governing the development, validation, approval and ongoing maintenance of the Bank’s Non-retail credit risk rating models and parameter estimates. RRGC also acts as a forum that provides an opportunity for executive/senior management discussion on various aspects of the Non-retail credit risk rating system, 62 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T including potential refinements and enhancements. As part of its mandate, RRGC is responsible for reviewing, updating and approving the Bank’s Non-retail credit risk rating system. RRGC membership includes the Bank’s Chief Risk Officer, the Executive Vice-President and Chief Credit Officer, the Senior Vice-President and Chief Market Risk Officer, as well as other executive/senior management representatives from risk management, banking and internal audit. Business Line and Corporate Functions: as the first line of defence in the Three Lines of Defence model, are accountable for effective management of the risks within their business lines and functions through identifying, assessing, mitigating and monitoring the risks. Business lines and corporate functions actively implement effective internal controls to manage risk and maintain activities within risk appetite and policies. Further, business lines have processes to be able to effectively identify, monitor and report against allocated risk appetite limits. Global Risk Management (GRM): supports the Bank’s objectives and is mandated to maintain an ongoing and effective enterprise-wide risk management framework that resonates through all levels of the Bank. GRM is responsible for providing reasonable assurance to executive management, the Board of Directors and shareholders that risks are actively identified, managed and communicated to all key stakeholders – this is achieved through timely and relevant reporting. GRM’s mission is to ensure that the outcomes of risk taking activities are consistent with the Bank’s strategies and risk appetite, and that there is an appropriate balance between risk and reward in order to maximize shareholder value. Global Compliance: on an enterprise-wide basis, promotes ethical conduct and compliance generally throughout Scotiabank; and supports directors, officers and employees of the Bank and its subsidiaries in managing compliance risk. Compliance is ultimately the responsibility of line management, supported by compliance officers. Together, they comprise the compliance network by which compliance activities are managed throughout Scotiabank. Global Compliance acts as a consultant and educator on regulatory and internal policies and procedures and in this role may establish, or assist with the establishment of, various compliance risk management related programs, sources of written policy, procedures or guidance, training programs or systems as may be necessary or appropriate. Global Finance: leads enterprise-wide financial strategies which support the Bank’s ability to maximize sustainable shareholder value, and actively manages the reliable and timely reporting of financial information to management, the Board of Directors and shareholders, as well as other stakeholders. This reporting includes the Bank’s consolidated financial statements and related quarterly and annual results. Global Finance executes the Bank’s financial and capital management strategies with appropriate governance and control, while ensuring its processes are efficient and effective. Internal Audit: reports independently to the Board through the Audit and Conduct Review Committee on the design and operating effectiveness of the Bank’s risk governance and risk management framework. The mission of the audit department is to provide enterprise-wide independent, objective assurance over the design and operation of the Bank’s controls and operational processes and to provide advisory services designed to improve the Bank’s operations. Risk Appetite Effective risk management requires clear articulation of the Bank’s risk appetite and how the Bank’s risk profile will be managed in relation to that appetite. The Bank’s Risk Appetite Framework consists of the identification of 1) risk capacity, the maximum level of risk the Bank can assume before breaching key constraints, 2) risk appetite, the level and types of risk the Bank is willing to assume within its risk capacity to achieve its strategic objectives, and 3) key risk appetite measures, quantitative metrics that capture the Bank’s risk appetite. Together, the application of these components helps to ensure the Bank stays within appropriate risk boundaries. Scotiabank’s risk appetite is integrated into the strategic and capital planning process and is reviewed annually by senior management who recommend it to the Board for approval. Business lines and control functions develop their own Risk Appetite Frameworks, which are in alignment with the risk appetite and strategies articulated in the Bank’s Risk Appetite Framework. Scotiabank actively communicates the Bank’s risk appetite, and how it relates to Scotiabankers, to further promote a sound risk culture. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T (cid:129) The Bank’s Risk Appetite Framework combines qualitative and quantitative terms of reference to guide the Bank in determining the amount and types of risk it wishes to prudently undertake in pursuing the Bank’s strategic and financial objectives. Risk Appetite Statement Risk Capacity Risk Appetite Key Risk Appetite Measures The Bank’s risk appetite is aligned with its enterprise strategy, where the most notable strategic choice is to have highly diversified, well-balanced and sustainable operations within a clearly defined, global footprint. Key risk appetite measures provide clear risk limits, which are critical in implementing effective risk management. For major risks (credit, market, liquidity, and operational), the key risk appetite measures are supported by management level limit structures and controls. Management’s dedicated attention to these risks creates a focus on forward-looking activities that keeps the Bank within its risk appetite on an on-going basis. Other components of Scotiabank’s key risk appetite measures include measures that: (cid:129) Set risk capacity and appetite in relation to regulatory constraints (cid:129) Use stress testing to provide forward-looking metrics (cid:129) Ensure Scotiabank’s credit rating remains strong (cid:129) Minimize earnings volatility (cid:129) Limit exposure to operational events that can have an impact on earnings, including regulatory fines (cid:129) Ensure reputational risk is top of mind and strategy is being executed within operating parameters 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 63 MANAGEMENT’S DISCUSSION AND ANALYSIS Risk Management Tools Effective risk management includes tools that are guided by the Bank’s Risk Appetite Framework and integrated with the Bank’s strategies and business planning processes. Scotiabank’s risk management framework is supported by a variety of risk management tools that are used together to manage bank-wide risks. Risk management tools are regularly reviewed and updated to ensure consistency with risk-taking activities, and relevance to the business and financial strategies of the Bank. Policies & limits The Bank develops and implements its key risk policies in consultation with the Board. Such policies (which include appetites and frameworks) are also subject to the requirements and guidelines of the Office of the Superintendent of Financial Institutions (OSFI), the Bank Act, and the Canada Deposit Insurance Corporation (CDIC). Policy development and implementation reflect best governance practices which the Bank strives to adhere to at all times. The Bank also provides advice and counsel to its subsidiaries in respect of their risk policies to ensure alignment with the Bank’s policies, subject to the local regulatory requirements of each subsidiary. Policies apply to specific types of risk or to the activities that are used to measure and control risk exposure. They are based on recommendations from risk management, internal audit, business lines, and senior executive management. Industry best practices and regulatory requirements are also factored into the policies. Policies are guided by the Bank’s Risk Appetite, and set the limits and controls within which the Bank and its subsidiaries can operate. Limits control risk-taking activities within the appetite and tolerances established by the Board and executive management. Limits also establish accountability for key tasks in the risk-taking process and establish the level or conditions under which transactions may be approved or executed. Guidelines, processes and standards Guidelines are the directives provided to implement policies as set out above. Generally, they describe the facility types, aggregate facility exposures and conditions under which the Bank is prepared to do business. Guidelines ensure the Bank has the appropriate knowledge of clients, products and markets, and that it fully understands the risks associated with the business it underwrites. Guidelines may change from time to time, due to market or other circumstances. Processes are the activities associated with identifying, evaluating, documenting, reporting and controlling risk. Standards define the breadth and quality of information required to make a decision, and the expectations in terms of quality of analysis and presentation. Processes and standards are documented in a series of policies, manuals and handbooks. Measurement, monitoring, and reporting Risk measurement tools include the use of models. The Bank uses models for a range of purposes including: (cid:129) valuing transactions, (cid:129) measuring risk exposures, (cid:129) determining credit risk ratings and parameters, and (cid:129) calculating economic and regulatory capital. The use of quantitative risk methodologies and models is balanced by a strong governance framework and includes the application of sound and experienced judgment. The development, independent review, and approval of models is subject to formalized policies such as the Model Risk Management Policy and oversight of senior management committees such as the Model Review Committee (for market risk, counterparty credit risk, and liquidity risk models). Key models used in the calculation of credit and market risk regulatory capital on an enterprise basis are OSFI approved. These models are incorporated into the Bank’s framework for governance and control of model risk to ensure that they continue to perform in line with regulatory requirements. The Bank continuously monitors its risk exposures to ensure business activities are operating within approved limits or guidelines, and the Bank’s strategies and risk appetite. Breaches, if any, of these limits or guidelines are reported to senior management and/or the Board depending on the limit or guideline. Risk Reports aggregate measures of risk across products and businesses, and are used to ensure compliance with risk policies, limits, and guidelines. They also provide a clear statement of the amounts, types, and sensitivities of the various risks in the portfolio. Senior management and the Board use this information to understand the Bank’s risk profile and the performance of the portfolios. A comprehensive summary of the Bank’s risk profile and performance of the portfolio is presented quarterly to the Risk Committee of the Board. Stress testing Stress testing programs at both the enterprise-wide level and individual risk level allow the Bank to estimate the potential impact on the Bank’s income and capital as a result of significant changes in market conditions, credit environment, liquidity demands, or other risk factors. Enterprise-wide stress testing is also integrated with both the strategic and financial planning processes, as well as crisis management planning. The development, approval and on-going review of the Bank’s stress testing programs are subject to policy, and the oversight of the Stress Testing Committee. Where appropriate, the Board of Directors or the Risk Committee of the Board approves stress testing limits for certain risk factors, and receives reports on performance regularly. Each stress testing program is developed with input from a broad base of stakeholders, and results are integrated into management decision-making processes for capital, funding, market risk limits, and credit risk appetite. The stress testing programs are designed to capture a number of enterprise-wide stress scenarios with differing severities and time horizons. 64 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Risk Culture Effective risk management requires a strong, robust, and pervasive risk management culture where every Bank employee is a risk manager and is responsible for managing risks. The Bank’s risk governance structure, risk appetite, and risk management tools influence – and are in turn influenced by – the Bank’s risk culture. This symbiotic inter-relationship ensures a strong alignment exists between strategy, risk culture, and the key components of the Bank’s risk management framework. The following are the foundational support on which the Bank’s risk culture is built upon: (cid:129) Tone from the top – Clear and consistent communication from leaders on risk behavior expectations and the importance of Scotiabank’s values. (cid:129) Accountability – All Scotiabankers in every business function are held accountable for risk ownership and their actions in accordance with the Three Lines of Defence model. (cid:129) Incentives – Motivate and reward key risk takers for identifying, managing and promoting a sound risk culture within their environment. (cid:129) Effective challenge – Effective challenge, alternative views and open dialogue are promoted when identifying risks – Scotiabankers are encouraged and expected to “Raise a hand”. Other elements of Scotiabank’s strong risk culture: (cid:129) Compensation: programs are structured to discourage behaviours that are not aligned with the Bank’s values or Scotiabank’s Code of Conduct, and ensure that such behaviors will not be rewarded. Higher risk behaviors are also discouraged and there are reduced opportunities for significant one-time rewards. The Bank’s material compensation programs are structured to reflect the Bank’s risk appetite, with a substantial portion deferred for material risk takers in order to achieve stronger alignment with the results of risk-taking activities. (cid:129) Risk appetite: the Bank uses a variety of communication channels to build and sustain employee awareness of the qualitative and quantitative constraints (i.e. the “boundaries”) that apply to each and every employee’s activities. (cid:129) Reporting: reputational & operational risk dashboards and other key metrics are monitored and reported. The Bank also seeks out employee feedback through a variety of surveys. (cid:129) Training: risk education programs are available to employees in the business lines and control functions. Scotiabank continually reinforces risk culture by providing effective and informative mandatory and non-mandatory training modules for all employees, as well as presentations, videos, and other training media on a variety of risk management topics. (cid:129) Decision-making on risk issues is highly centralized: The membership of senior and executive management committees responsible for the review, approval and monitoring of transactions and the related risk exposures (whether global or local) includes business line heads and senior risk officers from GRM. The flow of information and transactions to these committees keeps senior and executive management well informed of the risks the Bank faces, and ensures that transactions and risks are aligned with the Bank’s risk appetite. Risk culture is a component of the Bank’s organizational culture. Key elements that support the Bank’s organizational culture are as follows: (cid:129) Scotiabank’s Code of Conduct: stringent guidelines to which all staff must attest on an annual basis (cid:129) Values: Integrity – Act With Honour; Respect – Value Every Voice; Accountability – Make It Happen; Passion – Be Your Best (cid:129) Organizational fit: cultural behaviours are considered in hiring and promotional processes. Assessment of organizational fit is increasingly considered when evaluating new business opportunities and hiring practices M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 65 MANAGEMENT’S DISCUSSION AND ANALYSIS Principal Risk Types Risk Type Credit Risk Governing Documentation Application to Risk Appetite Credit Risk Policy Credit Risk Appetite Industry Concentration Framework Collective Allowance Policy for Performing Loans Residential Mortgage Underwriting Policy Quantitative limits: (cid:129) Exposure to a single counterparty or group of related parties (limits differentiated by counterparty type, customer risk rating and security cover); (cid:129) Country risk (exposure limits to control transfer/cross-border and sovereign default risks); and (cid:129) Industry concentrations (exposure and risk adjusted concentration limits). Market Risk Market and Structural Risk Management Policy Quantitative limits, such as various value at risk (VaR), stress test results, equity and debt investment exposures, and structural interest rate and foreign exchange exposures. Liquidity Risk Liquidity Risk and Collateral Management Policy Quantitative limits: (cid:129) Minimum Liquidity Coverage Ratio (LCR); (cid:129) Appropriate levels of unencumbered high quality liquid assets that can be readily sold or pledged; (cid:129) Limits to control the maximum net cash outflow over specified short-term horizon; and (cid:129) Diversification of funding by source, type of depositor, instrument, term and geographic market. (cid:129) Systematic identification, measurement, mitigation and monitoring of operational risk, regardless of whether the risk is internal to the Bank or outsourced to a third party; (cid:129) Minimization of residual operational risk; and (cid:129) Expressed quantitatively by an aggregate loss event limit, a single event loss limit, and a variety of limits for individual categories of operational risk. Low appetite for reputational, legal, or taxation risk arising in business activities, initiatives, products, services, transactions or processes, or from a lack of suitability of products for clients. Consistent with the Equator Principles, to which the Bank is a signatory, the Bank provides project finance loans and project-related corporate loans only to those projects whose borrowers can demonstrate their ability and willingness to comply with comprehensive processes aimed at ensuring that the projects are developed in a socially responsible manner and according to sound environmental management practices. Strategy report considers linkages between the Bank’s Risk Appetite Framework with the enterprise strategy, business line strategies and corporate function strategies; also incorporates linkages to measuring progress against strategic priorities and implementation. The Bank will limit its insurance risk-taking activities to those that are well understood and where there is sufficient expertise, resources and infrastructure to effectively measure and manage the risks and to earn commensurate returns. Where insurance risks are taken, it is on a selective basis to achieve stable and sustainable earnings; and the risk assumed is diversified geographically and by product. Operational Risk Operational Risk Management Policy and Framework Internal Control Policy Fiduciary Risk Management Policy Model Risk Management Policy New Products and Services Risk Management Policy Global Fraud Policy Third Party Risk Management Policy Reputational Risk Reputational Risk Policy Scotiabank’s Code of Conduct Compliance Policy KYC Policy Environmental Risk Environmental Policy Strategic Risk Annual Strategy Report to the Board of Directors Insurance Risk Insurance Risk Policy Insurance Risk Management Framework 66 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T T39 Exposure to risks arising from the activities of the Bank’s businesses The Bank Business Lines Canadian Banking International Banking Global Banking and Markets Other Business activities Balance Sheet Attributed Capital(2) (cid:129) Deposits (cid:129) Accounts services (cid:129) Credit and lending (cid:129) Commercial banking (cid:129) Payments and cash management (cid:129) Advisory services (cid:129) Asset management (cid:129) Insurance – creditor, life, home, health, auto, and travel (cid:129) Online brokerage (cid:129) Deposits (cid:129) Accounts services (cid:129) Credit and lending (cid:129) Commercial banking (cid:129) Payments and cash management (cid:129) Advisory services (cid:129) Asset management (cid:129) Insurance – creditor, life, home, health, auto, and travel (cid:129) Deposits (cid:129) Account services (cid:129) Corporate lending (cid:129) Equity and debt underwriting (cid:129) M&A advisory services (cid:129) Capital markets products & services (cid:129) Foreign exchange (cid:129) Precious metals (cid:129) Payment and cash management (cid:129) Group Treasury (cid:129) Other control functions (cid:129) Average assets $309bn (cid:129) Average assets $143bn (cid:129) Average assets $351bn (cid:129) Average assets(1) $111bn (cid:129) Attributed Capital $16.8bn (cid:129) Proportion of Bank 36% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk (cid:129) Other 46% –% 9% 45% Risk- Weighted Assets(3) (cid:129) RWA $109.0bn (cid:129) Proportion of Bank 30% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk 84% –% 16% (cid:129) Attributed Capital $15.9bn (cid:129) Proportion of Bank 34% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk (cid:129) Other 56% 1% 7% 36% (cid:129) RWA $131.9bn (cid:129) Proportion of Bank 36% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk 87% 2% 11% (cid:129) Attributed Capital $12.2bn (cid:129) Proportion of Bank 26% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk (cid:129) Other 73% 7% 5% 15% (cid:129) RWA (cid:129) Proportion of Bank $113.4bn 31% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk 87% 6% 7% (cid:129) Attributed Capital $2.1bn (cid:129) Proportion of Bank 4% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk (cid:129) Other 52% 2% -2% 48% (cid:129) RWA (cid:129) Proportion of Bank $9.7bn 3% Comprised of: (cid:129) Credit risk (cid:129) Market risk (cid:129) Operational risk 94% 6% –% Credit, market, liquidity, operational, reputational, environmental, strategic and insurance risk. (1) Average assets for the Other segment include certain non-earning assets related to the business lines. (2) Attributed Capital is a combination of regulatory: (i) Risk-based capital and (ii) Leverage capital. Attributed Capital is reported on an average basis. (3) Risk-weighted assets (RWA) are as at October 31, 2016 as measured for regulatory purposes in accordance with the Basel III all-in approach. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 67 MANAGEMENT’S DISCUSSION AND ANALYSIS Top and emerging risks The Bank is exposed to a variety of top and emerging risks. These risks can potentially adversely affect the Bank’s business, financial performance, reputation and business strategies. As part of our risk management approach, we proactively identify, assess, review, monitor and manage a broad range of top and emerging risks so that appropriate risk mitigation strategies can be taken. Every quarter, a listing and a brief discussion of selected top and emerging risks is presented to Senior Management and the Board of Directors. The Bank’s top and emerging risks are as follows: Geopolitical risk Geopolitical risks could affect volatility in foreign exchange and capital markets globally. This affects all participants in these markets. In the short run, a market shock could potentially impact the Bank’s trading and non-trading market activities and revenues. Over a longer period of time, the more broadly based macroeconomic effects could potentially impact the Bank’s exposures to customers and market segments impacted by those shocks. Although it is difficult to predict where new geopolitical disruption will occur, the Bank’s stress testing program assists in evaluating the potential impact of severe conditions, whether caused by geopolitical or other circumstances. Management’s strong understanding of the local political landscapes and macroeconomic environments in which the Bank operates, combined with the Bank’s business model and diversified geographic footprint, serve as ongoing mitigants to this risk. Legal and regulatory compliance risk The Bank is subject to extensive regulation in the jurisdictions in which it operates. Although the Bank continually monitors and evaluates the potential impact of regulatory developments to assess the impact on our businesses and to implement any necessary changes, regulators and private parties may challenge our compliance. Failure to comply with legal and regulatory requirements may result in fines, penalties, litigation, regulatory sanctions, enforcement actions and limitations or prohibitions from engaging in business activities, all of which may negatively impact the Bank’s financial performance and its reputation. In addition, day-to-day compliance with existing laws and regulations, has involved and will continue to involve significant resources, including requiring the Bank to take actions or incur greater costs than anticipated, which may negatively impact the Bank’s financial performance. Such changes could also adversely impact the Bank’s business strategies or limit its product or service offerings, or enhance the ability of the Bank’s competitors to offer their own products and services that rival the Bank’s. Anti-money laundering Money laundering and terrorist financing are receiving significant attention as nations attempt to deal with the harmful legal, economic, and social consequences of illegal activities. Governments, law enforcement agencies, and regulators around the world employ a variety of means, including establishing regulatory requirements on financial institutions, to curtail the ability of criminal and terrorist elements to profit from, or finance, their activities. It is widely recognized that financial institutions are uniquely positioned and possess the necessary infrastructure to assist in the fight against money laundering, terrorist financing, and criminal activity through prevention, detection, and the exchange of information. Money laundering, terrorist financing and economic sanctions violations represent regulatory, legal, financial and reputational risk to the Bank. Scotiabank is subject to a number of expanding and constantly evolving anti-money laundering/anti-terrorist financing (AML/ATF) and economic sanctions laws and regulations internationally given the Bank’s global footprint. The Bank is committed to sustaining secure financial systems in the countries around the world in which it maintains operations by taking the necessary action, using a risk-based approach. The Bank’s AML program includes policies and internal controls with respect to client identification and due diligence, transaction monitoring, investigating and reporting of suspicious activity, and evaluation of new products and services to prevent and/or detect activities that may pose AML risk to the Bank. The AML program also facilitates an annual enterprise-wide AML/ATF risk assessment process and ensures that all employees, including the Board of Directors, undergo initial and ongoing AML/ATF training. Technology and Information Security Risk Technology and information security risks have become increasingly prevalent in business in general and for financial institutions in particular. Globally these risks have increased as a result of the sophistication and constant evolution of new technologies and attack methodologies. The Bank’s technologies, systems and networks, and those of our customers and the third parties providing services to us, may be subject to attacks, breaches or other compromises. With any such attack, breach, compromise, or weakness of technology or information systems, hardware or related processes, the Bank may experience, among other things: financial loss; a loss of customers or business opportunities; disruption to operations; misappropriation or unauthorized release of confidential, financial or personal information; damage to computers or systems of the Bank and those of its customers and counterparties; violations of applicable privacy and other laws; litigation; regulatory penalties or intervention, remediation, investigation or restoration cost; increased costs to maintain and update our operational and security systems and infrastructure; and reputational damage. The Bank actively monitors and manages these technology and information security risks. Through enterprise-wide programs, industry best practices, and robust threat and vulnerability assessments and responses, the Bank dynamically adapts its information technology operations, protocols, and governance standards against these proliferating risks and their potential impacts. Technology disruption Technology continues to impact the banking industry and its customers. Non-traditional new participants are entering certain segments of the financial industry which, in some cases, reduced regulatory requirements or other oversight. New entrants may use new technologies, advanced data and analytical tools, lower cost to market and/or faster processes to challenge traditional financial institutions. The scope and breadth of technology disruption is difficult to anticipate and has the potential to impact revenues and costs in certain of the Bank’s businesses. To mitigate this risk, the Bank continues to adapt and employs a number of strategies to ensure its continuing competitiveness against disruptive technologies, including using data and analytical tools to understand and respond swiftly to customer needs, and investing in technology and innovation. The Bank also considers the use of partnerships to appropriately meet the pace of innovation in financial services products and delivery channels. Failure to properly implement and deploy key technological innovations could adversely affect the Bank’s operating results or financial position. 68 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Low commodity prices / energy exposure Oil prices have continued their weakness well into 2016. The protracted low oil price has challenged many businesses, and with forecasts calling for modest price increases into 2017, continued stress can be expected on vulnerable companies in this sector. Weak performance in the energy sector is also having a negative impact on Canadian tax revenues and has contributed to softness in Alberta’s housing market. The Bank has taken a number of actions to prudently manage loan exposures in this sector and in related consumer loan segments, and according to the Bank’s stress test scenarios, losses are expected to be manageable. Canadian consumer indebtedness Canadian household indebtedness continues to outpace growth in disposable income fueled by persistently low interest rates and stable national employment levels. In such an environment, higher consumer indebtedness contributed to an upward trend in mortgage credit growth and strong home sales. In light of these trends, multiple levels of government implemented new legislation to introduce additional safeguards to the housing market. These include the foreign buyer tax in British Columbia and changes on a national basis to tighten origination criteria for insured mortgages. While interest rates are expected to remain at relatively low in the mid to long term, the risks of an external shock, such as higher unemployment rates, could impact Canadians’ ability to repay their loans and consequently drive a correction in the housing market. We actively manage our lending portfolios and stress test them against various scenarios. For further discussion relating to our retail portfolio, refer to the Credit Risk Summary section. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 69 MANAGEMENT’S DISCUSSION AND ANALYSIS Credit Risk Credit risk is the risk of loss resulting from the failure of a borrower or counterparty to honour its financial or contractual obligations to the Bank. Credit risk arises in the Bank’s direct lending operations, and in its funding, investment and trading activities where counterparties have repayment or other obligations to the Bank. Credit risk includes settlement risk, suitability risk and wrong way risk. Index of all credit risk disclosures Credit risk summary Credit Risk Management Framework Risk measures Corporate and commercial Risk ratings Adjudication Credit Risk Mitigation-Collateral/Security Traditional Non-Retail Products Commercial/Corporate Real Estate Traded products Credit Risk Mitigation-Collateral/Security Retail Adjudication Risk ratings Credit Risk Mitigation-Collateral/Security Credit Quality Allowance for credit losses Impaired loans Acquisition-related purchased loans Portfolio review Risk diversification Risk mitigation Overview of loan portfolio Energy Real estate secured lending Loans to Canadian condominium developers European exposures Financial instruments 70 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Page Tables and charts Page 71 71 71 71 72 72 72 72 73 73 73 73 73 73 74 74 74 75 75 75 75 75 75 76 77 77 45 T3 Financial highlights T11 Provision for credit losses as a percentage of average loans and acceptances T12 Net charge-offs as a percentage of average loans and acceptances T65 Gross impaired loans by geographic segment T66 Provision against impaired loans by geographic segment T67 Cross-border exposure to select countries T68 Loans and acceptances by type of borrower T69 Off balance-sheet credit instruments T70 Changes in net impaired loans T71 Provision for credit losses T72 Provision for credit losses against impaired loans by type of borrower T73 Impaired loans by type of borrower T74 Total credit risk exposures by geography T75 AIRB credit risk exposures by maturity T76 Total credit risk exposures and risk-weighted assets Analysis of the aggregate credit risk exposure including market risk exposure, assets of the Bank’s insurance subsidiaries and other assets that fully reconciles to the balance sheet (refer Note 35 – Financial instruments – risk management in the consolidated financial statements) C24 Well diversified in Canada and internationally – loans and acceptances C25 and in household and business lending – loans and acceptances T64 Loans and acceptances by geography T44 European exposure T45 Funded exposures T46 Bank’s exposure distribution by country T47 Indirect exposures T32 Mortgage-backed securities T33 Collateralized debt obligations (CDOs) 14 22 22 110 110 111 112 112 113 113 114 114 115 115 116 202 76 76 110 77 78 78 79 46 46 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T Credit risk summary (cid:129) Loans and acceptances (Retail and Non-Retail) remained diversified by region, industry and customer. Regional exposure is spread across our key markets (Canada 66.1%, United States 7.7%, Mexico 4.2% and Other 22%). Financial Services, constitutes 3.9% of overall gross exposures (before consideration of collateral) and was $20 billion, a decrease of $1 billion from October 31, 2015. These exposures are predominately to highly rated counterparties and are generally collateralized. (cid:129) The Bank’s overall loan book as of October 31, 2016 increased to $497 billion versus $473 billion as of October 31, 2015, with growth reflected in Personal, and Business and Government lending. Residential mortgages were $223 billion as of October 31, 2016, with 87% in Canada. The corporate loan book, which accounts for 35% of the total loan book, is composed of 53% of loans with an investment grade rating as of October 31, 2016, down from 55% as of October 31, 2015. The effective management of credit risk requires the establishment of an appropriate credit risk culture. Key credit risk policies and appetite statements are important elements used to create this culture. The Board of Directors, either directly or through the Risk Committee (the Board), reviews and approves the Bank’s Credit Risk Appetite annually and Credit Risk Policy biennially. (cid:129) The objectives of the Credit Risk Appetite are to ensure that: – target markets and product offerings are well defined at both the enterprise-wide and business line levels; – the risk parameters for new underwritings and for the portfolios as a whole are clearly specified; and – transactions, including origination, syndication, loan sales and hedging, are managed in a manner that is consistent with the Bank’s risk appetite. (cid:129) The Credit Risk Policy articulates the credit risk management framework, including: – key credit risk management principles; – delegation of authority; – the credit risk management program; – counterparty credit risk management for trading and investment activities; and – aggregate limits, beyond which credit applications must be escalated to the Board for approval. Global Risk Management develops the credit risk management framework and policies that detail, among other things, the credit risk rating systems and associated parameter estimates; the delegation of authority for granting credit; the calculation of the allowance for credit losses; and the authorization of write-offs. Corporate and commercial credit exposures are segmented by country and by major industry group. Aggregate credit risk limits for each of these segments are also reviewed and approved annually by the Board. Portfolio management objectives and risk diversification are key factors in setting these limits. Consistent with the Board-approved limits, borrower limits are set within the context of established lending criteria and guidelines for individual borrowers, particular industries, countries and certain types of lending, to ensure the Bank does not have excessive concentration in any single borrower, or related group of borrowers, particular industry sector or geographic region. Through the portfolio management process, loans may be syndicated to reduce overall exposure to a single name. For certain segments of the portfolio, credit derivative contracts are also used to mitigate the risk of loss due to borrower default. Risk is also mitigated through the selective sale of loans. Banking units and Global Risk Management regularly review the various segments of the credit portfolio on an enterprise-wide basis to assess the impact of economic trends or specific events on the performance of the portfolio, and to determine whether corrective action is required. These reviews include the examination of the risk factors for particular products, industries and countries. The results of these reviews are reported to the Risk Policy Committee and, when significant, to the Board. Risk measures The credit risk rating systems support the determination of key credit risk parameter estimates which measure credit and transaction risk. These risk parameters – probability of default, loss given default and exposure at default are transparent and may be replicated in order to provide consistency of credit adjudication, as well as minimum lending standards for each of the risk rating categories. The parameters are an integral part of enterprise-wide policies and procedures encompassing governance, risk management, and control structure, and are used in various internal and regulatory credit risk quantification calculations. The Bank’s credit risk rating system is subject to a rigorous validation, governance and oversight framework. The objectives of this framework are to ensure that: (cid:129) Credit risk rating methodologies and parameters are appropriately designed and developed, independently validated, and regularly reviewed; and (cid:129) The review and validation processes represent an effective challenge to the design and development process. Non-retail credit risk rating methodologies and parameters are reviewed and validated at least annually. Units within Global Risk Management are responsible for design and development, validation and review, and are functionally independent from the business units responsible for originating transactions. Within Global Risk Management, they are also independent from the units involved in risk rating approval and credit adjudication. Internal credit risk ratings and associated risk parameters affect loan pricing, computation of the collective allowance for credit losses, and return on equity. Corporate and commercial Corporate and commercial credit exposure arises in Canadian Banking, International Banking and Global Banking and Markets business lines. Risk ratings The Bank’s risk rating system utilizes internal grade (IG) codes – an 18 point scale used to differentiate the risk of default of borrowers and the risk of loss on facilities. The general relationship between the Bank’s internal borrower IG codes and external agency ratings is shown in T24. IG codes are also used to define credit adjudication authority levels appropriate to the size and risk of each credit application. Lower-rated credits require increasingly more senior management involvement depending upon the aggregate exposure. Where the decision is beyond their authority 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 71 MANAGEMENT’S DISCUSSION AND ANALYSIS levels, credit units will refer the request – with its recommendation – to a senior credit committee for adjudication. Senior credit committees also have defined authority levels and, accordingly, forward certain requests to the Risk Policy Committee. In certain cases, these must be referred to the Risk Committee of the Board of Directors. Adjudication Credit adjudication units within Global Risk Management analyze and evaluate all significant credit requests for corporate and commercial credit exposures, to ensure that risks are adequately assessed, properly approved, continually monitored and actively managed. The decision-making process begins with an assessment of the credit risk of the individual borrower or counterparty. Key factors considered in the assessment include: (cid:129) The borrower’s management; (cid:129) The borrower’s current and projected financial results and credit statistics; (cid:129) The industry in which the borrower operates; (cid:129) Economic trends; and (cid:129) Geopolitical risk. Based on this assessment, a risk rating is assigned to the individual borrower or counterparty, using the Bank’s risk rating systems. A separate risk rating is also assigned at the facility level, taking into consideration additional factors, such as security, seniority of claim, structure, term and any other forms of credit risk mitigation that affect the amount of potential loss in the event of a default of the facility. Security typically takes the form of charges over inventory, receivables, real estate, and operating assets when lending to corporate and commercial borrowers; and cash or treasuries for trading lines such as securities lending, repurchase transactions, and derivatives. The types of acceptable collateral, and related valuation processes are documented in risk management policies and manuals. Other forms of credit risk mitigation include third party guarantees and, in the case of derivatives facilities, master netting agreements. Internal borrower and facility risk ratings are assigned when a facility is first authorized, and are promptly re-evaluated and adjusted, if necessary, as a result of changes to the customer’s financial condition or business prospects. Re-evaluation is an ongoing process, and is done in the context of general economic changes, specific industry prospects, and event risks, such as revised financial projections, interim financial results and extraordinary announcements. The internal credit risk ratings are also considered as part of the Bank’s adjudication limits, as guidelines for hold levels are tied to different risk ratings. Single borrower limits are much lower for higher risk borrowers than low risk borrowers. The credit adjudication process also uses a risk-adjusted return on equity profitability model to ensure that the client and transaction structure offers an appropriate return for a given level of risk. For the corporate portfolio, and the large borrowers in International, the Loan Portfolio Management Group reviews the profitability model results, together with external benchmarks, and provides an opinion on the relative return and pricing of each transaction above a minimum threshold. Individual credit exposures are regularly monitored by both the business line units and Global Risk Management for any signs of deterioration. In addition, a review and risk analysis of each borrower is conducted annually, or more frequently for higher-risk borrowers. If, in the judgement of management, an account requires the expertise of specialists in workouts and restructurings, it will be transferred to a special accounts group for monitoring and resolution. Credit Risk Mitigation – Collateral/Security Traditional Non-Retail Products (e.g. Operating lines of Credit, Term Loans) Collateral values are accurately identified at the outset and throughout the tenure of a transaction by using standard evaluation methodologies. Collateral valuation estimates are conducted at a frequency that is appropriate to the frequency by which the market value fluctuates, using the collateral type and the Borrower risk profile. In addition, when it is not cost effective to monitor highly volatile collateral (e.g. accounts receivable, inventory), appropriate lending margins are applied to compensate (e.g. accounts receivable are capped at 80% of value, inventory at 50%). The frequency of collateral valuations is also increased when early warning signals of a Borrower’s deteriorating financial condition are identified. Borrowers are required to confirm adherence to covenants including confirmation of collateral values on a periodic basis, which are used by the Bank to provide early warning signals of collateral value deterioration. Periodic inspections of physical collateral are performed where appropriate and where reasonable means of doing so are available. Bank procedures require verification including certification by Banking officers during initial, annual, and periodic reviews, that collateral values/ margins/etc. have been assessed and, where necessary, steps have been taken to mitigate any decreased collateral values. The Bank does not use automated valuation models (AVMs) for valuation purposes. Global Risk Management (GRM) performs its own valuations of companies based on various factors such as book value, discounted book value, enterprise value etc. Commercial/Corporate Real Estate New or updated appraisals are generally obtained at inception of a new facility, as well as during Loan Modifications, Loan Workouts and Troubled Debt Restructure. The primary reason for requiring a new appraisal is if, in the reasonable opinion of the Banking Execution Unit, or GRM Real Estate, there has been a material change in value. Additionally, none of the appraisal guidelines contained within the policies should dissuade the Bank from requesting an appraisal more frequently if an adverse change in market conditions, sponsorship, credit worthiness, of other underwriting assumptions is realized or expected. Appraisals must be in writing and must contain sufficient information and analysis to support the Bank’s decision to make the loan. Moreover, in rendering an opinion of the property’s market value, third party appraisers are responsible for establishing the scope of work necessary to develop credible assignment results. The appraisal must meet the regulatory and industry requirements which, depending on the type of property being appraised, contain any or all of the following three approaches to value: comparable sales approach replacement cost approach i. ii. iii. income approach The appraiser should disclose the rationale for the omission of any valuation approach. Furthermore, the appraiser must disclose whether the subject property was physically inspected and whether anyone provided significant assistance to the person signing the appraisal report. The report should contain a presentation and explanation of the assumptions used in determining value under each of the above mentioned approaches. 72 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Review of every appraisal is conducted by the banking units and GRM Real Estate to confirm that the appraisal identifies all of the relevant issues for the specific asset class, location and economic environment and incorporates all appropriate valuation methodologies and assumptions. In most cases, the banking units also include comparable properties in addition to what is included in the appraisal to further justify value. When third party assessors are used, they must be accredited and satisfactory to the Bank. In addition, GRM validates any third party valuations via internal desktop estimates either based on comparables or discounted income valuations. Traded products Traded products are transactions such as derivatives, foreign exchange, commodities, repurchase/reverse repurchase agreements, and securities lending/borrowing. Credit risks arising from traded products cannot be determined with certainty at the outset, because during the tenure of a transaction the dollar value of the counterparty’s obligation to the Bank will be affected by changes in the capital markets (such as changes in stock prices, interest rates, and exchange rates). The Bank adjudicates credit exposures arising from transacting in traded products by considering their current fair value plus an additional component to reflect potential future changes in their mark-to-market value. The credit adjudication process also includes an evaluation of potential wrong way risk, which arises when the exposure to a counterparty is positively correlated to the probability of default of that counterparty. Credit risk associated with traded products is managed within the same credit adjudication process as the lending business. The Bank considers the credit risk arising from lending activities, as well as the potential credit risk arising from transacting in traded products with that counterparty. Credit risk mitigation – collateral/security Derivatives are generally transacted under industry standard International Swaps and Derivatives Association (ISDA) master netting agreements, which allow for a single net settlement of all transactions covered by that agreement in the event of a default or early termination of the transactions. ISDA agreements are frequently accompanied by an ISDA Credit Support Annex (CSA), the terms of which may vary according to each party’s view of the other party’s creditworthiness. CSAs can require one party to post initial margin at the onset of each transaction. CSAs also allow for variation margin to be called if total uncollateralized mark-to-market exposure exceeds an agreed upon threshold. Such variation margin provisions can be one-way (only one party will ever post collateral) or bilateral (either party may post depending upon which party is in-the-money). The CSA will also detail the types of collateral that are acceptable to each party, and the haircuts that will be applied against each collateral type. The terms of the ISDA master netting agreements and CSAs are taken into consideration in the calculation of counterparty credit risk exposure. For derivative transactions, investment grade counterparties account for approximately 86% of the credit risk. Approximately 30% of the Bank’s derivative counterparty exposures are to bank counterparties. After taking into consideration, where applicable, netting and collateral arrangements, no net credit risk amount arising from traded products transactions with any single counterparty was considered material to the financial position of the Bank as at October 31, 2016. No individual exposure to an investment grade bilateral counterparty exceeded $1,002 million and no individual exposure to a corporate counterparty exceeded $293 million. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T Retail Retail credit exposures arise in the Canadian Banking and International Banking business lines. Adjudication The decision-making process for retail loans ensures that credit risks are adequately assessed, properly approved, continually monitored and actively managed. Generally, credit decisions on consumer loans are processed by proprietary adjudication software and are based on risk ratings, which are generated using predictive credit scoring models. The Bank’s credit adjudication and portfolio management methodologies are designed to ensure consistent underwriting and early identification of problem loans. The Bank’s rigorous credit underwriting methodology and retail risk modeling is more customer focused than product focused. The Bank’s view is that a customer-centric approach provides better risk assessment than product-based approaches, and should result in lower loan losses over time. All credit scoring and policy changes are initiated by units within Global Risk Management that are functionally independent from the business units responsible for retail portfolios. Risk models and parameters are also subject to independent validation and review from the units involved in the design and development of models. The review process includes referral to the appropriate Senior Credit Committee for approval, where required. Consumer credit portfolios are reviewed monthly to identify emerging trends in loan quality and to assess whether corrective action is required. Risk ratings The Bank’s consumer risk rating systems are oriented to borrower or transaction risk. Each retail exposure is assigned a risk grade based on the customer’s credit history and/or internal credit score. The Bank’s automated risk rating systems assess the ongoing credit-worthiness of individual customers on a monthly basis. This process provides for meaningful and timely identification and management of problem loans. The overall risk ratings system under AIRB approach is subject to regular review with ongoing performance monitoring of key components. Risk model validations are conducted independently from the areas responsible for rating system development and implementation, to ensure effective independence. Customer behavior characteristics which are used as inputs within the Bank’s Basel III AIRB models are consistent with those used by the Bank’s Canadian consumer risk rating systems. The International portfolios are subject to the Standardized approach at this time. Credit risk mitigation – collateral/security The property values for residential real estate secured exposures are confirmed at origination through a variety of validation methodologies, including AVM and full appraisal’s (in-person inspection). The appraisal is completed by a third party, Bank approved appraiser. For monitoring of material portfolios, property values are indexed quarterly to house prices. For loan impairment within the material portfolios, residential property values are re- confirmed using third party AVM’s. Where AVM values are used, these AVM values are subject to routine validation through a continuous random sampling process that back-tests AVM values against available property appraisals (primarily third party AVMs). Where third party appraisals are obtained, the Bank relies on the professional industry accreditation of the appraiser. Samples of approved appraisal reports are reviewed by the Bank’s senior appraisers to ensure consistent appraisal quality and satisfactory appraisal values. The third party appraisers are selected from a pre-approved list of Bank-vetted appraisers. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 73 MANAGEMENT’S DISCUSSION AND ANALYSIS Credit quality T40 Impaired loans by business line(1) As at October 31 ($ millions) Canadian Banking Retail Commercial International Banking Caribbean and Central America Latin America Mexico Peru Chile Colombia Other Latin America Total Latin America Global Banking and Markets Canada U.S. Asia and Europe Totals 2016 Gross impaired loans Allowance for credit losses Net impaired loans Gross impaired loans 2015 Allowance for credit losses Net impaired loans $ 1,003 228 $ 1,231 $ 1,540 301 764 499 381 143 $ $ $ (656) (160) (816) (648) (215) (501) (237) (239) (136) 2,088 (1,328) $ $ $ 347 68 415 $ 843 208 $ 1,051 892 $ 1,588 $ $ $ 86 263 262 142 7 760 271 603 405 356 117 (543) (157) (700) (647) (186) (422) (175) (235) (117) $ $ $ 300 51 351 941 85 181 230 121 – 617 1,752 (1,135) $ 3,628 $ (1,976) $ 1,652 $ 3,340 $ (1,782) $ 1,558 $ 27 210 298 $ 535 $ 5,394 $ (7) (47) (102) $ 20 163 196 $ 138 11 118 $ (156) $ 379 $ 267 $ $ (39) (6) (46) (91) $ 99 5 72 $ 176 $ (2,948) $ 2,446 $ 4,658 $ (2,573) $ 2,085 Allowance for credit losses against performing loans $ (1,444) $ (1,404) Impaired loan metrics As at October 31 ($ millions) Net impaired loans as a % of loans and acceptances Allowance against impaired loans as a % of gross impaired loans (1) Excludes loans acquired under the Federal Deposit Insurance Corporation (FDIC) guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. Net impaired loans 2016(1) 2015(1) 0.49% 55% 0.44% 55% Allowance for credit losses The total allowance for credit losses was up $415 million to $4,392 million as at October 31, 2016 (excluding $234 million related to loans acquired under FDIC guarantee related to the acquisition of R-G Premier Bank of Puerto Rico), from $3,977 million (excluding $220 million related to R-G Premier Bank) last year. Allowances in Canadian Banking increased by $116 million to $816 million, in line with the increases in gross impaired loans. In International Banking, allowances increased by $194 million to $1,976 million mainly in Peru, Chile, and Mexico. Global Banking and Markets allowances increased by $65 million to $156 million, reflecting the increase in gross impaired loans. The collective allowance against performing loans increased by $40 million to $1,444 million due to a $50 million increase in the collective allowance against performing loans and partially offset by a $10 million re-allocation to the reserves against unfunded commitments and other off-balance sheet items. Impaired loans Gross impaired loans increased to $5,394 million as at October 31, 2016 (excluding $100 million related to loans purchased under FDIC guarantee related to the acquisition of R-G Premier Bank of Puerto Rico), from $4,658 million (excluding $157 million related to R-G Premier Bank of Puerto Rico) last year. Impaired loans in Canadian Banking increased by $180 million, primarily in the retail portfolio. In International Banking, impaired loans increased by $288 million due to increases in Latin America region, primarily in Peru and Chile. Impaired loans in Global Banking and Markets increased by $268 million, primarily in the United States and Asia. Net impaired loans, after deducting the allowance for credit losses, were $2,446 million as at October 31, 2016, an increase of $361 million from a year ago. Net impaired loans as a percentage of loans and acceptances were 0.49% as at October 31, 2016, an increase of five basis points from a year ago. 74 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T Acquisition-related purchased loans All purchased loans are initially measured at fair value on the date of acquisition, with no allowance for credit losses recorded in the Consolidated Statement of Financial Position on the date of acquisition. Consequently, none of the purchased loans are considered to be impaired on the date of acquisition. In arriving at the fair value, the Bank considers interest rate mark and credit rate mark adjustments. The interest rate mark on the date of acquisition is principally set up for fixed interest rate loans and captures the impact of the interest rate differential between the contractual rate of interest on the loan and the prevailing interest rate on the loan on the date of acquisition for the remaining term. The interest rate mark is fully amortized into interest income in the Consolidated Statement of Income over the expected life of the loan using the effective interest method. The credit mark captures management’s best estimate of cash flow shortfalls on the loans over their lifetime as determined at the date of acquisition. Changes to the expected cash flows of these loans are recorded as a charge/recovery in the provision for credit losses in the Consolidated Statement of Income. The total credit mark remaining on all acquired loans in Canadian Banking and International Banking as at October 31, 2016 was $259 million (October 31, 2015 – $148 million). Adjusting for the impact of foreign currency translation, the utilization of incurred and expected losses in the credit mark during the year was $244 million (for the year ended October 31, 2015 – $68 million). The net benefit to net income attributable to common shareholders from the credit mark on acquired loans this year was $123 million (for the year ended October 31, 2015 – $23 million). Portfolio review Canadian Banking Gross impaired loans in the retail portfolio increased by $160 million to $1,003 million. Provision for credit losses in the retail portfolio were $770 million, up $128 million from last year driven by growth in relatively higher spread loans. In the commercial loan portfolio, gross impaired loans increased by $20 million to $228 million and the provision for credit losses was $62 million, up $17 million from last year. International Banking In retail, gross impaired loans increased by $70 million to $2,227 million during the year, with an increase attributable mainly to Peru. Retail provisions were flat compared to 2015. Increases from acquisitions and higher provisions for credit losses in Latin America from strong retail loan growth were offset by favourable foreign currency translation. In commercial banking, gross impaired loans were $1,401 million, an increase of $218 million over the prior year. The provision for credit losses in the commercial portfolio was $274 million in 2016, versus $126 million in 2015. The increase was attributable to higher provisions in the energy sector, primarily in Colombia, and in Puerto Rico. Global Banking and Markets Gross impaired loans in Global Banking and Markets increased by $268 million in 2016 to $535 million primarily in the energy sector. The provision for credit losses was $249 million in 2016, versus $67 million in 2015. The provisions this year were primarily in the energy sector. Risk diversification The Bank’s exposures to various countries and types of borrowers are well diversified (see T64 on page 110 and T68 on page 112). Chart C24 shows loans and acceptances by geography. Ontario represents the largest Canadian exposure at 31.5% of the total. Latin America was 10.7% of the total exposure and the U.S. was 7.7%. C25 shows loans and acceptances by type of borrower (see T68 on page 112). Excluding loans to households, the largest industry exposures were wholesale and retail (4.5%), real estate and construction (4.5%), financial services (3.9% including banks and non-banks), and energy (3.1%). Risk mitigation To mitigate exposures in its performing corporate portfolios, the Bank uses diversification by company, industry, and country, with loan sales and credit derivatives used sparingly. In 2016, loan sales totaled $42 million, compared to $143 million in 2015. The largest volume of loan sales in 2016 related to loans in the energy industry. As at October 31, 2016, credit derivatives used to mitigate exposures in the portfolios totaled $24 million (notional amount), compared to $39 million as at October 31, 2015. The Bank actively monitors industry and country concentrations. As is the case with all industry exposures, the Bank continues to closely follow developing trends and takes additional steps to mitigate risk as warranted. Energy, mining, and shipping portfolios are being closely managed. Overview of loan portfolio The Bank has a well-diversified portfolio by product, business and geography. Details of certain portfolios of current focus are highlighted below. Energy The Bank’s outstanding loan exposure to commercial and corporate companies in the energy sector was $15.6 billion as at October 31, 2016 (October 31, 2015 – $16.5 billion), reflecting approximately 3.1% (October 31, 2015 – 3.5%) of the Bank’s total loan portfolio. In addition, the Bank has related undrawn energy loan commitments amounting to $11.1 billion as at October 31, 2016 (October 31, 2015 – $14.3 billion). The decline in undrawn loan commitments is primarily driven by the upstream and midstream sub-sectors. Exposure in the upstream sub-sector declined by $2.2 billion since October 31, 2015. Approximately 59% of the Bank’s outstanding energy loan exposure and associated undrawn commitments are investment grade, after taking into account the benefit of collateral and guarantees. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 75 MANAGEMENT’S DISCUSSION AND ANALYSIS As expected, retail delinquencies are tracking higher in Alberta. The outstanding loan exposures are primarily secured. The Bank continues to consider the impact of lower energy prices in its ongoing stress testing program. Results continue to be within our risk tolerance. Real estate secured lending A large portion of the Bank’s lending portfolio is comprised of residential mortgages and consumer loans, which are well diversified by borrower. As at October 31, 2016, these loans accounted for $322 billion or 65% of the Bank’s total loans and acceptances outstanding (October 31, 2015 – $309 billion or 65%). Of these, $242 billion or 75% are real estate secured loans (October 31, 2015 – $236 billion or 76%). The tables below provide more details by portfolios. Insured and uninsured residential mortgages and home equity lines of credit The following table presents amounts of insured and uninsured residential mortgages and home equity lines of credit (HELOCs), by geographic area. T41 Insured and uninsured residential mortgages and home equity lines of credit (HELOCs), by geographic areas Residential mortgages Home equity lines of credit 2016 45% As at October 31 Insured(1) Uninsured Total Insured(1) Uninsured Total ($ millions) Amount % Amount % Amount % Amount % Amount % Amount % C24 Well diversified in Canada and internationally… loans and acceptances, October 2016 6% 3% 2% 11% 4% 8% Canada United States Mexico Latin America Europe 66% Caribbean and Central America Other C25 … and in household and business lending loans & acceptances, October 2016 30% 5% 20% Corporate Financial and government Personal Residential mortgages Canada:(2) Atlantic provinces $ Quebec Ontario Manitoba & Saskatchewan Alberta British Columbia & Territories 7,034 8,346 3.7 4.3 52,230 27.0 $ 4,901 7,150 2.5 3.7 41,935 21.7 6.2 $ 11,935 15,496 8.0 94,165 48.7 $ 1 – 2 – – – $ 1,259 999 6.6 5.2 9,646 50.6 $ 1,260 999 9,648 5,857 3.0 19,551 10.1 3,236 10,828 16,929 8.8 15,306 1.7 5.6 7.9 9,093 4.7 30,379 15.7 32,235 16.7 2 3 – – 0.1 840 4.4 3,027 15.8 842 3,030 – 3,294 17.3 3,294 17.3 6.6 5.2 50.6 4.4 15.9 Canada(3) $109,947 56.9% $ 83,356 43.1% $193,303 100% $ 8 0.1% $19,065 99.9% $19,073 100% International – – 29,585 100 29,585 100 – – – – – – Total $109,947 49.3% $112,941 50.7% $222,888 100% $ 8 0.1% $19,065 99.9% $19,073 100% 2015 Canada(3) $ 92,802 48.8% $ 97,321 51.2% $190,123 100% $ 9 0.1% $18,627 99.9% $18,636 100% International – – 27,375 100 27,375 100 – – – – – – Total $ 92,802 42.7% $124,696 57.3% $217,498 100% $ 9 0.1% $18,627 99.9% $18,636 100% (1) Default insurance is contractual coverage for the life of eligible facilities whereby the Bank’s exposure to real estate secured lending is protected against potential shortfalls caused by borrower default. This insurance is provided by either government-backed entities or private mortgage insurers. (2) The province represents the location of the property in Canada. (3) Includes multi-residential dwellings (4+ units) of $2,376 (October 31, 2015 – $2,104) of which $1,392 are insured (October 31, 2015 – $1,005). Amortization period ranges for residential mortgages The following table presents the distribution of residential mortgages by amortization periods, and by geographic areas. T42 Distribution of residential mortgages by amortization periods, and by geographic areas 2016 Residential mortgages by amortization Less than 20 years 20-24 years 25-29 years 30-34 years 35 years and greater Total residential mortgages 35.2% 36.3% 26.7% 67.7% 19.0% 11.5% 35.6% 35.6% 25.7% 66.4% 20.4% 11.4% 1.7% 1.7% 2015 3.0% 1.6% 0.1% 0.1% 0.1% 0.2% 100% 100% 100% 100% As at October 31 Canada International Canada International Loan to value ratios The Canadian residential mortgage portfolio is 43% uninsured (October 31, 2015 – 51%). The average loan-to-value (LTV) ratio of the uninsured portfolio is 50% (October 31, 2015 – 53%). The following table presents the weighted average LTV ratio for total newly originated uninsured residential mortgages and home equity lines of credit during the year, which include mortgages for purchases, refinances with a request for additional funds and transfer from other financial institutions, by geographic areas. 76 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T T43 Loan to value ratios Canada: Atlantic provinces Quebec Ontario Manitoba & Saskatchewan Alberta British Columbia & Territories Canada International Canada International Uninsured LTV ratios(1) For the year ended October 31, 2016 Residential mortgages LTV% Home equity lines of credit(2) LTV% 68.1% 63.0 62.4 67.6 66.7 60.7 62.9% 69.1% For the year end October 31, 2015 62.5% 68.3% 59.4% 68.8 64.6 64.4 69.3 61.7 64.5% N/A 65.7% N/A (1) The province represents the location of the property in Canada. (2) Includes only home equity lines of credit (HELOC) under Scotia Total Equity Plan. LTV is calculated based on the sum of residential mortgages and the authorized limit for related HELOCs, divided by the value of the related residential property, and presented on a weighted average basis for newly originated mortgages and HELOCs. Potential impact on residential mortgages and real estate home equity lines of credit in the event of an economic downturn The Bank performs stress testing on its portfolio to assess the impact of increased levels of unemployment, rising interest rates, reduction in property values and changes in other relevant macro-economic variables. Potential losses in the mortgage portfolio under such economic downturn scenarios are considered manageable given the diversified composition of the portfolio, the high percentage of insured exposures, and the low LTV in the portfolio. This is further supported by sound risk management oversight and pro-active risk mitigation strategies. Loans to Canadian condominium developers With respect to loans to Canadian condominium developers, the Bank had loans outstanding of $956 million as at October 31, 2016 (October 31, 2015 – $927 million). This is a high quality portfolio with well-known developers who have long-term relationships with the Bank. European exposures As a result of the Bank’s broad international operations, the Bank has sovereign credit risk exposure to a number of countries. The Bank actively manages this sovereign risk, including the use of risk limits calibrated to the credit worthiness of the sovereign exposure. The Bank believes that its European exposures are manageable, are sized appropriately relative to the credit worthiness of the counterparties (83% of the exposures are to investment grade counterparties based on a combination of internal and external ratings), and are modest relative to the capital levels of the Bank. The Bank’s European exposures are carried at amortized cost or fair value using observable inputs, with negligible amounts valued using models with unobservable inputs (Level 3). There were no significant events in the quarter that have materially impacted the Bank’s exposures. The current European exposure is provided in T44 below. T44 European exposure As at October 31 ($ millions) Gross exposures Less: Undrawn commitments Net funded exposure 2016 2015 Loans and loan equivalents Other Loans and acceptances(1) Letters of credit and guarantees(2) Undrawn commitments(3) Securities and deposits with financial institutions(4) Securities Financing Transactions (SFT) and derivatives(5) Total European exposure Total European exposure $ 11,858 $ 2,890 $ 12,472 $ 10,823 $ 3,554 $ 41,597 $ 39,231 – – 12,472 – – 12,472 12,409 $ 11,858 $ 2,890 $ – $ 10,823 $ 3,554 $ 29,125 $ 26,822 Individual allowances for credit loss are $37.7. Letters of credit and guarantees are included as funded exposure as they have been issued. (1) (2) (3) Undrawn commitments represent an estimate of the contractual amount that may be drawn upon by the obligor. (4) Exposures for securities are calculated taking into account derivative positions where the security is the underlying reference asset and short trading positions. (5) SFT comprise of securities purchased under resale agreements, obligations related to securities sold under repurchase agreements and securities lending and borrowing transactions. Gross and net funded exposures represent all net positive positions after taking into account collateral. Collateral held against derivatives was $2,547 and collateral held against SFT was $7,714. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 77 MANAGEMENT’S DISCUSSION AND ANALYSIS Below are the funded exposures related to all European countries: T45 Funded exposures As at October 31 ($ millions) Greece Ireland Italy Portugal Spain Total GIIPS U.K. Germany France Netherlands Switzerland Other Total Non-GIIPS Total Europe Total Europe as at October 31, 2015 Includes $1,959 (October 31, 2015 – $667) in exposures to supra-national agencies. (1) (2) Corporate includes financial institutions that are not banks. The Bank’s exposure are distributed as follows: T46 Bank’s exposure distribution by country As at October 31 ($ millions) Greece Ireland Italy Portugal Spain Total GIIPS U.K. Germany France Netherlands Switzerland Other Total Non-GIIPS Total Europe As at October 31, 2015 Sovereign(1) Bank Corporate(2) Total 2016 $ $ $ $ $ $ 311 286 11 – 307 915 7,561 1,975 599 1,255 1,051 3,275 15,716 16,631 15,128 $ $ $ $ $ $ – 27 (1) – 111 137 1,163 1,799 1,947 452 239 1,599 7,199 7,336 6,214 $ $ $ $ $ $ – 37 181 – 181 399 2,304 306 1,196 398 309 246 4,759 5,158 5,480 2016 Loans and loan equivalents Deposits with financial institutions Securities SFT and derivatives $ $ $ $ $ $ 311 99 213 – 486 1,109 6,090 1,371 754 1,090 1,102 3,232 13,639 14,748 14,547 $ $ $ $ $ $ – 27 – – – 27 1,620 204 517 85 23 43 2,492 2,519 2,709 $ $ $ $ $ $ – 55 (22) – 103 136 1,279 2,389 2,251 600 158 1,491 8,168 8,304 6,669 $ $ $ $ $ $ – 169 – – 10 179 2,039 116 220 330 316 354 3,375 3,554 2,897 $ $ $ $ $ $ $ $ $ $ $ $ 311 350 191 – 599 1,451 11,028 4,080 3,742 2,105 1,599 5,120 27,674 29,125 26,822 Total 311 350 191 – 599 1,451 11,028 4,080 3,742 2,105 1,599 5,120 27,674 29,125 26,822 2015 Total 339 428 509 (2) 505 1,779 12,895 2,847 2,569 974 1,042 4,716 25,043 26,822 2015 Total 339 428 509 (2) 505 1,779 12,895 2,847 2,569 974 1,042 4,716 25,043 26,822 $ $ $ $ $ $ $ $ $ $ The Bank’s exposure to certain European countries of focus – Greece, Ireland, Italy, Portugal and Spain (GIIPS) – is not significant. As of October 31, 2016, the Bank’s current funded exposure to the GIIPS sovereign entities, as well as banks and non-bank financial institutions and corporations domiciled in these countries, totaled approximately $1.5 billion, down from $1.8 billion last year. Of the $1.5 billion, $1.1 billion was related to loans and loan equivalents. Specific to sovereign exposures to GIIPS, the Bank’s exposure to Ireland included central bank deposits of $26 million and $1 million in trading book securities. The Bank was net long securities in sovereign exposures to Spain ($111 million) and net short to Italy (-$1 million). The Bank had no sovereign securities holdings of Greece and Portugal. The Bank had exposures to Italian banks of $181 million, as at October 31, 2016 (October 31, 2015 – $187 million), primarily related to short-term precious metals trading. Greek exposure of $311 million (October 31, 2015 – $339 million) related primarily to secured loans to shipping companies. Securities exposures to European sovereigns and banks (excluding GIIPS) were $6.0 billion as at October 31, 2016 (October 31, 2015 – $5.3 billion), predominantly related to issuers in France, Germany, Luxembourg, the Netherlands and the United Kingdom. Securities are carried at fair value and substantially all holdings have strong market liquidity. The majority of funded credit exposure is in the form of funded loans which are recorded on an accrual basis. As well, credit exposure to clients arises from client-driven derivative transactions and securities financing transactions (reverse repurchase agreements, repurchase agreements, and securities lending and borrowing). OTC derivative counterparty exposures are recorded on a fair value basis and security financing transactions are recorded on an accrual basis. As at October 31, 2016, credit exposure to banks in the form of issued letters of credit amounted to $1.4 billion (October 31, 2015 – $1.2 billion). 78 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Undrawn commitments of $12.5 billion (October 31, 2015 – $12.4 billion) are comprised of unfunded loan commitments and commitments to issue letters of credit on behalf of other banks in a syndicated bank lending arrangement. Total unfunded loan commitments to corporations in Europe (excluding GIIPS) were $9.1 billion as at October 31, 2016 (October 31, 2015 – $8.6 billion). As at October 31, 2016, commitments related to letters of credit with banks amounted to $2.7 billion (October 31, 2015 – $3.3 billion). Unfunded commitments are detailed further by country in T47. The Bank’s indirect exposure is also detailed in the table below and is defined as: (cid:129) Securities where the exposures are to non-European entities whose parent company is domiciled in Europe, and; (cid:129) Letters of credit or guarantees (included as loan equivalents in the above table). Included in the indirect exposure was securities exposure of $485 million related to GIIPS, $75 million to Germany and $25 million to the United Kingdom. Indirect exposure by way of letters of credit totaled $2,890 million at October 31, 2016 (October 31, 2015 – $2,593 million), of which $184 million (October 31, 2015 – $62 million) was indirect exposure to GIIPS. Indirect exposure is managed through the Bank’s credit risk management framework, with a robust assessment of the counterparty. In addition to the total indirect exposures detailed further below, the Bank had Euro-denominated collateral held for non-European counterparties of $295 million (October 31, 2015 – $555 million). The Bank may on occasion use credit default swaps (CDS) to partially offset its banking book exposure. As part of the trading portfolio, the Bank may purchase or sell CDS. Specific to GIIPS as at October 31, 2016, the Bank had no CDS protection on funded loan exposures. All exposures, including CDS, are subject to risk limits and ongoing monitoring by the Bank’s independent risk management department. Like other banks, the Bank also provides settlement and clearing facilities for a variety of clients in these countries and actively monitors and manages these intra-day exposures. However, the Bank has no funded exposure in these countries to retail customers or small businesses. T47 Undrawn commitments and indirect exposure As at October 31 ($ millions) Greece Ireland Italy Portugal Spain Total GIIPS U.K. Germany France Netherlands Switzerland Other Total Non-GIIPS Total Europe (1) Amounts in brackets represent net short positions arising from trading transactions. Undrawn Commitments Indirect Exposure (1) 2016 2015 2016 2015 $ $ $ – 421 49 – 172 642 4,958 798 1,583 1,364 701 2,426 $ $ $ – 256 53 – 180 489 5,526 607 1,599 1,188 740 2,260 $ – 35 73 – 561 $ – (1) 6 – 420 $ 669 $ 425 $ 1,270 154 459 291 146 463 $ 1,365 161 338 210 144 554 $ 11,830 $ 11,920 $ 2,783 $ 2,772 $ 12,472 $ 12,409 $ 3,452 $ 3,197 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 79 MANAGEMENT’S DISCUSSION AND ANALYSIS Market Risk Market risk is the risk of loss from changes in market prices and rates (including interest rates, credit spreads, equity prices, foreign exchange rates and commodity prices), the correlations between them, and their levels of volatility. Below is an index of market risk disclosures: Page Tables and charts Page Index of all market risk disclosures Index Market risk factors Interest rate risk Credit spread risk Foreign currency risk Equity risk Commodity risk Market risk governance Risk measurement summary Value at risk Incremental risk charge and comprehensive risk measure Stress testing Sensitivity analysis Gap analysis Validation of market risk models Non-trading market risk Interest rate risk Foreign currency risk Investment portfolio risks Trading market risk 81 81 81 81 81 81 81 81-82 81 82 82 82 82 82 82-84 C26 Interest rate gap T48 Interest rate gap T49 Structural interest rate sensitivity 84 84 84 T50 Total one-day VaR by risk factor C27 Trading revenue distribution C28 Daily trading revenue vs. VaR Market risk linkage to balance sheet 86 T51 Market risk linkage to balance sheet of the Bank Derivative instruments and structured transactions Derivatives Structured transactions European exposures 86 86 86-87 77-79 T44 European exposure T45 Funded exposures T46 Bank’s exposure distribution by country Market risk Financial instruments 41-42 T29 Total market risk capital 45-46 T32 Mortgage-backed securities T33 Collateralized debt obligations (CDOs) 80 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 83 83 83 84 85 85 86 77 78 78 42 46 46 Market risk factors Interest rate risk The risk of loss due to changes in the level and/or the volatility of interest rates. This risk affects instruments such as, but not limited to, debt securities, loans, mortgages, deposits and derivatives. Interest rate risks are managed through sensitivity, gap, stress testing, annual income and VaR limits and mitigated through portfolio diversification and hedges using interest rate derivatives and debt securities. Credit spread risk The risk of loss due to changes in the market price and volatility of credit, or the creditworthiness of issuers. This risk is mainly concentrated in loan and debt securities portfolios. Risk is managed through sensitivity, jump-to-default, stress testing and VaR limits and mitigated through hedges using credit derivatives. Foreign currency risk The risk of loss resulting from changes in currency exchange rates and exchange rate volatility. Foreign currency denominated debt and other securities as well as future cash flows in foreign currencies are exposed to this type of risk. Risk is managed through maximum net trading position, sensitivity, stress testing and VaR limits and mitigated through hedges using foreign exchange positions or derivatives. Equity risk The risk of loss due to changes in prices, volatility or any other equity related risk factor of individual equity or equity linked securities. This risk affects instruments such as, but not limited to, equities, exchange traded funds, mutual funds, derivatives and other equity linked products. Risk is managed through sensitivity, stress testing and VaR limits and mitigated through hedges using physical equity and derivative instruments. Commodity risk The risk of loss due to changes in prices or volatility of precious metal, base metal, energy and agriculture products. Both physical commodity and derivative positions are exposed to this risk. Risk is managed through aggregate and net trading position, sensitivity, stress testing and VaR limits and mitigated through hedges using physical commodity and derivative positions. The following maps risk factors to trading and non-trading activities: M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T Non-trading Funding Interest rate risk Foreign currency risk Market risk governance Overview Investments Interest rate risk Credit spread risk Foreign currency risk Equity risk Trading Interest rate risk Credit spread risk Foreign currency risk Equity risk Commodity risk The Board of Directors reviews and approves market risk policies and limits annually. The Bank’s Asset-Liability Committee (ALCO) and Market Risk Management and Policy Committee (MRMPC) oversee the application of the framework set by the Board, and monitor the Bank’s market risk exposures and the activities that give rise to these exposures. The MRMPC establishes specific operating policies and sets limits at the product, portfolio, business unit and business line levels, and for the Bank in total. Limits are reviewed at least annually. Global Risk Management provides independent oversight of all significant market risks, supporting the MRMPC and ALCO with analysis, risk measurement, monitoring, reporting, proposals for standards and support for new product development. To ensure compliance with policies and limits, market risk exposures are independently monitored on a continuing basis, either by Global Risk Management, the back offices, or Finance. They provide senior management, business units, the ALCO, and the MRMPC with a series of daily, weekly and monthly reports of market risk exposures by business line and risk type. The Bank uses a variety of metrics and models to measure and control market risk exposures. These measurements are selected based on an assessment of the nature of risks in a particular activity. The principal measurement techniques are Value at Risk (VaR), Incremental Risk Charge, Comprehensive Risk Measure, stress testing, sensitivity analysis and gap analysis. The use and attributes of each of these techniques are noted in the Risk Measurement Summary. Risk measurement summary Value at risk (VaR) VaR is a statistical method of measuring potential loss due to market risk based upon a common confidence interval and time horizon. The Bank calculates VaR daily using a 99% confidence level, and a one-day holding period for its trading portfolios. This means that once in every 100 days, the trading positions are expected to lose more than the VaR estimate. VaR has two components: general market risk and debt specific risk. The Bank calculates general market risk VaR using historical simulation based on 300 days of market data. Obligor specific risk on debt instruments and credit derivatives not captured in general market risk VaR is calculated through the debt specific risk VaR, which uses historical resampling. In addition, the Bank calculates a Stressed VaR measure which follows the same basic methodology as VaR but is calibrated to a one year stressed period. The stressed period is determined based on analysis of the trading book’s risk profile against historical market data. Stressed VaR complements VaR in that it evaluates the impact of market volatility that is outside the VaR’s historical set. All material risk factors are captured in VaR. Where historical data is not available, proxies are used to establish the relevant volatility for VaR and Stressed VaR until sufficient data is available. Changes in VaR between reporting periods are generally due to changes in positions, volatilities and/or correlations between asset classes. VaR is also used to evaluate risks arising in certain funding and investment portfolios. Backtesting is also an important and necessary part of the VaR process. The Bank backtests the actual trading profit or loss against the VaR result to validate the quality and accuracy of the Bank’s VaR model. The Board reviews VaR and backtesting results quarterly. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 81 MANAGEMENT’S DISCUSSION AND ANALYSIS Incremental Risk Charge (IRC) and Comprehensive Risk Measure (CRM) Basel market risk capital requirements include IRC and CRM which capture the following: Default risk: This is the potential for direct losses due to an obligor’s (equity/bond issuer or counterparty) default. Credit migration risk: This is the potential for direct losses due to a credit rating downgrade or upgrade. A Monte Carlo model is used to perform default and migration simulations for the obligors underlying credit derivative and bond portfolios. In addition, for CRM in correlation trading there is a market simulation model to capture historical price movements. Both IRC and CRM are calculated at the 99.9th percentile with a one year liquidity horizon. The Board reviews IRC and CRM results quarterly. Stress testing A limitation of VaR and Stressed VaR is that they only reflect the recent history of market volatility and a specific one year stressed period, respectively. To complement these measures, stress testing examines the impact that abnormally large changes in market factors and periods of prolonged inactivity might have on trading portfolios. Stress testing scenarios are designed to include large shifts in risk factors as well as historical and theoretical multi risk market events. Historical scenarios capture severe movements over periods that are significantly longer than the one-day holding period captured in VaR, such as the 2008 Credit Crisis or the 1998 Russian Financial Crisis. Similar to Stressed VaR, stress testing provides management with information on potential losses due to tail events. In addition, the results from the stress testing program are used to verify that the Bank’s market risk capital is sufficient to absorb these potential losses. The Bank subjects its trading portfolios to a series of daily, weekly and monthly stress tests. The Bank also evaluates risk in its investment portfolios monthly, using stress tests based on risk factor sensitivities and specific market events. The stress testing program is an essential component of the Bank’s comprehensive risk management framework which complements the VaR methodology and other risk measures and controls employed by the Bank. The Board reviews stress testing results quarterly. Sensitivity analysis In trading portfolios, sensitivity analysis is used to measure the effect of changes in risk factors, including prices and volatility, on financial products and portfolios. These measures apply across product types and geographies and are used for limit monitoring and management reporting. In non-trading portfolios, sensitivity analysis assesses the effect of changes in interest rates on current earnings and on the economic value of shareholders’ equity. It is applied globally to each of the major currencies within the Bank’s operations. The Bank’s sensitivity analysis for limit and disclosure purposes is measured through positive and negative parallel shifts in the underlying interest rate curves. The Bank also performs sensitivity analysis using various non-parallel interest rate curve shifts, for example: curve steepeners, curve flatteners and curve twists. The Board reviews sensitivity results quarterly. Gap analysis Gap analysis is used to assess the interest rate sensitivity of re-pricing mismatches in the Bank’s non-trading operations. Under gap analysis, interest rate sensitive assets, liabilities and off-balance sheet instruments are assigned to defined time periods based on expected re-pricing dates. Products with a contractual maturity are assigned an interest rate gap term based on the shorter of the contractual maturity date and the next re-pricing date. Products with no contractual maturity are assigned an interest rate gap based on observed historical consumer behaviour. Validation of market risk models Prior to the implementation of new market risk models, rigorous validation and testing is conducted. Validation is conducted when the model is initially developed and when any significant changes are made to the model. The models are also subject to ongoing validation, the frequency of which is determined by model risk ratings. Models may also be triggered for earlier revalidation when there have been significant structural changes in the market or changes to the composition of the portfolio. Model validation includes backtesting, and additional analysis such as: (cid:129) Theoretical review or tests to demonstrate whether assumptions made within the internal model are appropriate; (cid:129) Impact tests including stress testing that would occur under historical and hypothetical market conditions; (cid:129) The use of hypothetical portfolios to ensure that the model is able to capture concentration risk that may arise in an undiversified portfolio. The validation process is governed by the Bank’s Model Risk Management Policy. Non-trading market risk Funding and investment activities Market risk arising from the Bank’s funding and investment activities is identified, managed and controlled through the Bank’s asset-liability management processes. The Asset-Liability Committee meets biweekly to review risks and opportunities, and evaluate performance including the effectiveness of hedging strategies. Interest rate risk Interest rate risks in the non-trading portfolios are predominately driven by the interest rate mismatch (i.e. repricing frequency) in the asset and liability exposures. The largest exposures in the non-trading book arise from retail banking operations in Canada. The largest component of this risk is from positions related to the retail mortgage book. T48 shows a summary of the interest rate gaps for the Bank’s non-trading positions. Interest rate risk arising from the Bank’s lending, funding and investment activities is managed in accordance with Board-approved policies and global limits, which are designed to control the risk to net interest income and economic value of shareholders’ equity. The annual income limit measures the effect of a specified change in interest rates on the Bank’s annual net interest income over the next twelve months, while the economic value limit measures the impact of a specified change in interest rates on the present value of the Bank’s net assets. These limits are set according to the documented risk appetite of the Bank. Board-level limit utilization is reported to both the Asset-Liability Committee and the Board on a regular basis. Any limit exceptions are reported according to the Limit Monitoring and Compliance Policy of the Bank. 82 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T Net interest income and the economic value of equity result from the differences between yields earned on the Bank’s non-trading assets and interest rate paid on its liabilities. The difference in yields partly reflects mismatch between the maturity and re-pricing characteristics of the assets and liabilities. This mismatch is inherent in the non-trading operations of the Bank and exposes it to adverse changes in the level of interest rates. The Asset-Liability Committee provides strategic direction for the management of structural interest rate risk within the risk appetite framework authorized by the Board of Directors. The asset/liability management strategy is executed by Group Treasury with the objective of enhancing net interest income within established risk tolerances. Gap analysis, simulation modeling, sensitivity analysis and VaR are used to assess exposures and for limit monitoring and planning purposes. The Bank’s interest rate risk exposure calculations are generally based on the earlier of contractual re-pricing or maturity of on-balance sheet and off- balance sheet assets and liabilities, although certain assets and liabilities such as credit cards and deposits without a fixed maturity are assigned a maturity profile based on the longevity of the exposure. Expected prepayments from loans and cashable investment products are also incorporated into the exposure calculations. T49 shows the after-tax impact of an immediate and sustained 100 basis point shock over a one year period on annual income and economic value of shareholders’ equity. The interest rate sensitivities tabulated are based on a static balance sheet. There are no assumptions made for management actions that may mitigate risk. Based on the Bank’s interest rate positions at year-end 2016, an immediate and sustained 100 basis point rise in interest rates across all currencies and maturities would decrease after-tax net income by approximately $32 million over the next 12 months. The Bank is relatively balanced from an earnings perspective, with positive near-term earnings sensitivity to rising rates in the US and most other Foreign currencies, and positive medium-term earnings sensitivity to rising rates in Canada. During fiscal 2016, this measure ranged between $(55) million and $160 million. This same increase in interest rates would result in an after-tax decrease in the present value of the Bank’s net assets of approximately $785 million. During fiscal 2016, this measure ranged between $(263) million and $(805) million. The directional sensitivity of these two key metrics is largely determined by the difference in time horizons (annual income captures the impact over the next twelve months only, whereas economic value considers the potential impact of interest rate changes on the present value of all future cash flows). The annual income and economic value results are compared to the authorized Board limits. There were no limit breaches in the reporting period. C26 Interest rate gap $ billions, one-year interest rate gap 20 10 0 -10 -20 -30 12 13 14 15 16 Foreign currencies gap Canadian dollar gap T48 Interest rate gap Interest rate sensitivity position(1) As at October 31, 2016 ($ billions) Canadian dollars Assets Liabilities Gap Foreign currencies Assets Liabilities Gap Total Gap As at October 31, 2015 Gap Within 3 months 3 to 12 months Over 1 year Non-interest rate sensitive Total $ 208.7 $ 231.5 $ 46.8 $ 49.0 $ (22.8) $ (2.2) $ 146.0 $ 113.0 $ 33.0 $ 6.8 $ 14.8 $ 408.3 $ 408.3 $ (8.0) $ – $ 311.7 $ 296.8 $ 14.9 $ 28.0 $ 38.8 $ (10.8) $ $ (7.9) $ (13.0) 24.4 $ (29.1) $ $ $ $ $ 68.4 43.3 25.1 58.1 37.7 $ 79.9 $ 109.1 $ (29.2) $ (37.2) $ (33.0) $ 488.0 $ 488.0 $ $ $ – – – (1) The above figures reflect the inclusion of off-balance sheet instruments, as well as an estimate of prepayments on consumer and mortgage loans and cashable GICs. The off-balance sheet gap is included in liabilities. T49 Structural interest sensitivity As at October 31 ($ millions) After-Tax Impact of 100bp increase in rates Non-trading risk 100bp decrease in rates(1) Non-trading risk 2016 2015 Economic Value of Shareholders’ Equity Annual Income Economic Value of Shareholders’ Equity Annual Income $ (785) $ (32) $ (488) $ 242 $ 650 $ 32 $ 418 $ (240) (1) The annual income sensitivity for CAD, USD, EUR, and GBP exposures is now measured using a 100 basis point decline. Prior period items have been restated to reflect this change. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 83 MANAGEMENT’S DISCUSSION AND ANALYSIS Foreign currency risk Foreign currency risk in the Bank’s unhedged funding and investment activities arises primarily from the Bank’s net investments in foreign operations as well as foreign currency earnings in its domestic and remitting foreign branch operations. The Bank’s foreign currency exposure to its net investments in foreign operations is controlled by a Board-approved limit. This limit considers factors such as potential volatility to shareholders’ equity as well as the potential impact on capital ratios from foreign exchange fluctuations. On a quarterly basis, the Asset-Liability Committee reviews the Bank’s foreign currency net investment exposures and determines the appropriate hedging strategies. These may include funding the investments in the same currency or using other financial instruments, including derivatives. Foreign currency translation gains and losses from net investments in foreign operations, net of related hedging activities and tax effects, are recorded in accumulated other comprehensive income within shareholders’ equity. However, the Bank’s regulatory capital ratios are not materially affected by these foreign exchange fluctuations because the risk-weighted assets of the foreign operations tend to move in a similar direction. The Bank is also subject to foreign currency translation risk on the earnings of its domestic and remitting foreign branch operations. The Bank forecasts foreign currency revenues and expenses, which are primarily denominated in U.S. dollars, over a number of future fiscal quarters. The Asset- Liability Committee also assesses economic data trends and forecasts to determine if some or all of the estimated future foreign currency revenues and expenses should be hedged. Hedging instruments normally include foreign currency spot and forward contracts, as well as foreign currency options and swaps. Certain of these economic hedges may not qualify for hedge accounting resulting in a potential for a mismatch in the timing of the recognition of economic hedge gains/losses and the underlying foreign earnings translation gains/losses. In accordance with IFRS, foreign currency translation gains and losses relating to monetary and non-monetary items are recorded directly in earnings. As at October 31, 2016, a one per cent increase (decrease) in the Canadian dollar against all currencies in which the Bank operates decreases (increases) the Bank’s before-tax annual earnings by approximately $60 million (October 31, 2015 – $60 million) in the absence of hedging activity, primarily from the exposure to U.S. dollars. Investment portfolio risks The Bank holds investment portfolios to meet liquidity and statutory reserve requirements and for investment purposes. These portfolios expose the Bank to interest rate, foreign currency, credit spread and equity risks. Debt investments primarily consist of government, agency, and corporate bonds. Equity investments include common and preferred shares, as well as a diversified portfolio of third-party managed funds. The majority of these securities are valued using prices obtained from external sources. These portfolios are controlled by a Board-approved policy and limits. Trading market risk The Bank’s policies, processes and controls for trading activities are designed to achieve a balance between pursuing profitable trading opportunities and managing earnings volatility within a framework of sound and prudent practices. Trading activities are primarily customer focused. Market risk arising from the Bank’s trading activities is managed in accordance with Board-approved policies, and aggregate VaR and stress testing limits. The quality of the Bank’s VaR is validated by regular backtesting analysis, in which the VaR is compared to both theoretical profit or loss results based on fixed end of day positions and actual reported profit or loss. A VaR at the 99% confidence interval is an indication of a 1% probability that losses will exceed the VaR if positions remain unchanged during the next business day. Trading positions are however managed dynamically and, as a result, actual profit/loss backtesting exceptions are uncommon. In fiscal 2016, the total one-day VaR for trading activities averaged $12.6 million, compared to $11.3 million in 2015. T50 Total one-day VaR by risk factor ($ millions) Credit Spread plus Interest Rate Credit Spread Interest Rate Equities Foreign Exchange Commodities Debt Specific Diversification Effect All-Bank VaR All-Bank Stressed VaR 2016 2015 Year end Avg High Low Year end Avg $ $ $ 10.6 8.0 8.5 2.0 2.1 2.0 4.2 (7.6) 13.2 21.2 $ $ 10.6 8.3 6.4 2.7 1.3 2.4 6.3 (10.7) $ $ 12.6 27.6 $ $ 16.4 13.6 10.0 6.4 2.9 3.9 12.6 N/A 20.3 37.4 $ $ $ 7.5 4.5 3.0 0.8 0.6 1.3 3.7 N/A 8.7 18.0 $ $ $ 10.6 $ 8.1 4.3 4.1 0.8 2.0 7.4 (12.9) 9.0 $ 7.8 4.4 2.5 1.1 4.0 5.5 (10.8) 11.9 $ 11.3 $ 23.0 22.3 $ 24.4 $ 36.9 High 15.2 10.1 7.9 10.7 3.2 5.6 20.7 N/A Low 6.3 5.8 2.7 1.1 0.4 1.9 3.9 N/A 8.2 17.4 $ $ $ The Bank also calculates a Stressed VaR which uses the same basic methodology as the VaR. However, Stressed VaR is calculated using market volatility from a one-year time period identified as stressful, given the risk profile of the trading portfolio. The current period is the 2008/2009 credit crisis surrounding the collapse of Lehman Brothers. In fiscal 2016, the total one-day Stressed VaR for trading activities averaged $27.6 million compared to $24.4 million in 2015. Basel market risk capital requirements include IRC and CRM which capture obligor default and migration risk. On October 31, 2016 the market risk capital requirements for IRC and CRM were $407 million and $77 million, respectively. 84 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Description of trading revenue components and graphical comparison of VaR to daily P&L Chart C27 shows the distribution of daily trading revenue for fiscal 2016 and Chart C28 compares that distribution to daily VaR results. Trading revenue includes changes in portfolio value as well as the impact of new trades, commissions, fees and reserves. Some components of revenue which are calculated less frequently are pro-rated. Trading revenue averaged $6.5 million per day, compared to $6.1 million for 2015. Revenue was positive on 98% of trading days during the year, an increase from 95% in 2015. During the year, the largest single day trading loss was $8.0 million which occurred on May 2, 2016, and was smaller than the total VaR of $9.7 million on the same day. C27 Trading revenue distribution Year ended October 31, 2016 C28 Daily trading revenue vs. VaR $ millions, November 1, 2015 to October 31, 2016 40 35 30 25 20 15 10 5 0 # of days Gain Loss -7 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 18 20 25 30>30 $ millions 40 30 20 10 0 -10 -20 -30 Trading revenue VaR, 99%, 1 day holding period Q1 Q2 Q3 Q4 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 85 MANAGEMENT’S DISCUSSION AND ANALYSIS Market risk linkage to Consolidated Statement of Financial Position Trading assets and liabilities are marked to market daily and included in trading risk measures such as VaR. Derivatives risk related to Global Banking and Markets’ activities is captured under trading risk measures while derivatives used in asset/liability management are in the non-trading risk category. A comparison of Consolidated Statement of Financial Position items which are covered under the trading and non-trading risk measures is provided in the table below. T51 Market risk linkage to Consolidated Statement of Financial Position of the Bank As at October 31, 2016 ($ millions) Precious metals Trading assets Financial instruments designated at fair value through profit or loss Derivative financial instruments Investment securities Loans Assets not subject to market risk (1) Total assets Deposits Financial instruments designated at fair value through profit or loss Obligations related to securities sold short Derivative financial instruments Trading liabilities(2) Retirement and other benefit liabilities Liabilities not subject to market risk (3) Total liabilities Market Risk Measure Consolidated Statement of Financial Position Trading Risk Non-trading risk Not subject to market risk Primary risk sensitivity of non-trading risk $ 8,442 $ 8,442 $ 108,561 221 41,657 72,919 480,164 184,302 – – 221 5,256 72,919 480,164 – $ 896,266 $ 153,404 $ 558,560 108,561 – 36,401 – – – $ – – – – – – 184,302 $ 184,302 n/a n/a Interest rate Interest rate, FX, equity Interest rate, equity Interest rate, FX n/a $ 611,877 $ 1,459 23,312 42,387 8,430 3,011 147,969 – $ 580,814 1,459 – – 23,312 4,174 38,213 – 8,430 3,011 – – – $ Interest rate, FX, equity 31,063 Interest rate, equity – n/a – Interest rate, FX, equity – – n/a – Interest rate, credit spread n/a 147,969 $ 838,445 $ 69,955 $ 589,458 $ 179,032 Includes goodwill, intangibles, other assets and securities purchased under resale agreements and securities borrowed. (1) (2) Gold and silver certificates and bullion included in other liabilities. (3) Includes obligations related to securities sold under repurchase agreements and securities lent and other liabilities. As at October 31, 2015 ($ millions) Precious metals Trading assets Financial instruments designated at fair value through profit or loss Derivative financial instruments Investment securities Loans Assets not subject to market risk (1) Total assets Deposits Financial instruments designated at fair value through profit or loss Obligations related to securities sold short Derivative financial instruments Trading liabilities(2) Retirement and other benefit liabilities Liabilities not subject to market risk (3) Total liabilities Market Risk Measure Consolidated Statement of Financial Position Trading Risk Non-trading risk Not subject to market risk Primary risk sensitivity of non-trading risk $ 10,550 $ 99,140 320 41,003 43,216 458,628 203,640 10,550 $ 99,140 – 36,131 – – – – – 320 4,872 43,216 458,628 – $ – – – – – – 203,640 $ 856,497 $ 145,821 $ 507,036 $ 203,640 n/a n/a Interest rate Interest rate, FX, equity Interest rate, equity Interest rate, FX n/a $ 600,919 $ 1,486 20,212 45,270 7,812 2,054 125,265 – $ 572,766 1,486 – – 20,212 3,282 41,988 – 7,812 2,054 – – – $ 28,153 – – – – – 125,265 $ 803,018 $ 70,012 $ 579,588 $ 153,418 Interest rate, FX, equity Interest rate, equity n/a Interest rate, FX, equity n/a Interest rate, credit spread n/a Includes goodwill, intangibles, other assets and securities purchased under resale agreements and securities borrowed. (1) (2) Gold and silver certificates and bullion included in other liabilities. (3) Includes obligations related to securities sold under repurchase agreements and securities lent and other liabilities. Derivative instruments and structured transactions Derivatives The Bank uses derivatives to meet customer needs, generate revenues from trading activities, manage market and credit risks arising from its lending, funding and investment activities, and to lower its cost of capital. The Bank uses several types of derivative products, including interest rate swaps, futures and options, to hedge interest rate risk exposure. Forward contracts, swaps and options are used to manage foreign currency risk exposures. Credit exposures in its lending and investment books are managed using credit default swaps. As a dealer, the Bank markets a range of derivatives to its customers, including interest rate, foreign exchange, equity, commodity and credit derivatives. Market risk arising from derivatives transactions is subject to the control, reporting and analytical techniques noted above. Additional controls and analytical techniques are applied to address certain market-related risks that are unique to derivative products. Structured transactions Structured transactions are specialized transactions that may involve combinations of cash, other financial assets and derivatives designed to meet the specific risk management or financial requirements of customers. These transactions are carefully evaluated by the Bank to identify and address the 86 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T credit, market, legal, tax, reputational and other risks, and are subject to a cross-functional review and sign-off by Trading Management, Global Risk Management, Taxation, Finance and Legal departments. Large structured transactions are also subject to review by senior risk management committees and evaluated in accordance with the procedures described below in Reputational Risk. The market risk in these transactions is usually minimal, and returns are earned by providing structuring expertise and by taking credit risk. Once executed, structured transactions are subject to the same ongoing credit reviews and market risk analysis as other types of derivatives transactions. This review and analysis includes careful monitoring of the quality of the reference assets, and ongoing valuation of the derivatives and reference assets. Liquidity Risk Liquidity risk is the risk that the Bank is unable to meet its financial obligations in a timely manner at reasonable prices. Financial obligations include liabilities to depositors, payments due under derivative contracts, settlement of securities borrowing and repurchase transactions, and lending and investment commitments. Effective liquidity risk management is essential to maintain the confidence of depositors and counterparties, manage the Bank’s cost of funds and to support core business activities, even under adverse circumstances. Liquidity risk is managed within the framework of policies and limits that are approved by the Board of Directors. The Board receives reports on risk exposures and performance against approved limits. The Asset-Liability Committee (ALCO) provides senior management oversight of liquidity risk. The key elements of the liquidity risk framework are: (cid:129) Measurement and modeling – the Bank’s liquidity model measures and forecasts cash inflows and outflows, including off-balance sheet cash flows on a daily basis. Risk is managed by a set of key limits over the maximum net cash outflow by currency over specified short-term horizons (cash gaps), a minimum level of core liquidity, and liquidity stress tests. (cid:129) Reporting – Global Risk Management provides independent oversight of all significant liquidity risks, supporting the ALCO with analysis, risk measurement, stress testing, monitoring and reporting. (cid:129) Stress testing – the Bank performs liquidity stress testing on a regular basis, to evaluate the effect of both industry-wide and Bank-specific disruptions on the Bank’s liquidity position. Liquidity stress testing has many purposes including: – Helping the Bank to understand the potential behavior of various on-balance sheet and off-balance sheet positions in circumstances of stress; and – Based on this knowledge, facilitating the development of risk mitigation and contingency plans. The Bank’s liquidity stress tests consider the effect of changes in funding assumptions, depositor behavior and the market value of liquid assets. The Bank performs industry standard stress tests, the results of which are reviewed at senior levels of the organization and are considered in making liquidity management decisions. (cid:129) Contingency planning – the Bank maintains a liquidity contingency plan that specifies an approach for analyzing and responding to actual and potential liquidity events. The plan outlines an appropriate governance structure for the management and monitoring of liquidity events, processes for effective internal and external communication, and identifies potential counter measures to be considered at various stages of an event. A contingency plan is maintained both at the parent-level as well as for major subsidiaries. (cid:129) Funding diversification – the Bank actively manages the diversification of its deposit liabilities by source, type of depositor, instrument, term and geography. (cid:129) Core liquidity – the Bank maintains a pool of highly liquid, unencumbered assets that can be readily sold or pledged to secure borrowings under stressed market conditions or due to Bank-specific events. The Bank also maintains liquid assets to support its intra-day settlement obligations in payment, depository and clearing systems. Liquid assets Liquid assets are a key component of liquidity management and the Bank holds these types of assets in sufficient quantity to meet potential needs for liquidity management. Liquid assets can be used to generate cash either through sale, repurchase transactions or other transactions where these assets can be used as collateral to generate cash, or by allowing the asset to mature. Liquid assets include deposits at central banks, deposits with financial institutions, call and other short-term loans, marketable securities, precious metals and securities received as collateral from securities financing and derivative transactions. Liquid assets do not include borrowing capacity from central bank facilities. Marketable securities are securities traded in active markets, which can be converted to cash within a timeframe that is in accordance with the Bank’s liquidity management framework. Assets are assessed considering a number of factors, including the expected time it would take to convert them to cash. Marketable securities included in liquid assets are comprised of securities specifically held as a liquidity buffer or for asset liability management purposes; trading securities, which are primarily held by Global Banking and Markets; and collateral received for securities financing and derivative transactions. The Bank maintains large holdings of unencumbered liquid assets to support its operations. These assets generally can be sold or pledged to meet the Bank’s obligations. As at October 31, 2016, unencumbered liquid assets were $183 billion (October 31, 2015 – $201 billion). Securities including NHA mortgage-backed securities, comprised 74% of liquid assets (October 31, 2015 – 62%). Other unencumbered liquid assets, comprising cash and deposits with central banks, deposits with financial institutions, precious metals and call and short loans, was 26% (October 31, 2015 – 38%). The decrease in liquid assets was mainly attributable to a decrease in cash and deposits with central banks, partly offset by an increase in unencumbered government securities. The carrying values outlined in the liquid asset table are consistent with the carrying values in the Bank’s Statement of Financial Position as at October 31, 2016. The liquidity value of the portfolio will vary under different stress events as different assumptions are used for the stress scenarios. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 87 MANAGEMENT’S DISCUSSION AND ANALYSIS The Bank’s liquid asset pool is summarized in the following table: T52 Liquid asset pool As at October 31, 2016 ($ millions) Cash and deposits with central banks Deposits with financial institutions Precious metals Securities Canadian government obligations Foreign government obligations Other securities Loans NHA mortgage-backed securities(2) Call and short loans Encumbered liquid assets Unencumbered liquid assets Bank-owned liquid assets Securities received as collateral from securities financing and derivative transactions Total liquid assets Pledged as collateral Other(1) Available as collateral Other $ 35,396 10,948 8,442 45,825 50,761 58,833 33,072 1,673 $ – – – 12,482 36,822 60,745 – – $ $ 35,396 10,948 8,442 $ – – – $ 7,917 196 115 58,307 87,583 119,578 33,072 1,673 27,187 58,680 76,394 1,993 – – – – – – 27,479 10,752 8,327 31,120 28,903 43,184 31,079 1,673 $ – – – – – – – – Total $ 244,950 $ 110,049 $ 354,999 $ 164,254 $ 8,228 $ 182,517 $ – As at October 31, 2015 ($ millions) Cash and deposits with central banks Deposits with financial institutions Precious metals Securities Canadian government obligations Foreign government obligations Other securities Loans NHA mortgage-backed securities(2) Call and short loans Encumbered liquid assets Unencumbered liquid assets Bank-owned liquid assets Securities received as collateral from securities financing and derivative transactions Total liquid assets Pledged as collateral Other(1) Available as collateral Other $ 63,228 10,699 10,550 24,198 39,525 52,396 36,409 1,352 $ – – – 21,206 29,989 55,752 – – $ $ 63,228 10,699 10,550 $ – – – $ 8,700 293 117 45,404 69,514 108,148 36,409 1,352 22,242 44,547 65,405 2,847 – – – – – – 54,528 10,406 10,433 23,162 24,967 42,743 33,562 1,352 $ – – – – – – – – Total $ 238,357 $ 106,947 $ 345,304 $ 135,041 $ 9,110 $ 201,153 $ – (1) Assets which are restricted from being used to secure funding for legal or other reasons. (2) These mortgage-backed securities, which are available for sale, are reported as residential mortgage loans on the balance sheet. A summary of total unencumbered liquid assets held by the parent bank and its branches, and domestic and foreign subsidiaries, is presented below: T53 Total unencumbered liquid assets held by the parent bank and its branches, and domestic and foreign subsidiaries As at October 31 ($ millions) Bank of Nova Scotia (Parent) Bank domestic subsidiaries Bank foreign subsidiaries Total 2016 2015 $ 135,335 13,871 33,311 $ 154,830 20,374 25,949 $ 182,517 $ 201,153 The Bank’s liquidity pool is held across major currencies, mostly comprised of Canadian and U.S. dollar holdings. As shown above, the vast majority (82%) of liquid assets are held by the Bank’s corporate office, branches of the Bank, and Canadian subsidiaries of the Bank. To the extent a liquidity reserve held in a foreign subsidiary of the Bank is required for regulatory purposes, it is assumed to be unavailable to the rest of the Group. Other liquid assets held by a foreign subsidiary are assumed to be available only in limited circumstances. The Bank monitors and ensures compliance in relation to minimum levels of liquidity required and assets held within each entity, and/or jurisdiction. 88 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T Encumbered assets In the course of the Bank’s day-to-day activities, securities and other assets are pledged to secure an obligation, participate in clearing or settlement systems, or operate in a foreign jurisdiction. Securities may also be pledged under repurchase agreements. A summary of encumbered and unencumbered assets is presented below: T54 Asset Encumbrance As at October 31, 2016 ($ millions) Cash and deposits with central banks Deposits with financial institutions Precious metals Liquid securities: Canadian government obligations Foreign government obligations Other liquid securities Other securities Loans classified as liquid assets: NHA mortgage-backed securities Call and short loans Other loans Other financial assets(4) Non-financial assets Total As at October 31, 2015 ($ millions) Cash and deposits with central banks Deposits with financial institutions Precious metals Liquid securities: Canadian government obligations Foreign government obligations Other liquid securities Other securities Loans classified as liquid assets: NHA mortgage-backed securities Call and short loans Other loans Other financial assets(4) Non-financial assets Total Bank-owned assets Securities received as collateral from securities financing and derivative transactions $ 35,396 10,948 8,442 45,825 50,761 58,833 5,007 33,072 1,673 464,840 151,916 29,553 $ – – – 12,482 36,822 60,745 4,149 – – – (84,399) – Encumbered assets Unencumbered assets Total assets $ 35,396 10,948 8,442 $ 58,307 87,583 119,578 9,156 33,072 1,673 464,840 67,517 29,553 Pledged as collateral – – – 27,187 58,680 76,394 3,615 1,993 – 5,934 5,316 – $ Other(1) 7,917 196 115 – – – – – – 60,311 – – Available as collateral(2) Other(3) $ 27,479 10,752 8,327 31,120 28,903 43,184 – 31,079 1,673 11,596 – – $ – – – – – – 5,541 – – 386,999 62,201 29,553 $ 896,266 $ 29,799 $ 926,065 $ 179,119 $ 68,539 $ 194,113 $ 484,294 Bank-owned assets Securities received as collateral from securities financing and derivative transactions $ 63,228 10,699 10,550 24,198 39,525 52,396 5,797 36,409 1,352 439,207 145,063 28,073 $ – – – 21,206 29,989 55,752 3,313 – – – (80,907) – Encumbered assets Unencumbered assets Total assets $ 63,228 10,699 10,550 $ 45,404 69,514 108,148 9,110 36,409 1,352 439,207 64,156 28,073 Pledged as collateral – – – 22,242 44,547 65,405 2,806 2,847 – 2,915 5,299 – $ Other(1) 8,700 293 117 – – – – – – 49,481 – – Available as collateral(2) Other(3) $ 54,528 10,406 10,433 23,162 24,967 42,743 – 33,562 1,352 9,134 – – $ – – – – – – 6,304 – – 377,677 58,857 28,073 $ 856,497 $ 29,353 $ 885,850 $ 146,061 $ 58,591 $ 210,287 $ 470,911 (1) Assets which are restricted from being used to secure funding for legal or other reasons. (2) Assets that are readily available in the normal course of business to secure funding or meet collateral needs including central bank borrowing immediately available. (3) Other unencumbered assets are not subject to any restrictions on their use to secure funding or as collateral but the Bank would not consider them to be readily available. These include loans, a portion of which may be used to access central bank facilities outside of the normal course or to raise secured funding through the Bank’s secured funding programs. (4) Securities received as collateral against other financial assets are included within liquid securities and other securities. As of October 31, 2016 total encumbered assets of the Bank were $248 billion (October 31, 2015 – $205 billion). Of the remaining $678 billion (October 31, 2015 – $681 billion) of unencumbered assets, $194 billion (October 31, 2015 – $210 billion) are considered readily available in the normal course of business to secure funding or meet collateral needs as detailed above. In some over-the-counter derivative contracts, the Bank would be required to post additional collateral in the event its credit rating was downgraded. The Bank maintains access to sufficient collateral to meet these obligations in the event of a downgrade of its ratings by one or more of the rating agencies. In the event of a one-notch or two-notch downgrade of the Bank’s rating below its lowest current rating, the Bank has to provide an additional $98 million or $218 million of collateral, respectively, to meet contractual derivative funding or margin requirements. Encumbered liquid assets are not considered to be available for liquidity management purposes. Liquid assets which are used to hedge derivative positions in trading books or for hedging purposes are considered to be available for liquidity management provided they meet the criteria discussed in liquid assets above. Regulatory developments relating to liquidity The Net Stable Funding Ratio (NSFR) is expected to become a minimum standard in OSFI’s liquidity framework by November 1, 2017, following a consultation process with banks and the public. The NSFR is aimed at reducing structural funding risk by requiring banks to fund their activities with sufficiently stable sources of funding. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 89 MANAGEMENT’S DISCUSSION AND ANALYSIS Liquidity coverage ratio The Liquidity Coverage Ratio (LCR) measure is based on a 30 day liquidity stress scenario, with assumptions defined in the OSFI Liquidity Adequacy Requirements (LAR) Guideline. The LCR is calculated as the ratio of high quality liquid assets (HQLA) to net cash outflows. The Bank is subject to a regulatory minimum LCR of 100%. OSFI’s LAR stipulates that banks must maintain an adequate level of unencumbered HQLA that can be converted into cash to meet liquidity needs over a 30 calendar day horizon under a pre-defined significantly severe liquidity stress scenario. The LCR-prescribed liquidity stress scenario includes assumptions for asset haircuts, deposit run-off, wholesale rollover rates, and outflow rates for commitments. The HQLA are grouped into three categories: Level 1, Level 2A and Level 2B, based on guidelines from the LAR. Level 1 HQLA receive no haircuts, and includes cash, deposits with central banks, central bank reserves available to the Bank in times of stress, and securities with a 0% risk weight. Level 2A and 2B include HQLA of lesser quality and attracts haircuts ranging from 15%-50%. The total weighted values for net cash outflows for the next 30 days are derived by applying the assumptions specified in the LAR Guideline to specific items, including loans, deposits, maturing debt, derivative transactions and commitments to extend credit. The following table presents the Bank’s average LCR for the quarter ended October 31, 2016, based on month-end LCR calculations for August, September and October. T55 Bank’s average LCR For the quarter ended October 31, 2016 ($ millions) High-quality liquid assets Total high-quality liquid assets (HQLA) Cash outflows Retail deposits and deposits from small business customers, of which: Stable deposits Less stable deposits Unsecured wholesale funding, of which: Operational deposits (all counterparties) and deposits in networks of cooperative banks Non-operational deposits (all counterparties) Unsecured debt Secured wholesale funding Additional requirements, of which: Outflows related to derivative exposures and other collateral requirements Outflows related to loss of funding on debt products Credit and liquidity facilities Other contractual funding obligations Other contingent funding obligations(3) Total cash outflows Cash inflows Secured lending (e.g. reverse repos) Inflows from fully performing exposures Other cash inflows Total cash inflows Total HQLA Total net cash outflows Liquidity coverage ratio (%) For the quarter ended October 31, 2015 ($ millions) Total HQLA Total net cash outflows Liquidity coverage ratio (%) Total unweighted value (Average)(1) Total weighted value (Average)(2) * $ 136,401 160,438 73,193 87,245 155,616 37,039 96,196 22,381 169,782 17,134 5,681 146,967 3,002 426,203 * 11,070 2,346 8,724 82,996 8,957 51,658 22,381 37,940 42,806 17,097 5,681 20,028 1,292 7,182 * $ 183,286 $ 105,477 21,534 28,028 $ 34,145 13,291 28,028 $ 155,039 $ 75,464 Total adjusted value(4) * * * $ 136,401 $ 107,822 127% Total adjusted value(4) * * * $ 145,859 $ 117,474 124% * Disclosure is not required under regulatory guideline. (1) Unweighted values represent outstanding balances maturing or callable within the next 30 days. (2) Weighted values represent balances calculated after the application of HQLA haircuts or inflow and outflow rates, as prescribed by the OSFI LAR guidelines. (3) Total unweighted value includes uncommitted credit and liquidity facilities, guarantees and letters of credit, outstanding debt securities with remaining maturity greater than 30 days, and other contractual cash outflows. (4) Total adjusted value represents balances calculated after the application of both haircuts and inflow and outflow rates and any applicable caps. HQLA continues to be substantially comprised of Level 1 assets (as defined in the LAR guideline). The increase in the Bank’s average LCR for the quarter ended October 31, 2016 versus the average for the quarter ended October 31, 2015 was attributable to normal business activity. 90 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T The Bank’s significant operating currencies are Canadian and U.S. dollars. The Bank monitors its significant currency exposures in accordance with its liquidity risk management framework and risk appetite. Funding The Bank ensures that its funding sources are well diversified. Funding concentrations are regularly monitored and analyzed by type. The sources of funding are capital, deposits from retail and commercial clients sourced through the Canadian and international branch network, deposits from financial institutions as well as wholesale debt issuance. Capital and personal deposits are key components of the Bank’s core funding and these amounted to $266 billion as at October 31, 2016 (October 31, 2015 – $251 billion). The increase since October 31, 2015, was due primarily to personal deposits, internal capital generation and the issuance of NVCC subordinated debentures and preferred shares, net of redemptions. A portion of commercial deposits, particularly those of an operating or relationship nature, would be considered part of the Bank’s core funding. Furthermore, core funding is augmented by longer term wholesale debt issuances (original maturity over 1 year) of $141 billion (October 31, 2015 – $137 billion). Longer term wholesale debt issuances include medium-term notes, deposit notes, mortgage securitization, asset-backed securities and covered bonds. The increase since October 31, 2015, was primarily due to foreign exchange movement. The Bank operates in many different currencies and countries. From a funding perspective, the most significant currencies are Canadian and U.S. dollars. With respect to the Bank’s operations outside Canada, there are different funding strategies depending on the nature of the activities in a country. For those countries where the Bank operates a branch banking subsidiary, the strategy is for the subsidiary to be substantially self-funding in its local market. For other subsidiaries or branches outside Canada where local deposit gathering capability is not sufficient, funding is provided through the wholesale funding activities of the Bank. From an overall funding perspective the Bank’s objective is to achieve an appropriate balance between the cost and the stability of funding. Diversification of funding sources is a key element of the funding strategy. The Bank’s wholesale debt diversification strategy is primarily executed via the Bank’s main wholesale funding centres, located in Toronto, New York, London and Singapore. The majority of these funds are sourced in Canadian and U.S. dollars. Where required, these funds are swapped to fund assets in different currencies. The funding strategy deployed by wholesale funding centres and the management of associated risks, such as geographic and currency risk, are managed centrally within the framework of policies and limits that are approved by the Board of Directors. In the normal course, the Bank uses a mix of unsecured and secured wholesale funding instruments across a variety of markets. The choice of instruments and markets is based on a number of factors, including relative cost and market capacity as well as an objective of maintaining a diversified mix of sources of funding. Market conditions can change over time, impacting cost and capacity in particular markets or instruments. Changing market conditions can include periods of stress where the availability of funding in particular markets or instruments is constrained. In these circumstances the Bank would increase its focus on sources of funding in functioning markets and secured funding instruments. Should a period of extreme stress exist such that all wholesale funding sources are constrained, the Bank maintains a pool of liquid assets to mitigate its liquidity risk. This pool includes cash, deposits with central banks and securities. In Canada, the Bank raises short- and longer-term wholesale debt through the issuance of senior unsecured deposit notes. Additional longer-term wholesale debt is generated through the Bank’s Canadian Debt and Equity Shelf and the securitization of Canadian insured residential mortgages through CMHC securitization programs (such as Canada Mortgage Bonds), uninsured residential mortgages through the Bank’s Covered Bond Program, unsecured personal lines of credit through the Hollis Receivables Term Trust II Shelf and retail credit card receivables through the Trillium Credit Card Trust II Shelf. While the Bank includes CMHC securitization programs in its view of wholesale debt issuance, this source of funding does not entail the same type of run-off risk that can be experienced in funding raised from capital markets. Outside of Canada, short-term wholesale debt is raised through the issuance of negotiable certificates of deposit in the United States, Hong Kong and Australia and the issuance of commercial paper in the United States. The Bank operates longer-term wholesale debt issuance registered programs in the United States, such as its SEC Registered Debt and Equity Shelf and non-registered programs, such as the securitization of retail indirect auto loan receivables through Securitized Term Auto Receivables Trust 2016-1. The Bank’s Covered Bond Program is listed with the U.K. Listing Authority, and the Bank may issue under the program in Europe, the United States, Australia and Switzerland. The Bank also raises longer-term funding across a variety of currencies through its Australian Medium Term Note Programme, European Medium Term Note Programme and Singapore Medium Term Note Programme. The Bank’s European Medium Term Note Programme is listed with the U.K. Listing Authority, Swiss Stock Exchange and the Tokyo Pro-Bond Market. The Bank’s Singapore Medium Term Note Programme is listed with the Singapore Exchange and the Taiwan Exchange. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 91 MANAGEMENT’S DISCUSSION AND ANALYSIS The table below provides the remaining contractual maturities of funding raised through wholesale funding. In the Statement of Financial Position, these liabilities are primarily included in Business & Government Deposits. T56 Wholesale funding(1) As at October 31, 2016 ($ millions) Deposits from banks(2) Bearer deposit notes, commercial paper and certificate of deposits Asset-backed commercial paper(3) Medium term notes and deposit notes Asset-backed securities Covered bonds Mortgage securitization(4) Subordinated debentures(5) Total wholesale funding sources Of Which: Less than 1 month 1-3 months 3-6 months 6-9 months 9-12 months Sub-Total < 1 Year 1-2 years 2-5 years >5 years Total $ 2,958 $ 571 $ 187 $ 148 $ 31 $ 3,895 $ 103 $ 149 $ 11,434 16,838 25,324 8,181 7,357 69,134 3,151 2,625 1,573 – – – 22 3,978 5,700 451 3,353 1,376 30 1,906 4,576 25 2,707 663 62 – 3,681 26 – 950 1 – 8,509 – 3,962 189 – 1,063 3 19,492 691 6,060 4,052 118 21,935 1,218 3,413 2,102 – 333 – 31,195 1,555 19,160 7,834 109 – – – 7,576 417 1,381 3,782 8,767 $ 4,147 72,618 8,509 80,198 3,881 30,014 17,770 8,994 $ 18,612 $ 32,297 $ 35,450 $ 12,987 $ 12,605 $ 111,951 $ 31,922 $ 60,335 $ 21,923 $ 226,131 Unsecured funding Secured funding $ 15,987 2,625 $ 23,139 9,158 $ 30,149 5,301 $ 12,011 976 $ 11,353 1,252 $ 92,639 19,312 $ 25,189 6,733 $ 31,786 28,549 $ 16,343 5,580 $ 165,957 60,174 As at October 31, 2015 ($ millions) Deposits from banks(2) Bearer deposit notes, commercial paper and certificate of deposits Asset-backed commercial paper(3) Medium term notes and deposit notes Asset-backed securities Covered bonds Mortgage securitization(4) Subordinated debentures(5) Total wholesale funding sources Of Which: Less than 1 month 1-3 months 3-6 months 6-9 months 9-12 months Sub-Total < 1 Year 1-2 years 2-5 years >5 years Total $ 3,553 $ 904 $ 343 $ 211 $ 122 $ 5,133 $ 88 $ 80 $ – $ 5,301 15,006 20,128 42,633 13,417 3,671 94,855 4,195 1,720 390 – – – 19 3,920 2,365 1 – 1,208 59 1,648 7,565 – – 794 64 – 6,149 – – 997 3 – 7,288 – 1,837 500 2,615 829 6 18,306 501 2,615 3,828 151 16,926 661 5,909 4,100 – 964 – 33,674 1,042 11,359 6,214 20 36 – 9,929 440 2,473 5,632 6,626 100,050 7,288 78,835 2,644 22,356 19,774 6,797 $ 20,688 $ 28,585 $ 53,047 $ 20,777 $ 9,580 $ 132,677 $ 31,879 $ 53,353 $ 25,136 $ 243,045 Unsecured funding Secured funding $ 18,968 1,720 $ 23,456 5,129 $ 50,605 2,442 $ 19,780 997 $ 5,636 3,944 $ 118,445 14,232 $ 21,209 10,670 $ 34,738 18,615 $ 16,591 8,545 $ 190,983 52,062 (1) Wholesale funding sources exclude repo transactions and bankers acceptances, which are disclosed in T57 Contractual maturities. Amounts are based on remaining term to maturity. (2) Only includes commercial bank deposits raised by Group Treasury. (3) Wholesale funding sources also exclude asset-backed commercial paper issued by certain ABCP conduits that are not consolidated for financial reporting purposes. (4) Represents residential mortgages funded through Canadian Federal Government agency sponsored programs. Funding accessed through such programs does not impact the funding capacity of the Bank in its own name. (5) Although subordinated debentures are a component of regulatory capital, they are included in this table in accordance with EDTF recommended disclosures. 92 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Wholesale funding generally bears a higher risk of run-off in a stressed environment than other sources of funding. The Bank mitigates this risk through funding diversification, ongoing engagement with investors and by maintaining a large holding of unencumbered liquid assets. Unencumbered liquid assets of $183 billion as at October 31, 2016 (October 31, 2015 – $201 billion) were well in excess of wholesale funding sources that mature in the next twelve months. Contractual maturities and obligations The table below provides the maturity of assets and liabilities as well as the off-balance sheet commitments as at October 31, 2016, based on the contractual maturity date. From a liquidity risk perspective the Bank considers factors other than contractual maturity in the assessment of liquid assets or in determining expected future cash flows. In particular, for securities with a fixed maturity date, the ability and time horizon to raise cash from these securities is more relevant to liquidity management than contractual maturity. For other assets and deposits the Bank uses assumptions about rollover rates to assess liquidity risk for normal course and stress scenarios. Similarly, the Bank uses assumptions to assess the potential drawdown of credit commitments in various scenarios. The Bank’s contractual obligations include contracts and purchase obligations, including agreements to purchase goods and services that are enforceable, legally binding on the Bank and affect the Bank’s liquidity and capital resource needs. The Bank leases a large number of its branches, offices and other locations. The majority of these leases are for a term of five years, with options to renew. The total cost of these leases, net of rental income from subleases, was $428 million in 2016 (2015 – $433 million). The decrease reflects cost reductions resulting from structural cost transformation initiatives, partially offset by unfavourable forex impact. Two major outsourcing contracts have been entered into by the Bank. Both are cancellable with notice. The largest is a contract with IBM Canada entered into in 2001 to manage the Bank’s domestic computer operations, including data centres, branches, Automated Banking Machines, and desktop computing environment. The contract was expanded in 2005 to also include the computer operations for the Caribbean & Central America, and Mexico. The contract for the Canadian operations, Mexico and Caribbean & Central America was renewed earlier in 2013, for a further five year period. The second is with Symcor Inc. consisting of two contracts (a 2 year term and a 5 year term with a renewal option) to manage the Bank’s cheque and bill payment processing, including associated statement and report printing activities and cheque services across Canada. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 93 MANAGEMENT’S DISCUSSION AND ANALYSIS T57 Contractual maturities ($ millions) Assets Cash and deposits with financial institutions and precious metals Trading assets Financial instruments designated at fair value Less than one month One to three months Three to six months Six to nine months Nine to twelve months One to two years Two to five years Over five years No specific maturity Total As at October 31, 2016 $ 37,703 $ 8,579 1,071 $ 7,984 320 $ 237 $ 2,485 2,754 1,198 $ 2,762 932 $ 537 $ 38 $ 4,683 17,149 20,109 12,750 $ 42,056 54,786 108,561 through profit or loss – – – – 205 – 16 – – 221 Securities purchased under resale agreement and securities borrowed Derivative financial instruments Investment securities – available-for-sale Investment securities – held-to-maturity Loans Residential mortgages Personal and credit cards Business and government Allowance for credit losses Customers’ liabilities under acceptances Other assets Liabilities and equity Deposits Personal Non-personal Financial instruments designated at fair value through profit or loss Acceptances Obligations related to securities sold short Derivative financial instruments Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Other liabilities Total equity Off-Balance sheet commitments Operating leases Credit commitments(3) Financial guarantees(4) Outsourcing obligations 70,343 2,311 1,933 207 23,431 3,382 2,790 17,259 – 9,899 – 13,250 3,041 4,088 439 24,057 5,485 2,484 16,088 – 1,816 – 6,156 1,210 3,265 1,162 26,091 8,771 2,902 14,418 – 248 – 1,541 1,218 2,641 522 25,375 12,693 3,154 9,528 – 9 – 839 900 1,301 1,003 26,331 10,796 2,777 12,758 – 6 – – 3,694 5,666 4,347 81,473 48,038 10,277 23,158 – – – – 9,986 23,587 14,434 190,391 112,675 20,914 56,802 – – – – 19,297 5,945 296 31,851 19,265 5,813 6,773 – – – – – 2,083 – 51,164 1,783(1) 48,391 5,616(2) (4,626) – 33,851 92,129 41,657 50,509 22,410 480,164 222,888 99,502 162,400 (4,626) 11,978 33,851 $ 55,066 $ 59,091 $ 55,977 $ 24,792 $ 22,794 $ 50,504 $ 6,944 48,122 8,892 50,199 9,131 46,846 7,392 17,400 6,501 16,293 15,206 35,298 75,096 $ 13,125 $ 255,432 $ 611,877 199,302 16,317 412,575 58,779 128,370 127,062 549 12,576 – 9,899 80 1,711 87,130 – 568 – 4 1,816 200 2,237 7,050 – 819 – – 248 388 1,399 215 – 591 – – 9 897 1,399 335 – 316 – 3 6 22 1,035 2,352 – 550 – 110 – 2,755 4,267 1 – 1,434 – 1,038 – 4,544 10,473 – – 2,432 – 304 – 9,039 19,866 – 7,633 4,094 – – – 5,387 – – – 31,912 57,821 1,459 11,978 23,312 42,387 97,083 7,633 42,716 57,821 $ 28 $ 60 $ 88 $ 85 $ 83 $ 291 $ 631 $ 536 $ 5,081 – 17 5,170 – 35 12,498 – 50 15,381 – 49 20,870 – 49 15,723 – 197 93,842 – 114 5,680 – – – $ – 35,297 1 1,802 174,245 35,297 512 (1) (2) (3) (4) Includes primarily impaired mortgages. Includes primarily overdrafts and impaired loans. Includes the undrawn component of committed credit and liquidity facilities. Includes outstanding balances of guarantees, standby letters of credit and commercial letters of credit which may expire undrawn. 94 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T ($ millions) Assets Cash and deposits with financial institutions and precious metals Trading assets Financial instruments designated at fair value through profit or loss Securities purchased under resale agreement and securities borrowed Derivative financial instruments Investment securities – available-for-sale Investment securities – held-to-maturity Loans Residential mortgages Personal and credit cards Business and government Allowance for credit losses Customers’ liabilities under acceptances Other assets Liabilities and equity Deposits Personal Non-personal Financial instruments designated at fair value through profit or loss Acceptances Obligations related to securities sold short Derivative financial instruments Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Other liabilities Total equity Off-Balance sheet commitments Operating leases Credit commitments(3) Financial guarantees(4) Outsourcing obligations Less than one month One to three months Three to six months Six to nine months Nine to twelve months One to two years Two to five years Over five years No specific maturity Total As at October 31, 2015 $ 65,315 6,595 $ 1,367 6,148 $ 477 4,580 $ 593 3,467 $ 567 1,177 $ 593 6,599 $ 892 12,665 $ 7 19,759 $ 14,666 38,150 $ 84,477 99,140 – – 66 – – – 16 – 238 320 65,182 2,789 1,292 – 25,763 3,120 2,456 20,187 – 7,987 – 11,121 2,412 2,215 – 24,120 5,695 1,732 16,693 – 2,120 – 5,738 1,580 3,941 65 27,190 11,584 2,577 13,029 – 146 – 2,003 1,168 2,059 – 23,976 11,690 2,607 9,679 – 37 – 3,268 1,479 2,136 4 24,561 11,570 2,500 10,491 – 6 – – 3,761 7,423 111 71,989 43,088 10,146 18,755 – – – – 9,541 16,185 463 181,600 108,597 19,563 53,440 – – – – 18,273 4,291 8 32,772 20,366 5,719 6,687 – – – – – 3,023 – 46,657 1,788(1) 44,177 4,889(2) (4,197) – 32,105 87,312 41,003 42,565 651 458,628 217,498 91,477 153,850 (4,197) 10,296 32,105 $ 54,015 6,506 47,509 $ 50,230 7,960 42,270 $ 67,936 8,938 58,998 $ 33,177 8,303 24,874 $ 19,993 7,186 12,807 $ 50,181 15,762 34,419 $ 68,116 16,646 51,470 $ 17,118 326 16,792 $ 240,153 118,417 121,736 $ 600,919 190,044 410,875 – 7,987 52 3,767 60,814 – 867 – $ $ 27 6,633 – 19 18 2,120 50 2,196 8,232 – 1,535 – 57 6,588 – 36 – 146 208 1,912 4,483 – 358 – – 37 162 1,182 332 – 533 – 7 6 223 1,241 3,154 – 307 – 9 – 2,530 3,786 648 – 5,425 11,109 804 – 7,851 20,077 – – 878 – – – 2,444 – $ 83 16,985 – 51 $ 81 16,264 – 50 $ 80 18,052 – 50 $ 285 20,335 – 183 $ 595 76,660 – 225 $ – – 3,711 – – – 30,913 53,479 1,486 10,296 20,212 45,270 77,015 6,182 41,638 53,479 $ – 5 31,865 1 $ 1,754 166,400 31,865 619 – 6,182 3,803 – 546 4,878 – 4 (1) (2) (3) (4) Includes primarily impaired mortgages. Includes primarily overdrafts and impaired loans. Includes the undrawn component of committed credit and liquidity facilities. Includes outstanding balances of guarantees, standby letters of credit and commercial letters of credit which may expire undrawn. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 95 MANAGEMENT’S DISCUSSION AND ANALYSIS Other Risks Operational Risk Operational risk is the risk of loss, whether direct or indirect, to which the Bank is exposed due to inadequate or failed internal processes or systems, human error, or external events. Operational risk includes legal and regulatory risk, business process and change risk, fiduciary or disclosure breaches, technology failure, financial crime and environmental risk. It exists in some form in every Bank business and function. Operational risk can not only result in financial loss, but also regulatory sanctions and damage to the Bank’s reputation. The Bank is very successful at managing operational risk with a view to safeguarding client assets and preserving shareholder value. In fiscal 2016, operational risk losses continue to be within the Bank’s risk appetite. Governance and organization The Bank has developed policies, processes and assessment methodologies to ensure that operational risk is appropriately identified and managed with effective controls. The governing principles of the Bank’s Operational Risk Management Framework include: (cid:129) The three lines of defence model helps to ensure proper accountability and clearly defines the roles and responsibilities for operational risk management. The first line of defence is the business units, who own the risks in their businesses and operations. The second line of defence is led by a central risk management unit within Global Risk Management, with support from control and stewardship functions across the Bank. The third line of defence is Internal Audit. (cid:129) The individual business lines are accountable for the identification, management and control of the significant operational risks to which they are exposed. The Bank has a governance and organizational structure through which there is effective oversight and in which operational risk is managed to an established risk appetite, including: (cid:129) The Board of Directors is responsible for sound corporate governance and approves biennially the Bank’s Operational Risk Management Policy; (cid:129) A senior level Operational & Compliance Risk Committee comprised of Heads of business lines and key control functions, and chaired by the Chief Risk Officer. This Committee provides consistent, Bank-wide oversight of operational and compliance risk management; (cid:129) Business-line level committees are in place to ensure operational risk issues are known, discussed, managed and escalated, as needed and in a timely manner; (cid:129) Executive management with clearly defined areas of responsibility; (cid:129) A central unit in Global Risk Management responsible for: developing methods to identify, assess, manage and monitor operational risks; and reporting on risks as well as actual loss events and to play a challenge role to the business units in their assessment and management of operational risk; (cid:129) Independent specialist units responsible for developing methods to mitigate specific components of operational risk, including codifying policies and processes required to control those specific risks; (cid:129) Separation of duties between key functions; and (cid:129) An independent internal audit department responsible for verifying that significant risks are identified and assessed, and for testing controls to ensure that overall risk is at an acceptable level. The Internal Audit department is also responsible for auditing and assessing the Bank’s Operational Risk Management Framework, including its design and effectiveness. Operational Risk Management Framework The Bank’s Operational Risk Management Framework sets out an integrated approach to identify, assess, control, mitigate and report operational risks across the Bank. The following are key components of the Bank’s Operational Risk Management Framework: (cid:129) The Bank’s risk and control assessment program, which includes formal reviews of significant units, operations and processes to identify and assess operational risks. This program provides a basis for management to ensure that key risks have been identified and that controls are functioning effectively. Business line management attests to the accuracy of each assessment and develops action plans to mitigate residual risk exposure, as appropriate. Results of these reviews are summarized and reported to executive management and the Board of Directors. (cid:129) The Bank has a standard inventory of operational risks which are discussed and considered in each risk assessment. (cid:129) The Bank’s scenario analysis program provides a forward looking view of key risks and provides management with insights into how plausible but highly unlikely operational risk events might occur. Scenario analysis will also assist in the selection of severity distributions in the Bank’s Advanced Measurement Approach (AMA) capital model (discussed below). (cid:129) The Bank’s Key Risk Indicator (KRI) program provides information on the level of exposure to a given operational risk to a particular point in time and can help to monitor potential shifts in risk conditions or new emerging risk and/or measure residual risk exposure and effectiveness of controls. KRIs exist within the business lines and at the enterprise level. (cid:129) The Business Environment and Internal Control Factors (BEICF) program incorporates the impact of key business environment and internal control factors into the regulatory capital allocated to divisions by utilizing a BEICF scorecard. The scorecard will be used to potentially adjust capital calculations produced using the Bank’s AMA capital model and due to its forward-looking nature, it also assists with identifying new trends and emerging risks. (cid:129) The Bank’s centralized operational loss event database, which is managed and maintained by the central operational risk unit within Global Risk Management, captures key information on operational losses. This data is analyzed, benchmarked against industry loss data and significant metrics, then reported to executive management and the Board of Directors to provide insight into operational risk exposures, appetites and trends. (cid:129) Operational risk is difficult to quantify in a fulsome and accurate manner, due to the nature of operational risk itself. Operational risk is often included with or is a by-product of another form of risk and is not taken on intentionally. Tools for operational risk management and measurement continue to evolve across the global financial services industry. There are two methods for the calculation of operational risk regulatory capital available to the Bank under Basel framework – The Standardized Approach and the Advanced Measurement Approach (AMA). The Bank was approved by OSFI in August 2016 to use AMA; implementation is planned for FY2017. (cid:129) Operational risk reporting is provided to the Bank’s senior executive management and the Board of Directors, and includes information relating to key events, results, trends and themes across the operational risk tools. The combination of these information sources provides both a backward and forward-looking view of operational risk at the Bank. 96 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | R I S K M A N A G E M E N T (cid:129) The Bank is a member of the Operational Riskdata Exchange Association (ORX), an international consortium of banks that share anonymized loss data. This industry data is used to support risk identification, assessment and will be used as an input to the Bank’s AMA capital model. Discussion forums within ORX also help to ensure that the Bank is current of all industry best practices and developments. (cid:129) The Bank’s Fraud Management Office, which identifies threats of financial crime, implements systems and processes to mitigate loss and reports on fraud loss activity to senior management. (cid:129) The Bank’s monitoring of industry events, identifies significant losses incurred at other financial institutions and provides a reference for reviewing and assessing the Bank’s own risk exposure. (cid:129) The compliance risk management program led by Global Compliance through an established network and associated processes that include: monitoring regulatory changes; conducting compliance risk assessments; implementing policies and procedures; training; monitoring and resolving issues; and reporting on the status of compliance and compliance controls to executive management, the Board of Directors, and regulators as required. (cid:129) The Bank’s New Products and Services Risk Management Policy which describes the general principles applicable to the review, approval and implementation of new products and services within Scotiabank and is intended to provide overarching guidance. Processes are in place at the all- Bank level and in each business line for evaluation of risk in new businesses, services and products. (cid:129) The Bank’s Business Continuity Management Department is responsible for governance and oversight of the Bank’s business continuity, and monitors units to ensure compliance with these policies. The Bank’s business continuity management policy requires that all business units develop business continuity capabilities for their respective functions. (cid:129) The Bank is exposed to ever increasing cyber risks, which may include theft of assets, unauthorized access to sensitive information, or operational disruption such as breaches or denials of service attacks, and has implemented a robust and continuously evolving cyber security program in response. While the Bank’s computer systems continue to be subject to cyber-attack attempts, the countermeasures in place remain effective. Scotiabank has not experienced material breaches of cyber security. The Bank continues to actively monitor this risk, leveraging external threat intelligence, internal monitoring, reviewing best practices and implementing additional controls as required, to mitigate these risks. (cid:129) The Bank’s Model Risk Management Policy, which provides the framework for model review and approval under the oversight of the Operational Risk Committee. (cid:129) The Bank’s training programs, including the mandatory Anti-Money Laundering, Operational Risk and Information Security courses and examinations which ensure employees are aware and equipped to safeguard our customers’ and the Bank’s assets. (cid:129) Risk mitigation programs, which use insurance policies to transfer the risk of high severity losses, where feasible and appropriate. Reputational Risk Reputational risk is the risk that negative publicity regarding Scotiabank’s conduct, business practices or associations, whether true or not, will adversely affect its revenues, operations or customer base, or require costly litigation or other defensive measures. Negative publicity about an institution’s business practices may involve any aspect of its operations, but usually relates to questions of business ethics and integrity, or quality of products and services. Negative publicity and attendant reputational risk frequently arise as a by-product of some other kind of risk management control failure. Reputational risk is managed and controlled throughout the Bank by codes of conduct, governance practices and risk management programs, policies, procedures and training. Many relevant checks and balances are outlined in greater detail under other risk management sections, particularly Operational Risk, where reference is made to the Bank’s well-established compliance program. All directors, officers and employees have a responsibility to conduct their activities in accordance with Scotiabank’s Code of Conduct, and in a manner that minimizes reputational risk. While all employees, officers and directors are expected to protect the reputation of Scotiabank by complying with Scotiabank’s Code of Conduct, the activities of the Legal, Corporate Secretary, Public, Corporate and Government Affairs and Compliance departments, and the Reputational Risk Committee, are particularly oriented to the management of reputational risk. In providing credit, advice, or products to customers, or entering into associations, the Bank considers whether the transaction, relationship or association might give rise to reputational risk. The Bank has an established, Board-approved Reputational Risk Policy, as well as policy and procedures for managing reputational and legal risk related to structured finance transactions. Global Risk Management plays a significant role in the identification and management of reputational risk related to credit underwriting. In addition, the Reputational Risk Committee is available to support Global Risk Management, as well as other risk management committees and business units, with their assessment of reputational risk associated with transactions, business initiatives, and new products and services. The Reputational Risk Committee considers a broad array of factors when assessing transactions, so that the Bank meets, and will be seen to meet, high ethical standards. These factors include the extent, and outcome, of legal and regulatory due diligence pertinent to the transaction; the economic intent of the transaction; the effect of the transaction on the transparency of a customer’s financial reporting; the need for customer or public disclosure; conflicts of interest; fairness issues; and public perception. The Committee may impose conditions on customer transactions, including customer disclosure requirements to promote transparency in financial reporting, so that transactions meet Bank standards. In the event the Committee recommends not proceeding with a transaction and the sponsor of the transaction wishes to proceed, the transaction is referred to the Risk Policy Committee. Environmental Risk Environmental risk refers to the possibility that environmental concerns involving Scotiabank or its customers could affect the Bank’s performance. To safeguard the Bank and the interests of its stakeholders, Scotiabank has an environmental policy, which is approved by the Bank’s Board of Directors. The policy guides day-to-day operations, lending practices, supplier agreements, the management of real estate holdings and external reporting practices. It is supplemented by specific policies and practices relating to individual business lines. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 97 MANAGEMENT’S DISCUSSION AND ANALYSIS Environmental risks associated with the business operations of each borrower and any real property offered as security are considered in the Bank’s credit evaluation procedures. This includes an environmental assessment where applicable, and commentary on the impact of climate (including regulatory, physical or reputational impacts) on the borrower. Global Risk Management has primary responsibility for establishing the related policies, processes and standards associated with mitigating environmental risk in the Bank’s lending activities. Decisions are taken in the context of the risk management framework. In the area of project finance, the Equator Principles have been integrated into the Bank’s internal processes and procedures since 2006. The Equator Principles help financial institutions determine, assess, manage and report environmental and social risk. The principles apply to project finance loans and advisory assignments where total capital costs exceed US$10 million, and to certain project-related corporate loans. The Equator Principles provide safeguards for sensitive projects to ensure protection of natural habitats and the rights of indigenous peoples, as well as safeguards against the use of child and forced labour. Environmental concerns also play a prominent role in shaping the Bank’s real estate practices and purchasing decisions. The Real Estate Department adheres to an Environmental Compliance Policy to ensure responsible management of the Bank’s real estate holdings from an environmental perspective. In addition, recycling and resource management programs are in place in the Bank’s corporate offices and branch networks. Internal tracking systems are in place with respect to energy use, greenhouse gas emissions (GHG) and paper consumption. Since 2012, GHG emissions data for the branch network and corporate offices has been externally verified. A variety of reduction measures are in place for energy, paper and waste. In order to further reduce the Bank’s environmental footprint, it is guided by an Environmental Paper Policy. To ensure it continues to operate in an environmentally responsible manner, the Bank monitors policy and legislative requirements through ongoing dialogue with government, industry and stakeholders in countries where it operates. Scotiabank has been meeting with environmental organizations, industry associations and socially responsible investment organizations with respect to the role that banks can play to help address issues such as climate change, protection of biodiversity, promotion of sustainable forestry practices, and other environmental issues important to its customers and communities where it operates. The Bank has an ongoing process of reviewing its practices in these areas. Scotiabank has a number of environmentally related products and services to meet demand and promote the “green” economy. These include: an EcoEnergy Financing program designed to support personal and small business customers who wish to install small-scale renewable energy projects; an auto loan product for hybrid, electric and clean diesel vehicles; an Energy and Agriculture Commodities group, which assists corporate clients by providing liquidity and hedge solutions in the carbon market; and an eco-home renovation program. Environmental Reporting Scotiabank is also a signatory to, and participant in the Carbon Disclosure Project, which provides corporate disclosure to the investment community on greenhouse gas emissions and climate change management. Further information is available in the Bank’s annual Corporate Social Responsibility Report. Insurance Risk The Bank is both a distributor of third party insurance products and underwriter of insurance risk. As a distributor of third party insurance products, the Bank earns fees but bears no insurance risk. The Bank bears insurance risk in its role as an underwriter, either through direct underwriting or via reinsurance. Insurance risk is the risk of potential financial loss due to actual experience being different from that assumed in the pricing process of the insurance products. Insurance by nature involves the distribution of products that transfer individual risks to the issuer with the expectation of a return built into the insurance premiums earned. The Bank is exposed to insurance risk primarily through its creditor, life and select property and casualty insurance and reinsurance products. The insurance governance and risk management frameworks are calibrated within each insurance subsidiary commensurate with the nature and materiality of risk assumed. Senior management within the insurance business subsidiaries has primary responsibility for managing insurance risk, with oversight by Global Risk Management through the Insurance Risk Committee. The insurance subsidiaries have their own boards of directors, as well as independent appointed actuaries who provide additional risk management oversight. The insurance subsidiaries maintain a number of policies and practices to manage insurance risk. Sound product design is an essential element. The vast majority of risks insured are short-term in nature, that is, they do not involve long-term pricing guarantees. Geographic diversification and product-line diversification are important elements as well. Reinsurance is commonly used as an effective tool to manage the insurance risk exposures. Insurance risk is also managed through effective underwriting and claim adjudication practices, ongoing monitoring of experience, and stress-testing scenario analysis. Strategic Risk Strategic risk is the risk that the Bank’s business strategies are ineffective, being poorly executed, or insufficiently resilient to changes in the business environment. The Board of Directors is ultimately responsible for oversight of strategic risk, by adopting a strategic planning process and approving, on an annual basis, a strategic plan for the Bank. The Bank manages its strategic planning process through a series of coordinated efforts between the Executive Management Team, the Business Lines and the Corporate Functions. These efforts address a wide range of relevant considerations including capital and resource allocation, business initiatives, strategic transactions and investments, stress testing and alignment with the Bank’s Risk Appetite Framework. These considerations are reviewed in a consistent and disciplined manner. The process involves input from the entire Executive Management Team and from the Board of Directors. On an annual basis, a comprehensive Strategy Report is prepared that summarizes the Bank’s key strategic considerations, and is presented by the President and Chief Executive Officer to the Board of Directors for their review and approval. The execution and evaluation of strategic plans within the Bank is critically important to the Bank’s enterprise-wide risk management framework. The Bank makes continuous efforts to ensure that all employees are aware of the Bank’s overall strategic direction, and that employees are also aware of the strategies and objectives for their respective business line or corporate function. On an ongoing basis, the business lines and corporate functions identify, manage and assess the internal and external considerations – including risk factors – that could affect the achievement of their strategic objectives. These matters are considered on an enterprise-wide basis by the Bank’s Executive Management Team, which makes adjustments, as required. 98 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C O N T R O L S A N D A C C O U N T I N G P O L I C I E S CONTROLS AND ACCOUNTING POLICIES Controls and Procedures Management’s responsibility for financial information contained in this annual report is described on page 130. Disclosure controls and procedures The Bank’s disclosure controls and procedures are designed to provide reasonable assurance that information is accumulated and communicated to the Bank’s management, including the President and Chief Executive Officer and the Group Head and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of October 31, 2016, the Bank’s management, with the participation of the President and Chief Executive Officer and Group Head and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures, as defined under the rules adopted by the U.S. Securities and Exchange Commission (SEC) and the Canadian securities regulatory authorities, and have concluded that the Bank’s disclosure controls and procedures are effective. Internal control over financial reporting Management of the Bank is responsible for establishing and maintaining adequate internal control over financial reporting. These controls include policies and procedures that: (cid:129) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Bank; (cid:129) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the Bank; and (cid:129) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Bank’s assets that could have a material effect on the financial statements. All control systems contain inherent limitations, no matter how well designed. As a result, the Bank’s management acknowledges that its internal control over financial reporting will not prevent or detect all misstatements due to error or fraud. In addition, management’s evaluation of controls can provide only reasonable, not absolute, assurance that all control issues that may result in material misstatements, if any, have been detected. Management assessed the effectiveness of internal control over financial reporting, using the Internal Control-Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and based on that assessment concluded that internal control over financial reporting was effective as at October 31, 2016. Changes in internal control over financial reporting There have been no changes in the Bank’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting during the year ended October 31, 2016. Critical Accounting Estimates The Bank’s accounting policies are integral to understanding and interpreting the financial results reported in this annual report. Note 3 summarizes the significant accounting policies used in preparing the Bank’s consolidated financial statements. Certain of these policies require management to make estimates, assumptions and subjective judgements that are difficult, complex, and often relate to matters that are inherently uncertain. The policies discussed below are considered to be particularly important to the presentation of the Bank’s financial position and results of operations, because changes in the estimates, assumptions and judgements could have a material impact on the Bank’s consolidated financial statements. These estimates, assumptions and judgements are adjusted in the normal course of business to reflect changing underlying circumstances. Allowance for credit losses The allowance for credit losses represents management’s best estimate of the probable credit losses in the portfolio of deposits with other institutions, loans to borrowers and acceptances. Management undertakes regular reviews of credit quality to assess the adequacy of the allowance for credit losses. This process requires the use of estimates, assumptions and subjective judgements at many levels. These subjective judgements include identifying credits that are impaired, and considering factors specific to individual credits, as well as portfolio characteristics and risks. Changes to these estimates or use of other reasonable judgements and estimates could directly affect the provision for credit losses. The allowance for credit losses is comprised of collective and individually assessed allowances. Allowances in respect of individually significant credit exposures are an estimate of probable incurred losses related to existing impaired loans. In establishing these allowances applicable to individual credit exposures, management individually assesses each loan for objective indicators of impairment and forms a judgement as to whether the loan is impaired. Loan impairment is recognized when, in management’s opinion, there is no longer reasonable assurance that interest and principal payments will be collected based on original contractual terms. Once a loan is determined to be impaired, management estimates its net realizable value by making judgements relating to the timing of future cash flow amounts, the fair value of any underlying security pledged as collateral, costs of realization, observable market prices, and expectations about the future prospects of the borrower and any guarantors. Individual provisions were higher in 2016 than in 2015 across all business lines. Management estimates allowances on a collective basis for exposures in certain homogenous portfolios, including residential mortgages, credit card loans and most personal loans. This collective assessment for these positions involves estimating the probable losses inherent in the portfolio by using a formulaic method that considers recent loss experience. An allowance is also determined in respect of probable incurred losses that are inherent in the portfolio, of performing loans, but have not yet been specifically identified on an individual basis. Management establishes this allowance on a collective basis through an assessment of quantitative and qualitative factors. Using an internally developed methodology, management arrives at an initial quantitative estimate of the collective allowance for the performing portfolio based on numerous factors, including historical average default probabilities, loss given default rates and exposure at default 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 99 MANAGEMENT’S DISCUSSION AND ANALYSIS factors. Material changes in any of these parameters or assumptions would affect the range of expected credit losses and, consequently, could affect the collective allowance level. For example, if either the probability of default or the loss given default rates for the non-retail portfolio were independently increased or decreased by 10%, the methodology would indicate an increase or decrease to the quantitative estimate of approximately $71 million (2015 – $73 million). A qualitative assessment of the collective allowance is made based on observable data, such as: economic trends and business conditions, portfolio concentrations, risk migrations and recent trends in volumes and severity of delinquencies, and a component for the imprecision inherent in the methodology and parameters. Management reviews the collective allowance quarterly to assess whether the allowance is at the appropriate level in relation to the size of the portfolio, inherent credit risks and trends in portfolio quality. The total collective allowance for credit losses as at October 31, 2016, was $3,498 million, an increase of $238 million from a year earlier. This year included an increase in collective allowance against performing loans of $50 million primarily related to the energy sector. Of the collective allowance amount, $662 million is attributable to business and government performing loans (2015 - $644 million), with the remainder allocated to personal lending and credit cards of $2,258 million (2015 - $1,941 million) and residential mortgages of $578 million (2015 - $675 million). These amounts for personal lending and credit cards, and for residential mortgages include allowances for both performing and impaired loans. As noted above, the individual allowance for credit losses for personal loans, credit cards and mortgages is formula-based and also reflects incurred but not yet identified losses. Fair value of financial instruments All financial instruments are measured at fair value on initial recognition. Subsequent measurement of a financial instrument depends on its classification. Non-trading loans and receivables, certain securities and most financial liabilities are carried at amortized cost unless classified or designated as fair value through profit or loss or available-for-sale at inception. All other financial instruments, including those designated as fair value through profit or loss at inception, are carried at fair value. Fair value of a financial asset or liability is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal, or in its absence, the most advantageous market to which the Bank has access at the measurement date. The best evidence of fair value for a financial instrument is the quoted price in an active market. Quoted market prices represent a Level 1 valuation. Quoted prices are not always available for over-the-counter transactions, as well as transactions in inactive or illiquid markets. In these instances, internal models that maximize the use of observable inputs are used to estimate fair value. The chosen valuation technique incorporates all the factors that market participants would take into account in pricing a transaction. When all significant inputs are observable, the valuation is classified as Level 2. Financial instruments traded in a less active market have been valued using indicative market prices, present value of cash-flows or other valuation techniques. Fair value estimates normally do not consider forced or liquidation sales. Where financial instruments trade in inactive markets or when using models where observable parameters do not exist, greater management judgement is required for valuation purposes. Valuations that require the significant use of unobservable inputs are considered Level 3. The calculation of estimated fair value is based on market conditions at a specific point in time and therefore may not be reflective of future fair values. The Bank has controls and processes in place to ensure that the valuation of financial instruments is appropriately determined. Global Risk Management (GRM) is responsible for the design and application of the Bank’s risk management framework. GRM is independent from the Bank’s business units and is overseen by Executive Management and the Board of Directors. Senior management committees within GRM oversee and establish standards for risk management processes that are critical in ensuring that appropriate valuation methodologies and policies are in place for determining fair value. Where possible, valuations are based on quoted prices or observable inputs obtained from active markets. GRM oversees a monthly Independent Price Verification (IPV) process in order to assess the reliability and accuracy of prices and inputs used in the determination of fair value. The IPV process is performed by price verification groups that are independent from the business. The Bank maintains an approved list of pricing sources that are used in the IPV process. These sources include, but are not limited to, brokers, dealers and consensus pricing services. The valuation policies relating to the IPV process require that all pricing or rate sources used be external to the Bank. On a periodic basis, an independent assessment of pricing or rate sources is also performed by GRM to determine market presence or market representative levels. Where quoted prices are not readily available, such as for transactions in inactive or illiquid markets, internal models that maximize the use of observable inputs are used to estimate fair value. An independent senior management committee within GRM oversees the vetting, approval and ongoing validation of valuation models used in determining fair value. Risk policies associated with model development are approved by Executive Management and/or key risk committees. In determining fair value for certain instruments or portfolios of instruments, valuation adjustments or reserves may be required to arrive at a more accurate representation of fair value. The Bank’s policy of applying valuation reserves to a portfolio of instruments is approved by a senior management committee. These reserves include adjustments for credit risk, bid-offer spreads, unobservable parameters, constraints on prices in inactive or illiquid markets and when applicable funding costs. The methodology for the calculation of valuation reserves are reviewed at least annually by senior management. Valuation adjustments recorded against the fair value of financial assets and financial liabilities totaled $119 million as at October 31, 2016, (2015 – $27 million), net of any write-offs. These valuation adjustments are due mainly to credit risk considerations and bid-offer spreads on derivative transactions. As at October 31, 2016, a funding valuation adjustment (FVA) of $92 million pre-tax (2015 – $42 million) was recorded relating to uncollateralized derivative instruments. The Bank discloses the classification of all financial instruments carried at fair value in a hierarchy based on the determination of fair value. The valuation hierarchy is as follows: (cid:129) Level 1 – fair value is based on unadjusted quoted prices in active markets for identical instruments, (cid:129) Level 2 – fair value is based on models using significant market-observable inputs other than quoted prices for the instruments, or (cid:129) Level 3 – fair value is based on models using significant inputs that are not based on observable market data. 100 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C O N T R O L S A N D A C C O U N T I N G P O L I C I E S The Bank’s assets and liabilities which are carried at fair value as classified by the valuation hierarchy are reflected in Note 6. The percentage of each asset and liability category by fair value hierarchy level are outlined as follows: T58 Fair value hierarchy of financial instruments carried at fair value Fair value hierarchy As at October 31, 2016 Level 1 Level 2 Level 3 Trading assets (incl. precious metals) 56% 43% 1% 100% Assets Available- for-sale securities 62% 36% 2% 100% Liabilities Obligations related to securities sold short 85% 15% –% 100% Derivatives 1% 98% 1% 100% Derivatives 2% 98% –% 100% Impairment of investment securities Investment securities are evaluated for impairment at the end of each reporting date, or more frequently, if events or changes in circumstances indicate the existence of objective evidence of impairment. In the case of equity instruments classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its original cost is considered in determining whether impairment exists. In the case of debt instruments classified as available-for-sale and held-to-maturity investment securities, the criteria for assessment of impairment is consistent with the criteria for impairment of loans. When a decline in value of available-for-sale debt or equity instrument is due to impairment, the value of the security is written down to fair value. The losses arising from impairment are reclassified from accumulated other comprehensive income and included in net gain on investment securities within other operating income in the Consolidated Statement of Income. The losses arising from impairment of held-to-maturity investment securities are recognized in net gain on investment securities within other operating income in the Consolidated Statement of Income. Reversals of impairment losses on available-for-sale debt instruments resulting from increases in fair value related to events occurring after the date of impairment are included in net gain on investment securities within other operating income in the Consolidated Statement of Income, to a maximum of the original impairment charge. Reversals of impairment on available-for-sale equity instruments are not recognized in the Consolidated Statement of Income; increases in fair value of such instruments after impairment are recognized in equity. Reversals of impairment losses on held-to-maturity investment securities are included in net gain on investment securities within other operating income in the Consolidated Statement of Income, to a maximum of the amortized cost of the investment before the original impairment charge. As at October 31, 2016, the gross unrealized gains on available-for-sale securities recorded in accumulated other comprehensive income were $740 million (2015 – $1,058 million), and the gross unrealized losses were $285 million (2015 – $291 million). Net unrealized gains were therefore $455 million (2015 – $767 million) before hedge amounts. The net unrealized gains after hedge amounts were $26 million (2015 – $267 million). At October 31, 2016, the unrealized loss recorded in accumulated other comprehensive income relating to securities in an unrealized loss position for more than 12 months was $206 million (2015 – $191 million). This unrealized loss was comprised of $11 million (2015 – $24 million) in debt securities, $160 million (2015 – $164 million) related to preferred shares and $35 million (2015 – $3 million) related to common shares. The unrealized losses on the debt securities arose primarily from changes in interest rates and credit spreads. For debt securities, based on a number of considerations, including underlying credit of the issuers, the Bank expects that future interest and principal payments will continue to be received on a timely basis in accordance with the contractual terms of the security. Employee benefits The Bank sponsors various pension and other benefit plans for eligible employees in Canada, the U.S., and other international operations. The pension benefits are generally based on years of service and average earnings at retirement. Other benefits generally include post-retirement health care, dental care and life insurance, along with other long-term employee benefits such as long-term disability. Employee benefit expense and the related benefit obligation are calculated using actuarial methods and certain actuarial assumptions. These assumptions are based on management’s best estimate and are reviewed and approved annually. The management assumptions with the greatest potential impact are the discount rates. These rates are used for measuring the benefit obligation, service cost and interest cost. The discount rate used to determine the defined benefit obligation is based on the yield at the reporting date on high quality corporate bonds that have durations that match the terms of the Bank’s obligations. Prior to 2016, the discount rate used to determine the annual benefit expense was the same as the rate used to determine the defined benefit obligation. Beginning in 2016, separate discount rates were used to determine the annual benefit expense in Canada and the U.S. These rates were determined with reference to the yields on high quality corporate bonds with durations that match the various components of the annual defined benefit expense. The discount rate used to determine the annual benefit expense for all other plans continues to be same as the rate used to determine the defined benefit obligation. If the assumed discount rates were 1% lower, the benefit expense for 2016 would have been $116 million higher. Other key assumptions include future compensation, health care costs, employee turnover, retirement age and mortality. When making these estimates, management considers expectations of future economic trends and business conditions, including inflation rates as well as other factors, such as plan specific experience and best practices. The Bank uses a measurement date of October 31, and based on this measurement date, the Bank reported a deficit of $1,369 million in its principal pension plans as at October 31, 2016, as disclosed in Note 27 to the consolidated financial statements. Actual experience that differs from assumptions made by management will result in a net actuarial gain or loss recognized immediately in other comprehensive income. Note 27 contains details of the Bank’s employee benefit plans, such as the disclosure of pension and other benefit amounts, management’s key assumptions, and a sensitivity analysis of changes in these assumptions on the employee benefit obligation and expense. Corporate income taxes Management exercises judgment in determining the provision for income taxes and deferred income tax assets and liabilities. The provision is based on management’s expectations regarding the income tax consequences of transactions and events during the period. Management interprets the tax 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 101 MANAGEMENT’S DISCUSSION AND ANALYSIS legislation for each jurisdiction in which the Bank operates and makes assumptions about the expected timing of the reversal of deferred income tax assets and liabilities. If management’s interpretations of the legislation differ from those of the tax authorities or if the actual timing of the reversals of the deferred income tax assets and liabilities is not as anticipated, the provision for income taxes could increase or decrease in future periods. Total deferred tax assets related to the Bank’s unused income tax losses from operations arising in prior years were $484 million as at October 31, 2016 (2015 – $539 million). The tax related to temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognized in the Consolidated Statement of Financial Position amounted to $55 million (2015 – $166 million). The amount related to unrecognized tax losses was $14 million, which will expire as follows: $13 million in 2018 and beyond and $1 million have no fixed expiry date. The Bank maintains provisions for uncertain tax positions that it believes appropriately reflect the risk of tax positions under discussion, audit, dispute, or appeal with tax authorities, or which are otherwise considered to involve uncertainty. These provisions are made using the Bank’s best estimate of the amount expected to be paid based on an assessment of all relevant factors, which are reviewed at the end of each reporting period. In November 2016 the Bank received a federal reassessment of $179 million for tax and interest as a result of the Canada Revenue Agency denying the tax deductibility of certain Canadian dividends received during the 2011 taxation year. The circumstances of the dividends subject to the reassessment are similar to those prospectively addressed by recently enacted rules which had been introduced in the 2015 Canadian federal budget. The Bank is confident that its tax filing position was appropriate and in accordance with the relevant provisions of the Income Tax Act (Canada), and intends to vigorously defend its position. Note 26 of the 2016 consolidated financial statements contains further details with respect to the Bank’s provisions for income taxes. Structured entities In the normal course of business, the Bank enters into arrangements with structured entities on behalf of its customers and for its own purposes. These structured entities can be generally categorized as multi-seller commercial paper conduits, Bank funding vehicles and structured finance entities. Further details are provided in the off-balance sheet arrangements section. Management is required to exercise judgement to determine whether a structured entity should be consolidated. This evaluation involves understanding the arrangements, determining whether decisions about the relevant activities are made by means of voting rights or other contractual arrangements and determining whether the Bank controls the structured entity. The Bank controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The three elements of control are: (cid:129) power over the investee; (cid:129) exposure, or rights, to variable returns from involvement with the investee; and (cid:129) the ability to use power over the investee to affect the amount of the investor’s returns. This definition of control applies to circumstances: (cid:129) when voting rights or similar rights give the Bank power, including situations where the Bank holds less than a majority of voting rights or involving potential voting rights; (cid:129) when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee (i.e., relevant activities are directed by contractual arrangements); (cid:129) involving agency relationships; and (cid:129) when the Bank has control over specified assets of an investee. The Bank does not control an investee when it is acting in an agent’s capacity. The Bank assesses whether it is an agent by determining whether it is primarily engaged to act on behalf and for the benefit of another party or parties. Factors that the Bank considers in this assessment include the scope of its decision-making authority over the investee, the rights held by other parties, the remuneration to which it is entitled, and the Bank’s exposure to variability of returns from other interests that it holds in the investee. The analysis uses both qualitative and quantitative analytical techniques and involves the use of a number of assumptions about the business environment in which the structured entity operates and the amount and timing of future cash flows. The Bank reassesses whether it controls an investee if facts and circumstances indicate that one or more of the three elements of control change. Management is required to exercise judgement to determine if a change in control event has occurred. During 2016, there were no change in control events that caused the Bank to change its control conclusion of its multi-seller conduits or other structured entities. As described in Note 14 to the consolidated financial statements and in the discussion of off-balance sheet arrangements, the Bank does not control the two Canadian-based multi-seller conduits that it sponsors and they are not required to be consolidated on the Bank’s Consolidated Statement of Financial Position. The Bank controls its U.S.-based multi-seller conduit and consolidates it on the Bank’s Consolidated Statement of Financial Position. Goodwill For the purpose of impairment testing, goodwill acquired in a business combination is, on the acquisition date, allocated to each of the Bank’s group of cash-generating units (CGU) that are expected to benefit from the particular acquisition. Goodwill is not amortized but tested for impairment annually and when circumstances indicate that the carrying value may be impaired. Goodwill is reviewed at each reporting date to determine whether there is any indication of impairment. Each CGU to which goodwill is allocated for impairment testing purposes reflects the lowest level at which goodwill is monitored for internal management purposes. The Bank determines the carrying value of the CGU using a regulatory capital approach based on credit, market, and operational risks, and leverage, consistent with the Bank’s capital attribution for business line performance measurement. An impairment loss is recognized if the carrying amount of a CGU exceeds its recoverable amount. The recoverable amount is the greater of fair value less costs of disposal and value in use. If either fair value less costs of disposal or value in use exceeds the carrying amount, there is no need to determine the other. The recoverable amount for the CGU has been determined using the fair value less costs of disposal method. In arriving at such value an appropriate valuation model is used which considers various factors including normalized net income, price earnings multiples and control premium. These calculations are corroborated by valuation multiples, quoted share prices for publicly traded subsidiaries or other available fair value indicators. An impairment loss, in respect of goodwill, is not reversed. 102 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C O N T R O L S A N D A C C O U N T I N G P O L I C I E S Significant judgement is applied in determining the recoverable amounts of the CGU and assessing whether certain events or circumstances constitute objective evidence of impairment. Goodwill was assessed for annual impairment based on the methodology as at July 31, 2016, and no impairment was determined to exist. Indefinite life intangible assets Intangible assets with indefinite useful lives are not amortized but tested for impairment annually and when circumstances indicate that the carrying value may be impaired. Intangible assets are reviewed at each reporting date to determine whether there is any indication of impairment. The recoverable amount is the greater of fair value less costs of disposal and value in use. If either fair value less costs of disposal or value in use exceeds the carrying amount, there is no need to determine the other. Value in use method is used by the Bank to determine the recoverable amount of the intangible asset. In determining value in use, an appropriate valuation model is used which considers factors such as management-approved cash flow projections, discount rate and terminal growth rate. An impairment loss is recognized if the carrying amount of the intangible asset exceeds its recoverable amount. Impairment losses recognized in prior periods are reassessed at each reporting period for any indication that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the intangible asset’s carrying amount does not exceed the carrying amount that would have been determined if no impairment loss had been recognized. The recoverable amount is significantly impacted by the discount rate and the terminal value. Significant judgement is applied in determining the intangible asset’s recoverable amount and assessing whether certain events or circumstances constitute objective evidence of impairment. Intangible assets were assessed for annual impairment based on the methodology as at July 31, 2016, and no impairment was determined to exist. Provisions According to IFRS, the Bank should recognize a provision if, as a result of a past event, the Bank has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Probable in this context means more likely than not. Off-balance sheet credit risks The provisions for off-balance sheet credit risks relates primarily to off-balance sheet credit risks such as undrawn lending commitments, letters of credit and letters of guarantee. These are collectively assessed in a manner consistent with the collective allowance for performing on-balance sheet credit risks. Restructuring Certain of the Banks provisions relate to restructuring as part of the Bank’s efforts to enhance the customer experience, drive digital transformation and improve productivity. Restructuring provisions are primarily related to employee severance and require managements best estimate of the amount required to settle the obligation. Uncertainty exists with respect to when the obligation will be settled and the amounts ultimately paid, as this will largely depend upon individual facts and circumstances. The restructuring provision is expected to be utilized in line with the approved plans; the actual utilization will be assessed quarterly and may lead to changes in the provision amount recorded. Litigation and other In the ordinary course of business, the Bank and its subsidiaries are routinely defendants in, or parties to a number of pending and threatened legal actions and regulatory proceedings, including actions brought on behalf of various classes of claimants. In view of the inherent difficulty of predicting the outcome of such matters, the Bank cannot state what the eventual outcome of such matters will be. However, based on current knowledge, management does not believe that liabilities, if any, arising from pending litigation or regulatory proceedings will have a material adverse effect on the Consolidated Statement of Financial Position or results of operations of the Bank. Legal provisions are established when it becomes probable that the Bank will incur an expense related to a legal action and the amount can be reliably estimated. Such provisions are recorded at the best estimate of the amount required to settle any obligation related to these legal actions as at the balance sheet date, taking into account the risks and uncertainties surrounding the obligation. Management and internal and external experts are involved in estimating any amounts that may be required. The actual costs of resolving these claims may vary significantly from the amount of the legal provisions. The Bank’s estimate involves significant judgement, given the varying stages of the proceedings, the fact that the Bank’s liability, if any, has yet to be determined and the fact that the underlying matters will change from time to time. As such, there is a possibility that the ultimate resolution of those legal actions may be material to the Bank’s consolidated results of operations for any particular reporting period. Future Accounting Developments The Bank actively monitors developments and changes in accounting standards from the IASB as well as regulatory requirements from the Canadian Securities Administrators and OSFI. Effective November 1, 2017 IFRS 9 Financial instruments On July 24, 2014, the IASB issued IFRS 9 Financial Instruments (“the Standard”), which will replace IAS 39. The Standard covers three broad topics: Classification and Measurement, Impairment and Hedging. In line with OSFI’s advisory, all Canadian D-SIBs, including the Bank are required to early adopt IFRS 9 effective November 1, 2017. In June 2016, OSFI issued “IFRS 9 Financial Instruments and Disclosures” which provides guidance on the application of IFRS 9 that is consistent with the BCBS guidance issued in 2015. In light of IASB and FASB’s new standards on expected credit loss (“ECL”) accounting, the Basel Committee appointed the Task Force on Provisioning (TFP) to consider the implications of this change in accounting for regulatory capital. The TFP published in October 2016: (cid:129) A Consultative Document outlining the Committee’s proposal in the interim along with possible transitional arrangements – this document proposes to retain in the interim the current regulatory treatment of provisions in each jurisdiction. There are three approaches that all propose to transition the impact over a number of years. The TFP also issued for discussion a document that assesses regulatory capital policy options for the longer-term. (cid:129) Governance and project management The adoption of IFRS 9 is a significant initiative for the Bank that commenced in 2014, involving substantial finance, risk management and technology resources. The project is managed through a governance structure that includes an Executive Steering Committee (EC) comprised of senior levels of management from risk management, finance, technology, and the business units. Periodic reporting on the progress against plan is provided to the Executive Steering committee and Bank senior management. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 103 MANAGEMENT’S DISCUSSION AND ANALYSIS To date, as per the plan, the Bank’s efforts have largely been focused on updating accounting policies to address key aspects of the Standard, developing risk models and associated methodologies, and conducting training sessions to impacted internal stakeholders. The Bank will complete the development and validation of the impairment models for the calculation of expected credit losses in 2017 to support a parallel run during 2017. The Bank will update accounting policy manuals, internal control documents, implement changes to business and financial reporting processes and systems, and enhance the Bank’s existing governance process to support the high quality implementation of the Standard by November 1, 2017. The following is a summary of some of the more significant items that are likely to be important in understanding the impact of the implementation of IFRS 9: Classification and measurement, and hedging The Standard introduces new requirements to determine the measurement basis of financial assets, involving the cash flow characteristics of assets and the business models under which they are managed. Accordingly, the basis of measurement for the Bank’s financial assets may change. The Bank is currently completing detailed reviews of its business models and the cash flow characteristics of its portfolio holdings. This Standard affects the accounting for available-for-sale equity securities, requiring a designation, by portfolio, between recording both unrealized and realized gains either through (i) OCI or (ii) Income Statement. As a result, the amount of equity securities gains recorded through income is expected to be lower than current levels and levels recorded in recent years. For other financial instruments, based on assessments completed to date, the Bank does not expect the implementation will result in a significant change in the classification and measurement of the Bank’s financial assets, between Amortized cost, Fair Value through OCI and Fair Value through Income Statement. The Standard expands the scope of eligible hedged items and aims to better align the accounting with risk management activities. The Bank is permitted to adopt the hedge accounting requirements of IFRS 9 concurrently or to defer the adoption of the hedge accounting requirements of the standard to a future period. The Bank is currently considering deferring the adoption of these requirements, although it will implement the revised hedge accounting disclosures. Impairment The adoption of IFRS 9 will have a significant impact on the Bank’s impairment methodology. The IFRS 9 expected credit loss (ECL) model is forward looking compared to the current incurred loss approach. Expected credit losses under IFRS 9 are the present value of all cash shortfalls related to default events either (i) over the following twelve months or (ii) over the expected life of a financial instrument depending on credit deterioration from inception. ECL should reflect an unbiased, probability-weighted outcome as opposed to the single best estimate allowed under the current approach. The probability-weighted outcome considers multiple scenarios based on reasonable and supportable forecasts. The Bank’s approach leverages the existing regulatory capital models and processes to the extent possible. New models and systems are being developed to meet the requirements of IFRS 9. While most of the Bank’s loan portfolios use the existing Advanced Internal Ratings Based (AIRB) credit models for Basel purposes and can be leveraged for developing IFRS 9 models, for other Standardized portfolios the Bank will develop new methodologies and models taking into account the relative size, quality and complexity of the portfolios. IFRS 9 considers the calculation of ECL by multiplying the Probability of default (PD), Loss Given Default (LGD) and Exposure at Default (EAD). IFRS 9 Impairment model uses a three stage approach based on the extent of credit deterioration since origination: Stage 1 – 12-month ECL applies to all financial assets that have not experienced a significant increase in credit risk (SIR) since origination and are not credit impaired. The ECL will be computed using a 12-month PD that represents the probability of default occurring over the next 12 months or less in line with the maturity profile of the asset. This is different than the current approach which estimates a collective allowance to recognize losses that have been incurred but not reported on performing loans. Stage 2 – When a financial asset experiences a SIR since origination but is not credit impaired, it is considered to be in Stage 2. This requires the computation of ECL based on lifetime PD that represents the probability of default occurring over the remaining lifetime of the financial asset. Provisions are higher in this stage because of an increase in risk and the impact of a longer time horizon being considered compared to 12 months in Stage 1. Stage 3 – Financial assets that have an objective evidence of impairment will be included in this stage. Similar to stage 2, the allowance for credit losses will continue to capture the lifetime expected credit losses for such loans. As the Bank’s definition of default is not likely to change materially and will align with the regulatory definition, the treatment of loans in stage 3 remains substantially the same as the current treatment of impaired loans under IAS 39. Some of the key concepts in IFRS 9 that have the most significant impact and require a high level of judgement are: Assessment of Significant Increase in Credit Risk The assessment of a significant increase in credit risk is done on a relative basis. To assess whether the credit risk on a financial asset has increased significantly since origination, the Bank will compare the risk of default at the reporting date to the risk of default at origination, using key risk indicators that are used in the Bank’s existing risk management processes. At each reporting date, the assessment of a change in credit risk will be individually assessed for those considered individually significant and at the segment level for retail exposures. This assessment is symmetrical in nature, allowing credit risk of financial assets to move back to Stage 1 if the increase in credit risk since origination has reduced and is no longer deemed to be significant. Macroeconomic Factors, Forward Looking Information (FLI) and Multiple Scenarios IFRS 9 requires an unbiased and probability weighted estimate of credit losses by evaluating a range of possible outcomes that incorporates forecasts of future economic conditions. Macroeconomic factors and FLI are required to be incorporated into the measurement of ECL as well as the determination of whether there has been a significant increase in credit risk since origination. Measurement of ECLs at each reporting period should reflect reasonable and supportable information at the reporting date about past events, current conditions and forecasts of future economic conditions. The assessment of whether there has been a SIR is to be performed at each reporting date. The Bank will use multiple scenarios that will be probability weighted to determine ECL, leveraging its existing Enterprise Wide Stress Testing modeling framework. Expected Life When measuring ECL, the Bank must consider the maximum contractual period over which the Bank is exposed to credit risk. All contractual terms should be considered when determining the expected life, including prepayment options and extension and rollover options. 104 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C O N T R O L S A N D A C C O U N T I N G P O L I C I E S For certain revolving credit facilities, such as credit cards which qualify for a narrow exception under IFRS 9, the expected life is extended beyond the contractual period and is estimated based on the period over which the Bank is exposed to credit risk and where the credit losses would not be mitigated by management actions. Definition of Default and Write-off The Bank’s definition of default described in Note 3 is not expected to be materially different and will align with the regulatory definition of default upon implementation of IFRS 9. The Bank does not expect to rebut the presumption in IFRS 9 that loans which are 90 days past due are in default for retail loans. The policy on the write-off of loans is expected to remain unchanged. The main adjustments to the regulatory capital risk components are summarized in the following chart: PD LGD EAD Regulatory capital IFRS 9 Through the cycle (represents long-run average PD throughout a full economic cycle) Point in time (based on current conditions, adjusted to take into account estimates of future conditions that will impact PD). 12 month PD is used. Downturn LGD based on losses that would be expected in an economic downturn and subject to certain regulatory floors. Both direct and indirect collection costs are considered. Based on the drawn balance plus expected utilization of any undrawn portion prior to default, and cannot be lower than the drawn balance. 12 month PD for Stage 1 ECL and Lifetime PD for Stage 2 and Stage 3 ECL. Expected LGD based on historical charge-off events and recovery payments, current information about attributes specific to borrower, and direct costs. Forward-looking macroeconomic variables and expected cash flows from credit enhancements will be incorporated as appropriate and excludes floors and undue conservatism. EAD represents the expected balance at default over the lifetime and is conditional on forward looking expectations. Expected credit losses are discounted from default date to the reporting date Discounting factors Not applicable Transition and impact The new requirements will be applied retrospectively by adjusting the opening balance sheet for the transition impact at November 1, 2017 with no requirement to restate comparative periods. The impact of IFRS 9 on the Bank’s consolidated financial results at the time of adoption is dependent upon prevailing market factors and economic conditions at that time, as well as future forecasts of macro-economic factors and forward looking information. The Bank will disclose the impact on transition to the balance sheet and regulatory capital, when reliable estimates are available and this will be no later than in the annual report of 2017. At transition, we expect the existing Collective Allowances against performing loans to contribute a significant component of allowance levels required for Stage 1 and Stage 2 assets under IFRS 9 at transition. The existing Specific Allowances and Collective Allowances against impaired loans should not change significantly for Stage 3 assets under IFRS 9 at transition. Under the existing accounting practice by the Bank, the change to Collective Allowance against performing loans is recorded in the Other business segment on a periodic basis as risk changes and/or if volumes change over a period of time. Under IFRS 9, the change in allowances on performing loans (Stage 1 and Stage 2) will now be recorded in the Bank’s three main business lines on a regular quarterly basis. For a description of the changes in requirements please refer to Note 4 of the 2016 consolidated financial statements. Effective November 1, 2018 Revenue from contracts with customers On May 28, 2014, the IASB issued IFRS 15 Revenue from Contracts with Customers, which provides a single principle based framework to be applied to all contracts with customers. IFRS 15 replaces the previous revenue standard IAS 18 Revenue, and the related Interpretations on revenue recognition. The standard scopes out contracts that are considered to be lease contracts, insurance contracts and financial instruments, and as such will impact the businesses that earn fee and commission revenues. The new standard is a control based model as compared to the existing revenue standard which is primarily focused on risks and rewards. Under the new standard revenue is recognized when a customer obtains control of a good or service. Transfer of control occurs when the customer has the ability to direct the use of and obtain the benefits of the good or service. The standard is effective for the Bank on November 1, 2018, with early adoption permitted, using either a full retrospective approach or a modified retrospective approach. A majority of the Bank’s revenue generating instruments meet the definition of financial instruments and remain out of scope. The areas of focus for the Bank’s assessment will be fees and commission revenues from wealth management and other banking services. On April 12, 2016, the IASB issued amendments to the revenue standard, IFRS 15 Revenue From Contracts with Customers. The amendments provide additional clarification on the identification of a performance obligation in a contract, determining the principal and agent in an agreement, and determining whether the licensing revenues should be recognized at a point in time or over a specific period. The amendments also provide additional practical expedients upon transition to IFRS 15. The amendments are effective for the Bank on November 1, 2018, consistent with the effective date of the standard. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 105 MANAGEMENT’S DISCUSSION AND ANALYSIS Effective November 1, 2019 Leases On January 13, 2016, the IASB issued IFRS 16 Leases, which requires a lessee to recognize an asset for the right to use the leased item and a liability for the present value of its future lease payments. IFRS 16 will result in leases being recorded on the Bank’s balance sheet, including those currently classified as operating leases except for short-term leases and leases with low value of the underlying asset. IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17. IFRS 16 is effective for the Bank on November 1, 2019, with early adoption permitted from the date the Bank applies IFRS 15 Revenue from Contracts with Customers on or before the date of initial application of IFRS 16. On transition there are practical expedients available whereby the Bank will not need to reassess whether a contract is, or contains a lease, or reassess the accounting of sale leaseback transactions recognized prior to the date of initial application. A lessee will apply IFRS 16 to its leases either retrospectively to each prior reporting period presented; or retrospectively with the cumulative effect of initially applying IFRS 16 being recognized at the date of initial application. Regulatory Developments The Bank continues to respond to global regulatory developments, such as capital and liquidity requirements under the Basel Committee on Banking Supervision global standards (Basel III), over-the-counter derivatives reform, consumer protection measures and specific financial reforms, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The Bank continues to monitor these and other developments and is working to ensure business impacts, if any, are minimized. Bank recapitalization regime On June 22, 2016, the Federal Government passed legislation to implement a “bail-in” regime, in accordance with regulations to the Canada Deposit Insurance Corporation Act that have not yet been prescribed (the “CDIC Act Regulations”), for the largest six Canadian banks, including The Bank of Nova Scotia, designated as domestic systemically important banks (D-SIBs). The legislation aims to enhance the resolution toolkit for D-SIBs, including the framework for the conversion of certain eligible shares and liabilities of the D-SIB into common equity of the bank (or any of its affiliates) in the event the D-SIB becomes non-viable. This bail-in regime is aimed at ensuring that in the unlikely event of a failure of a D-SIB, it is the D-SIB’s shareholders and creditors that are responsible for the institution’s risks and not the taxpayers. The types of eligible shares and liabilities subject to the statutory conversion power will be set out in the CDIC Act Regulations, and while these regulations have not yet been prescribed, in its previous consultation paper, the Federal Government had proposed that certain unsecured debt would be subject to the conversion power and customer deposits would be excluded. D-SIBs would also be subject to minimum loss absorbency requirements to ensure they can withstand significant losses and emerge from a conversion well capitalized, as well as comprehensive disclosure and reporting requirements. The regime would apply only to eligible shares and liabilities issued after the implementation of the proposed regime with no retroactive application to existing debt. The proposed “bail-in” regime has not yet been finalized, much of the detail will be set out in the CDIC Act Regulations, and timing for implementation has yet to be determined, but these proposed changes could adversely impact the Bank’s cost of funding. Synthetic Equity Arrangement Rules Proposed tax rules for synthetic equity arrangements, which impact the tax deductibility of Canadian dividends in certain circumstances, have been enacted. These rules are not expected to materially affect the Bank’s overall financial results. Dodd-Frank Act The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in the U.S. in July 2010. The Dodd-Frank Act contains many broad reforms impacting the financial services industry. These reforms impact every financial institution in the U.S. and many financial institutions that operate outside the U.S. Certain portions of the Dodd-Frank Act became effective immediately, and many are now effective following transition periods or final rulemakings, while the effectiveness of some other portions is still subject to final rulemakings by U.S. government agencies, or the expiration of transition periods. The Bank is subject to a number of specific requirements, including, among other things, mandatory clearing, trade reporting and registration of OTC derivative trading activities, heightened capital liquidity and prudential standards, such as the enhanced prudential standards and early remediation requirements under Sections 165 and 166 of the Dodd-Frank Act, and restrictions on proprietary trading, private equity and hedge fund activities, commonly known as the Volcker Rule. The Bank continues to devote resources necessary to ensure that it implements the requirements in compliance with all applicable regulations under the Dodd-Frank Act. The Bank continually monitors developments to prepare for rulemakings that have the potential to impact its operations in the U.S. and elsewhere. More recently, on April 14, 2016, the SEC adopted final rules requiring securities-based swap dealers (SBSDs) to establish a supervisory regime for their securities-based swaps activities, including designating a Chief Compliance Officer. The final rule also requires SBSDs to disclose risks, conflicts, and other material information about a swap to a counterparty, and ensure any recommendations made to a counterparty are suitable. Most recently, on August 12, 2016, the SEC adopted amendments and guidance related to rules regarding the regulatory reporting and public dissemination of security-based swap transactions, known as Regulation SBSR. On May 31, 2016, the U.S. Commodity Futures Trading Commission (CFTC) issued a final rule establishing margin requirements for uncleared cross- border swaps (to the extent not already covered by its previously adopted uncleared swaps rules), and is expected to issue final rules on algorithmic trading by the end of 2016. The CFTC is also considering the adoption of final rules that would impose limits on the size of positions that may be entered into in certain derivatives contracts. The Bank does not expect costs and restrictions associated with the new regulations to have a material impact on our financial results. 106 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Over-the-counter derivatives reform In March 2015, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions published a framework establishing minimum standards for margin requirements for non-centrally cleared derivatives for financial firms and systemically important non- financial entities (“BCBS Framework”). On February 29, 2016, the Office of the Superintendent of Financial Institutions (“OSFI”) issued the final version of Guideline E-22 to implement the BCBS Framework for federally regulated financial institutions. The Guideline is effective September 1, 2016 with compliance to be phased in over the next four years in accordance with the BCBS Framework. The regulatory dates for the Bank are March 1, 2017 for variation margin and September 1, 2019 for initial margin. Margin requirements are designed to be coordinated with the rules established in the U.S., the European Union and other relevant jurisdictions with respect to cross-border activities. The Bank expects to meet all obligations imposed by the Guideline as the relevant requirements come into effect. The Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) FATCA is U.S. legislation designed to prevent U.S. taxpayers from using accounts held outside of the U.S. to evade taxes. FATCA and in some countries, related local regulations now require financial institutions to report annually on specified accounts held outside of the U.S. by U.S. taxpayers. This reporting is made available to the U.S. Internal Revenue Service either directly or through local regulatory agencies. Under an initiative known as Global FATCA, more than 100 OECD member countries have committed to automatic exchange of information relating to accounts held by tax residents of signatory countries, using a CRS. Implementation of the CRS commenced in January 2016 in countries that signed on as “early adopters.” Draft legislation to implement the CRS in Canada was released by the Department of Finance on October 14, 2016. More than 40 countries where the Bank has a presence have now signed on to the CRS, and 17 of these signed on as early adopters. Under the guidance of an enterprise program office, dedicated project teams in each of the Bank’s business lines are working to meet all FATCA and CRS related obligations worldwide while minimizing negative impact on the client experience. The Bank will meet all obligations imposed under FATCA, CRS, and other tax information exchange regimes, in accordance with local law. United Kingdom’s Membership in the European Union (Brexit) On June 23, 2016, the United Kingdom (UK) held a referendum to decide on its membership in the European Union. The resulting vote was to leave the European Union. There are a number of uncertainties in connection with the future of the UK and its relationship with the European Union, including the terms of the agreement it reaches in relation to its withdrawal from the European Union. The negotiation of the UK’s exit terms is likely to take a number of years. Until the terms and timing of the UK’s exit from the European Union are clearer, it is not possible to determine the longer term impact that the referendum, the UK’s departure from the European Union and/or any related matters may have on the Bank or its business. UK’s exit from the European Union may result in significant changes in law, which may include changes in statutory, tax and regulatory regimes in the UK and in Europe. Such changes may impact the Bank’s business, financial condition and results of operations and could adversely impact the Bank’s cost of funding in Europe. The Bank continually monitors developments to prepare for changes that have the potential to impact its operations in the UK and elsewhere in Europe. Related Party Transactions Compensation of key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Bank, directly or indirectly, and comprise the directors of the Bank, the President and Chief Executive Officer, certain direct reports of the President and Chief Executive Officer and Group Heads. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | C O N T R O L S A N D A C C O U N T I N G P O L I C I E S T59 Compensation of the Bank key management personnel For the year ended October 31 ($ millions) Salaries and cash incentives(1) Equity-based payment(2) Pension and other benefits(1) Total (1) Expensed during the year. (2) Awarded during the year. 2016 $ 20 24 3 $ 47 2015 $ 13 20 3 $ 36 Directors can use some or all of their director fees earned to buy common shares of the Bank at market rates through the Directors’ Share Purchase Plan. Non-officer directors may elect to receive all or a portion of their fees in the form of deferred stock units which vest immediately. Refer to Note 25 – Share-based payments for further details of these plans. T60 Loans and deposits of key management personnel Loans are currently granted to key management personnel at market terms and conditions. As at October 31 ($ millions) Loans Deposits 2016 $ 6 $11 2015 $ 5 $ 5 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 107 MANAGEMENT’S DISCUSSION AND ANALYSIS The Bank’s committed credit exposure to companies controlled by directors totaled $99.5 million as at October 31, 2016 (October 31, 2015 – $182.9 million) while actual utilized accounts were $3.9 million (October 31, 2015 – $6.7 million). Transactions with associates and joint ventures In the ordinary course of business, the Bank provides normal banking services and enters into transactions with its associated and other related corporations on terms similar to those offered to non-related parties. If these transactions are eliminated on consolidation, they are not disclosed as related party transactions. Transactions between the Bank and its associated companies and joint ventures also qualify as related party transactions and are as follows: T62 Transactions with associates and joint ventures As at and for the year ended October 31 ($ millions) Net income / (loss) Loans Deposits Guarantees and commitments Scotiabank principal pension plan 2016 $ (45) 788 338 99 $ 2015 $ (27) 747 187 84 $ The Bank manages assets of $1.9 billion (October 31, 2015 – $2.0 billion) which is a portion of the Scotiabank principal pension plan assets and earned $4 million (October 31, 2015 – $4 million) in fees. Oversight and governance The oversight responsibilities of the Audit and Conduct Review Committee (ACRC) with respect to related party transactions include reviewing policies and practices for identifying transactions with related parties that may materially affect the Bank, and reviewing the procedures for ensuring compliance with the Bank Act for related party transactions. The Bank Act requirements encompass a broader definition of related party transactions than is set out in IFRS. The Bank has various procedures in place to ensure that related party information is identified and reported to the ACRC on a semi-annual basis. The ACRC is provided with detailed reports that reflect the Bank’s compliance with its established procedures. The Bank’s Internal Audit department carries out audit procedures as necessary to provide the ACRC with reasonable assurance that the Bank’s policies and procedures to identify, authorize and report related party transactions are appropriately designed and operating effectively. 108 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T SUPPLEMENTARY DATA Geographic information T63 Net income by geographic segment 2016 2015 2014 Canada U.S. Mexico Peru Chile Colombia Other Inter- national Total Canada U.S. Mexico Peru Chile Colombia Other Inter- national Total Canada U.S. Mexico Peru Chile Colombia Other Inter- national Total For the fiscal years ($ millions) Net interest income $7,022 $479 $1,224 $1,231 $763 $674 $2,950 $14,343 $6,458 $472 $1,246 $1,077 $554 $677 $2,631 $13,115 $6,219 $440 $1,180 $935 $407 $726 $2,443 $12,350 Non-interest income 6,893 871 554 600 325 419 2,409 12,071 6,272 882 561 601 231 372 2,163 11,082 7,071 810 599 534 226 391 2,049 11,680 Provision for credit losses 876 112 225 315 113 320 401 2,362 728 6 260 266 108 246 268 1,882 662 6 240 267 74 145 309 1,703 Non-interest expenses 7,339 633 1,121 740 605 550 3,036 14,024 6,936 507 1,160 744 431 541 2,745 13,064 6,986 513 1,154 645 348 556 2,495 12,697 Income tax expense 1,235 155 69 201 45 89 497 2,291 1,038 267 27 195 24 84 401 2,036 1,156 237 35 175 16 141 340 2,100 Total $4,465 $450 $ 363 $ 575 $325 $134 $1,425 $ 7,737 $4,028 $574 $ 360 $ 473 $222 $178 $1,380 $ 7,215 $4,486 $494 $ 350 $382 $195 $275 $1,348 $ 7,530 Corporate adjustments Net Income (369) $ 7,368 (2) $ 7,213 (232) $ 7,298 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 109 MANAGEMENT’S DISCUSSION AND ANALYSIS T64 Loans and acceptances by geography (1) As at October 31 ($ billions) Canada Atlantic provinces Quebec Ontario Manitoba and Saskatchewan Alberta British Columbia U.S. Mexico Peru Chile Colombia Other International Latin America Europe Caribbean and Central America Asia and Other 2016 2015 2014 2016 2014 Percentage mix $ 26.7 29.7 156.7 17.0 50.8 47.6 328.5 $ 25.6 28.5 150.7 16.5 49.6 44.5 315.4 $ 25.5 27.7 145.1 15.1 46.3 43.0 302.7 38.5 20.8 17.8 19.4 9.3 6.4 8.4 32.6 15.0 62.4 30.2 18.6 17.0 16.4 8.7 6.7 9.3 31.8 19.0 66.8 23.5 16.0 13.3 13.9 9.1 5.3 6.3 27.7 20.0 59.3 5.4% 6.0 31.5 3.4 10.2 9.6 66.1 7.7 4.2 3.6 3.9 1.9 1.3% 1.7 6.6 3.0 5.8% 6.3 33.1 3.4 10.6 9.8 69.0 5.4 3.7 3.0 3.2 2.1 1.2% 1.5 6.3 4.6 12.6 13.6 Total allowance for loan losses(2) (4.6) (4.2) (3.6) Total loans and acceptances net of allowance for loan losses $ 492.1 $ 468.9 $ 434.2 (1) Prior periods have been restated to reflect the current period presentation. (2) Total allowance includes a collective allowance on performing loans of $1,444 million in 2016 and $1,404 million in 2015. The increase reflects an overall increase in the collective allowance of $50 million and a $10 million reallocation to reserves against unfunded commitments and other off-balance-sheet items. $ 496.7 $ 473.1 $ 437.8 100.0% 100.0% T65 Gross impaired loans by geographic segment As at October 31 ($ millions) Canada U.S. Mexico Peru Chile Colombia Other International Total (1) Excludes loans acquired under the Federal Deposit Insurance Corporation (FDIC) guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. T66 Provision against impaired loans by geographic segment For the fiscal years ($ millions) Canada U.S. Mexico Peru Chile Colombia Other International Total 2016(1) 2015(1) $ 1,258 210 301 764 499 381 1,981 $ 1,189 11 271 603 405 356 1,823 $ 5,394 $ 4,658 2014(1) $ 1,116 11 314 423 381 332 1,623 $ 4,200 2016 $ 876 112 224 317 112 320 401 $2,362 2015 2014 $ 727 6 260 265 108 247 269 $ 662 6 240 267 74 146 308 $ 1,882 $ 1,703 110 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T As at October 31 ($ millions) Asia China India Thailand South Korea Hong Kong Malaysia Japan Taiwan Others(2) Total Latin America Chile Mexico Brazil Peru Colombia Others(3) Total Caribbean and Central America Panama Costa Rica El Salvador Dominican Republic Jamaica Others(4) $ 2016 Total 5,205 1,893 3,249 1,564 1,736 1,108 1,756 269 1,404 $ 2015 Total 8,248 3,144 3,074 2,626 1,827 1,423 730 1,173 1,460 $ 18,184 $ 23,705 $ 6,314 6,464 5,198 6,760 2,940 632 $ 6,387 6,374 6,050 6,112 2,476 667 $ $ $ 69 21 14 281 52 3 34 32 5 511 47 40 718 60 4 – M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A T67 Cross-border exposure to select countries(1) Loans Trade Interbank deposits Government and other securities Investment in subsidiaries and affiliates Other $ 2,893 1,641 143 1,213 1,468 793 324 112 1,101 $ 938 231 4 70 178 – 11 16 247 $ 414 – 476 – 38 1 114 72 51 $ 206 – – – – – 1,273 37 – $ 685 – 2,612 – – 311 – – – $ 9,688 $ 1,695 $ 1,166 $ 1,516 $ 3,608 $ 2,479 2,772 3,132 2,310 1,122 80 $ 276 367 1,024 139 216 7 $ 11,895 $ 2,029 $ 4,025 1,543 788 961 51 1,638 $ 126 131 26 69 2 72 $ $ $ – – – – – – – 45 – – 81 – 1 $ 200 144 99 205 6 – $ 3,312 3,141 225 4,046 1,592 545 $ 654 $ 12,861 $ 869 $ 28,308 $ 28,066 $ $ – – – – – 9 9 $ $ 297 1,090 646 – 690 463 $ 3,186 $ 2 3 – 2 – – 7 $ 4,495 2,767 1,460 1,113 743 2,183 $ 3,646 2,213 1,209 892 747 2,267 $ 12,761 $ 10,974 Total $ 9,006 $ 426 $ 127 As at October 31, 2016 $ 30,589 $ 4,150 $ 1,293 As at October 31, 2015 $ 33,509 $ 7,602 $ 1,292 $ 2,179 $ 1,723 $ 19,655 $ 1,387 $ 59,253 $ 17,304 $ 1,316 $ 62,745 (1) Cross-border exposure represents a claim, denominated in a currency other than the local one, against a borrower in a foreign country on the basis of ultimate risk. (2) (3) (4) Includes Indonesia, Macau, Singapore, Vietnam and Turkey. Includes Venezuela and Uruguay Includes other English and Spanish Caribbean countries, such as Bahamas, Barbados, British Virgin Islands, Trinidad & Tobago, Turks & Caicos. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 111 MANAGEMENT’S DISCUSSION AND ANALYSIS Credit Risk T68 Loans and acceptances by type of borrower As at October 31 ($ billions) Residential mortgages Personal loans and credit cards Personal Financial services Non-bank Bank(1) Wholesale and retail Real estate and construction Energy Transportation Automotive Agriculture Hospitality and leisure Mining Metals refinery and processing Utilities Health care Technology and media Chemical Food and beverage Forest products Other(2) Sovereign(3) Business and government Total allowance for loan losses Total loans and acceptances net of allowance for loan losses (1) Deposit taking institutions and securities firms. (2) Other related to $3.2 in financing products, $2.4 in services and $2.0 in wealth management (2015 – $2.3, $1.5, and $1.5 respectively). (3) (4) 2015 and 2014 numbers have been restated to reflect the separate Mining and Metals Refinery and Processing. Includes central banks, regional and local governments, and supra-national agencies. T69 Off-balance sheet credit instruments As at October 31 ($ billions) Commitments to extend credit(1) Standby letters of credit and letters of guarantee Securities lending, securities purchase commitments and other Total (1) Excludes commitments which are unconditionally cancellable at the Bank’s discretion at any time. 2016 Balance % of total 2015(4) 2014(4) $ 222.9 99.5 $ 322.4 44.9% $ 217.5 91.5 20.0 $ 212.6 84.2 64.9% $ 309.0 $ 296.8 $ 16.1 3.7 22.1 22.6 15.6 9.0 11.5 8.8 3.5 5.4 2.5 7.8 5.2 11.8 1.6 4.9 2.5 14.7 5.0 3.2% $ 0.7 4.5 4.5 3.1 1.8 2.3 1.8 0.7 1.1 0.5 1.6 1.1 2.4 0.3 1.0 0.5 3.0 1.0 14.3 6.7 21.5 19.5 16.5 9.1 10.4 8.1 3.6 4.5 2.8 5.8 5.0 9.1 2.0 4.9 1.7 13.6 5.0 $ 13.4 8.9 16.6 15.5 12.8 8.1 8.1 7.1 3.6 3.2 2.8 5.9 3.5 5.4 1.4 3.9 1.3 15.3 4.2 $ 174.3 $ 496.7 (4.6) $ 492.1 35.1% $ 164.1 $ 141.0 100.0% $ 473.1 $ 437.8 (4.2) (3.6) $ 468.9 $ 434.2 2016 2015 2014 $ 174.2 34.5 40.0 $ 166.4 30.9 42.8 $ 248.7 $ 240.1 $ 137.3 26.0 38.9 $ 202.2 112 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T T70 Changes in net impaired loans(1) For the fiscal years ($ millions) Gross impaired loans Balance at beginning of year Net additions New additions Declassifications Payments Sales Write-offs Residential mortgages Personal loans Credit cards Business and government Foreign exchange and other Balance at end of year Allowance for credit losses on impaired loans Balance at beginning of year Provision for credit losses Write-offs Recoveries Residential mortgages Personal loans Credit cards Business and government Foreign exchange and other Balance at end of year Net impaired loans Balance at beginning of year Net change in gross impaired loans Net change in allowance for credit losses on impaired loans Balance at end of year (1) Excludes loans acquired under the Federal Deposit Insurance Corporation (FDIC) guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. T71 Provision for credit losses For the fiscal years ($ millions) Gross provisions Reversals Recoveries Net provisions for credit losses on impaired loans Collective provision (reversals) on performing loans Total net provisions for credit losses M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A 2016 2015 2014 $ 4,658 $ 4,200 $ 3,701 4,684 (24) (1,344) (95) 3,221 (201) (1,279) (671) (428) (2,579) 94 3,763 (13) (1,254) (11) 2,485 (109) (1,310) (490) (319) (2,228) 201 3,767 (32) (1,295) (141) 2,299 (69) (1,027) (463) (338) (1,897) 97 $ 5,394 $ 4,658 $ 4,200 $ 2,573 2,362 (2,579) $ 2,198 1,916 (2,228) $ 1,893 1,668 (1,897) 20 305 217 40 582 10 35 260 82 52 429 258 68 224 107 93 492 42 $ 2,948 $ 2,573 $ 2,198 $ 2,085 736 (375) $ 2,002 458 (375) $ 1,808 499 (305) $ 2,446 $ 2,085 $ 2,002 2016 2015 2014 $ 3,072 (110) (600) 2,362 50 $ 2,435 (68) (485) 1,882 60 $ 2,312 (99) (510) 1,703 – $ 2,412 $ 1,942 $ 1,703 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 113 MANAGEMENT’S DISCUSSION AND ANALYSIS T72 Provision for credit losses against impaired loans by type of borrower For the fiscal years ($ millions) Residential mortgages Personal loans and credit cards Personal Financial services Non-bank Bank Wholesale and retail Real estate and construction Energy Transportation Automotive Agriculture Hospitality and leisure Mining Metals refinery and processing Utilities Health care Technology and media Chemical Food and beverage Forest products Other Sovereign Business and government Total provisions against impaired loans T73 Impaired loans by type of borrower As at October 31 ($ millions) Residential mortgages Personal loans and credit cards Personal Financial services Non-bank Bank Wholesale and retail Real estate and construction Energy Transportation Automotive Agriculture Hospitality and leisure Mining Metals refinery and processing Utilities Health care Technology and media Chemical Food and beverage Forest products Other Sovereign Business and government Total 2016 2015 2014 $ 100 1,677 $ 118 1,526 $ – 1,414 $ 1,777 $ 1,644 $ 1,414 (1) 2 61 34 290 45 28 14 25 6 11 20 9 14 (7) 6 1 23 4 585 $ (1) (1) 62 30 48 23 9 12 1 7 4 – 9 4 4 16 4 6 1 238 $ 5 – 58 61 3 12 1 7 44 13 (1) 24 15 32 – 9 – 6 – 289 $ $ 2,362 $ 1,882 $ 1,703 2016(1) Allowance for credit losses $ 458 1,596 $ 2,054 8 2 193 105 89 84 38 37 27 6 25 53 29 28 6 44 6 108 6 894 $ $ 2,948 Gross $ 1,608 1,622 $ 3,230 23 2 290 234 324 214 70 75 83 14 159 252 49 32 15 110 23 150 45 $ 2,164 $ 5,394 Net $ 1,150 26 $ 1,176 15 – 97 129 235 130 32 38 56 8 134 199 20 4 9 66 17 42 39 $ 1,270 $ 2,446 Gross $ 1,668 1,332 $ 3,000 21 – 260 266 165 152 35 95 60 7 20 274 46 18 23 64 19 123 10 $ 1,658 $ 4,658 2015(1) Allowance for credit losses $ 529 1,327 $ 1,856 9 – 174 120 61 43 12 39 8 4 13 30 30 14 23 37 5 91 4 717 $ Net $ 1,139 5 $ 1,144 12 – 86 146 104 109 23 56 52 3 7 244 16 4 – 27 14 32 6 941 $ $ 2,573 $ 2,085 (1) Excludes loans acquired under the Federal Deposit Insurance Corporation (FDIC) guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. 114 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A T74 Total credit risk exposures by geography(1)(2) As at October 31 ($ millions) Drawn Undrawn exposures(3) Non-Retail 2016 Other $ 89,894 79,932 15,331 16,693 10,384 4,891 23,164 19,048 7,258 23,971 $ 32,953 27,951 1,183 1,413 782 186 5,936 1,704 522 4,115 $ 42,208 35,925 1,725 2,984 1,374 518 12,425 1,564 495 2,843 Retail Total $ 303,868 – 8,634 7,238 10,970 5,348 – 18,852 633 – $ 468,923 143,808 26,873 28,328 23,510 10,943 41,525 41,168 8,908 30,929 2015 Total $ 435,953 153,285 23,808 27,007 19,777 9,899 40,048 39,831 8,962 36,052 Canada U.S. Mexico Peru Chile Colombia Other International Europe Caribbean and Central America Latin America (other) Other Total As at October 31, 2015 $ 290,566 $ 76,745 $ 102,061 $ 355,543 $ 824,915 $ 794,622 $ 280,942 $ 72,434 $ 105,581 $ 335,665 $ 794,622 (1) Geographic segmentation is based upon the location of the ultimate risk of the credit exposure. Includes all credit risk portfolios and excludes available-for-sale equities and other assets. (2) Amounts represent exposure at default. (3) Includes off-balance sheet lending instruments such as letters of credit, letters of guarantee, derivatives, securitization and repo-style transactions after collateral. T75 AIRB credit risk exposures by maturity(1)(2) Residual maturity as at October 31 ($ millions) 2016 Drawn Undrawn exposures(3) Other Non-retail Less than 1 year One to 5 years Over 5 years Total non-retail Retail Less than 1 year One to 5 years Over 5 years Revolving credits(4) Total retail Total $ 109,752 112,975 10,351 $ 233,078 $ 28,829 167,999 20,243 37,177 $ $ $ 22,766 46,971 1,239 70,976 15,386 – – 21,108 $ 254,248 $ 36,494 $ 487,326 $ 107,470 $ $ $ $ $ 62,851 28,805 7,290 98,946 – – – – – Total $ 195,369 188,751 18,880 $ 403,000 $ 44,215 167,999 20,243 58,285 $ 290,742 98,946 $ 693,742 2015 Total $ 213,600 163,961 17,937 $ 395,498 $ 45,368 160,660 20,682 54,555 $ 281,265 $ 676,763 As at October 31, 2015 $ 475,832 $ 98,446 $ 102,485 $ 676,763 (1) Remaining term to maturity of the credit exposure. Includes all credit risk portfolios and excludes available-for-sale equities and other assets. (2) Exposure at default, before credit risk mitigation. (3) Off-balance sheet lending instruments, such as letters of credit, letters of guarantee, securitization, derivatives and repo-style transactions after collateral. (4) Credit cards and lines of credit with unspecified maturity. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 115 MANAGEMENT’S DISCUSSION AND ANALYSIS T76 Total credit risk exposures and risk-weighted assets AIRB Standardized(1) Total 2016 2015 Total As at October 31 ($ millions) Default(2) assets(3) Default(2) assets(3) Default(2) assets(3) Exposure at CET1 risk- weighted Exposure at CET1 risk- weighted Exposure at CET1 risk- weighted Exposure at Default(2) CET1 risk- weighted assets(3) Non-retail Corporate Drawn Undrawn Other(4) Bank Drawn Undrawn Other(4) Sovereign Drawn Undrawn Other(4) Total Non-retail Drawn Undrawn Other(4) Retail(5) Retail residential mortgages Drawn Secured lines of credit Drawn Undrawn Qualifying retail revolving exposures Drawn Undrawn Other retail Drawn Undrawn Total retail Drawn Undrawn Securitization exposures Trading derivatives CVA derivatives Subtotal Equities Other assets Total credit risk, before scaling $ 128,742 67,990 37,024 $ 71,771 28,839 13,455 $ 47,042 5,721 2,919 $ 45,407 5,660 2,901 $ 175,784 73,711 39,943 $ 117,178 34,499 16,356 $ 157,514 58,915 40,425 $ 112,836 29,035 15,476 233,756 114,065 55,682 53,968 289,438 168,033 256,854 157,347 23,978 1,944 12,979 38,901 80,358 1,042 497 81,897 233,078 70,976 50,500 5,211 334 2,371 7,916 3,861 112 12 3,985 80,843 29,285 15,838 2,044 38 196 2,278 8,402 10 – 8,412 57,488 5,769 3,115 1,356 34 196 1,586 1,300 7 – 1,307 26,022 1,982 13,175 41,179 88,760 1,052 497 90,309 6,567 368 2,567 9,502 5,161 119 12 5,292 48,063 5,701 3,097 290,566 76,745 53,615 128,906 34,986 18,935 27,165 11,386 14,906 53,457 96,263 2,133 1,016 99,412 280,942 72,434 56,347 8,344 3,726 3,253 15,323 4,203 355 36 4,594 125,383 33,116 18,765 $ 354,554 $ 125,966 $ 66,372 $ 56,861 $ 420,926 $ 182,827 $ 409,723 $ 177,264 $ 190,052 $ 10,228 $ 30,865 $ 14,800 $ 220,917 $ 25,028 $ 215,590 $ 24,967 190,052 10,228 30,865 14,800 220,917 25,028 215,590 24,967 19,233 14,587 33,820 16,717 21,108 37,825 28,246 799 29,045 254,248 36,494 4,497 1,359 5,856 9,463 2,656 12,119 13,055 203 13,258 37,243 4,218 – – – – – – – – – – – – 33,936 – 33,936 64,801 – 24,951 – 24,951 39,751 – 19,233 14,587 33,820 16,717 21,108 37,825 62,182 799 62,981 319,049 36,494 4,497 1,359 5,856 9,463 2,656 12,119 38,006 203 38,209 76,994 4,218 18,804 12,631 31,435 16,910 17,705 34,615 53,313 712 54,025 304,617 31,048 4,197 1,133 5,330 10,031 2,241 12,272 32,002 178 32,180 71,197 3,552 $ 290,742 $ 41,461 $ 64,801 $ 39,751 $ 355,543 $ 81,212 $ 335,665 $ 74,749 25,025 23,421 – 2,613 6,599 – – – – – – 4,165 25,025 23,421 – 2,613 6,599 4,165 21,000 28,234 – 2,759 8,232 7,183 $ 693,742 $ 176,639 $ 131,173 $ 100,777 $ 824,915 $ 277,416 $ 794,622 $ 270,187 2,042 – 2,042 – – 49,829 – 24,659 2,042 49,829 2,042 24,659 2,985 50,873 2,985 24,265 factor $ 695,784 $ 178,681 $ 181,002 $ 125,436 $ 876,786 $ 304,117 $ 848,480 $ 297,437 Add-on for 6% scaling factor(6) – 10,705 – – – 10,705 – 10,597 Total credit risk $ 695,784 $ 189,386 $ 181,002 $ 125,436 $ 876,786 $ 314,822 $ 848,480 $ 308,034 (1) Net of specific allowances for credit losses. (2) Outstanding amount for on-balance sheet exposures and loan equivalent amount for off-balance sheet exposures, before credit risk mitigation. (3) As at October 31, 2016, CVA risk-weighted assets were calculated using scalars of 0.64, 0.71 and 0.77 for the CET1, Tier 1 and Total capital ratios, respectively (scalars of 0.64, 0.71 and 0.77 in 2015). (4) Other exposures include off-balance sheet lending instruments, such as letters of credit, letters of guarantee, non-trading derivatives and repo-style exposures, after collateral. (5) During the year ended October 31, 2015, the Bank implemented new retail probability of default and loss given default models for mortgages and term loans. (6) Basel Committee imposed a scaling factor (6%) on risk-weighted assets for Internal Ratings-Based credit risk portfolios. 116 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Revenues and Expenses T77 Volume/rate analysis of change in net interest income ($ millions) Net interest income Total earning assets Total interest-bearing liabilities Change in net interest income Assets Deposits with banks Trading assets Securities purchased under resale agreements Investment securities Loans: Residential mortgages Personal loans and credit cards Business and government Total loans Total earning assets Liabilities Deposits: Personal Business and government Banks Total deposits Obligations related to securities sold under repurchase agreements Subordinated debentures Other interest-bearing liabilities M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A Increase (decrease) due to change in: 2016 versus 2015 Increase (decrease) due to change in: 2015 versus 2014 Average volume Average rate Net change Average volume Average rate Net change $ 1,859 515 $ 1,344 $ (14) (7) – 407 147 701 625 1,473 $ 1,859 $ 174 151 47 372 22 62 59 $ 13 157 $(144) $ 116 (6) (4) (79) (311) 44 253 (14) $ 1,872 672 $ 1,200 $ 1,304 428 $ 876 $ (558) (466) $ (92) $ 746 (38) $ 784 $ 102 (13) (4) 328 (164) 745 878 $ 48 (2) 17 46 127 597 471 1,459 1,195 $ (19) 52 (34) (95) (195) (77) (190) (462) $ 29 50 (17) (49) (68) 520 281 733 $ 13 $ 1,872 $ 1,304 $ (558) $ 746 $ (95) 359 79 343 (64) (17) (105) $ 79 510 126 715 (42) 45 (46) $ 125 290 (8) 407 11 11 (1) $ (261) (393) 28 (626) (53) (28) 241 $ (136) (103) 20 (219) (42) (17) 240 Total interest-bearing liabilities $ 515 $ 157 $ 672 $ 428 $ (466) $ (38) T78 Provision for income taxes For the fiscal years ($ millions) Income taxes Income tax expense Other taxes Payroll taxes Business and capital taxes Harmonized sales tax and other Total other taxes Total income and other taxes(1) Net income before income taxes Effective income tax rate (%) Total tax rate (%)(2) (1) Comprising $1,742 of Canadian taxes (2015 – $1,849; 2014 – $1,679) and $1,401 of foreign taxes (2015 – $1,004; 2014 – $1,244). (2) Total income and other taxes as a percentage of net income before income and other taxes. 2016 2015 2014 2016 versus 2015 $2,030 $ 1,853 $ 2,002 10% 347 403 363 1,113 $3,143 $9,398 21.6 29.9 329 361 310 1,000 312 314 295 921 $ 2,853 $ 2,923 $ 9,066 $ 9,300 20.4 28.3 21.5 28.6 6 12 17 11 10% 4% 1.2 1.6 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 117 MANAGEMENT’S DISCUSSION AND ANALYSIS T79 Assets under administration and management ($ billions) Assets under administration Personal Retail brokerage Investment management and trust Mutual funds Institutional Total Assets under management Personal Mutual funds Institutional Total T80 Assets under administration and management As at October 31 ($ billions) Assets under administration Balance at beginning of year Net inflows (outflows)(1) Impact of market changes, including foreign currency translation Balance at end of year (1) Includes impact of business acquisitions/dispositions of nil (2015 – nil; 2014 – $(0.9)). 2016 2015 2014 $ $ $ 163.5 106.4 269.9 139.2 63.7 472.8 47.9 125.1 19.7 $ $ $ 155.9 100.2 256.1 130.7 67.1 453.9 43.0 117.7 18.3 $ $ $ 148.8 95.1 243.9 122.5 61.1 427.5 35.7 110.6 18.5 $ 192.7 $ 179.0 $ 164.8 2016 2015 2014 $ 453.9 4.3 14.6 $ 427.5 14.3 12.1 $ 377.8 22.0 27.7 $ 472.8 $ 453.9 $ 427.5 As at October 31 ($ billions) 2016 2015 2014 Assets under management Balance at beginning of year Net inflows (outflows)(1) Impact of market changes, including foreign currency translation Balance at end of year (1) Includes impact of business acquisitions/dispositions of nil (2015 – nil; 2014 – $(0.9)). T81 Fees paid to the shareholders’ auditors For the fiscal years ($ millions) Audit services Audit-related services Tax services outside of the audit scope Other non-audit services Total $ 179.0 6.6 7.1 $ 164.8 8.2 6.0 $ 145.5 6.5 12.8 $ 192.7 $ 179.0 $ 164.8 2016 26.1 0.7 – 0.4 27.2 $ $ 2015 25.5 0.9 – 0.4 26.8 $ $ 2014 24.6 0.6 – 0.7 25.9 $ $ 118 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A Selected Quarterly Information T82 Selected quarterly information As at and for the quarter ended Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 2016 2015 Operating results ($ millions) Net interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income tax expense Net income Net income attributable to common shareholders Operating performance Basic earnings per share ($) Diluted earnings per share ($) Adjusted diluted earnings per share ($)(1) Return on equity (%) Productivity ratio (%)(2) Core banking margin (%)(1)(2) Financial position information ($ billions) Cash and deposits with financial institutions Trading assets Loans Total assets Deposits Common equity Preferred shares Assets under administration Assets under management Capital and liquidity measures Common Equity Tier 1 (CET1) capital ratio (%) Tier 1 capital ratio (%) Total capital ratio (%) Leverage ratio (%) CET1 risk-weighted assets ($ billions)(3) Liquidity coverage ratio (LCR)(%) Credit quality Net impaired loans ($ millions)(4) Allowance for credit losses ($ millions) Net impaired loans as a % of loans and acceptances(4) Provision for credit losses as a % of average net loans and acceptances (annualized) Common share information Closing share price ($) (TSX) Shares outstanding (millions) Average – Basic Average – Diluted End of period Dividends per share ($) Dividend yield (%)(5) Market capitalization ($ billions) (TSX) Book value per common share ($) Market value to book value multiple Price to earnings multiple (trailing 4 quarters) 3,653 3,098 6,751 550 3,650 540 2,011 1,908 1.58 1.57 1.58 14.7 54.1 2.40 46.3 108.6 480.2 896.3 611.9 52.7 3.6 472.8 192.7 11.0 12.4 14.6 4.5 364.0 127 2,446 4,626 0.49 3,602 3,038 6,640 571 3,505 605 1,959 1,860 1.55 1.54 1.55 14.8 52.8 2.38 69.8 103.9 472.8 906.8 631.3 50.8 3.1 464.9 187.9 10.5 11.8 14.1 4.2 357.7 125 2,491 4,542 0.51 3,518 3,076 6,594 752 3,817 441 1,584 1,489 1.24 1.23 1.48 12.1 57.9 2.38 61.2 101.4 466.8 895.0 609.3 48.9 3.4 453.5 179.4 10.1 11.4 13.6 4.1 356.9 121 2,347 4,402 0.49 3,519 2,846 6,365 539 3,568 444 1,814 1,730 1.44 1.43 1.44 13.8 56.1 2.38 75.3 104.3 476.6 919.6 630.9 50.9 3.3 452.6 179.0 10.1 11.2 13.4 4.0 374.5 124 2,335 4,354 0.48 3,371 2,754 6,125 551 3,286 445 1,843 1,754 1.46 1.45 1.46 14.2 53.6 2.35 73.9 99.1 458.6 856.5 600.9 49.1 2.9 453.9 179.0 10.3 11.5 13.4 4.2 358.0 124 2,085 4,197 0.44 3,354 2,770 6,124 480 3,334 463 1,847 1,767 1.46 1.45 1.47 14.7 54.4 2.40 82.8 103.7 451.0 863.1 602.8 48.7 2.9 459.8 182.9 10.4 11.6 13.5 4.1 348.0 127 2,096 4,125 0.45 3,198 2,739 5,937 448 3,224 468 1,797 1,727 1.43 1.42 1.43 15.1 54.3 2.41 60.7 113.1 436.0 837.2 575.3 46.7 2.9 445.8 176.8 10.6 11.9 13.9 4.1 328.7 123 2,172 3,694 0.48 3,169 2,694 5,863 463 3,197 477 1,726 1,649 1.36 1.35 1.36 14.2 54.5 2.41 65.9 109.6 439.9 851.9 584.6 46.9 2.9 440.8 173.8 10.3 11.5 13.2 4.1 335.2 N/A 2,266 3,788 0.50 0.45 0.47 0.64 0.45 0.47 0.42 0.41 0.42 72.08 66.33 65.80 57.39 61.49 64.19 66.53 61.06 1,206 1,226 1,208 0.74 4.3 87.1 43.59 1.7 12.4 1,203 1,222 1,205 0.72 4.5 79.9 42.14 1.6 11.7 1,203 1,228 1,203 0.72 4.9 79.1 40.70 1.6 11.8 1,203 1,225 1,203 0.70 4.9 69.0 42.32 1.4 9.9 1,205 1,227 1,203 0.70 4.8 74.0 40.80 1.5 10.8 1,210 1,231 1,208 0.68 4.3 77.5 40.30 1.6 12.0 1,210 1,231 1,210 0.68 4.2 80.5 38.61 1.7 11.6 1,215 1,220 1,210 0.66 4.0 73.9 38.75 1.6 10.7 (1) Refer to page 13 for a discussion of non-GAAP measures. (2) Effective Q3, 2016 the tax equivalent adjustment was no longer included in the calculation. Prior period amounts have been restated. (3) Credit valuation adjustment (CVA) risk-weighted assets were calculated using scalars of 0.64, 0.71 and 0.77 to compute CET1, Tier 1 and Total capital ratios, respectively in 2016. (4) Excludes loans acquired under the Federal Deposit Insurance Corporation (FDIC) guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. (5) Based on the average of the high and low common share price for the period. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 119 MANAGEMENT’S DISCUSSION AND ANALYSIS Eleven-Year Statistical Review T83 Consolidated Statement of Financial Position As at October 31 ($ millions) 2016 2015 2014 2013(1) 2012(1) 2011 IFRS Assets Cash and deposits with financial institutions Precious metals Trading assets Securities Loans Other Financial instruments designated at fair value through profit or loss Securities purchased under resale agreements and securities borrowed Derivative financial instruments Investment securities Loans Residential mortgages Personal and credit cards Business and government Allowance for credit losses Other Customers’ liability under acceptances Property and equipment Investments in associates Goodwill and other intangible assets Deferred tax assets Other assets Liabilities Deposits Personal Business and government Financial institutions Financial instruments designated at fair value through profit or loss Other Acceptances Obligations related to securities sold short Derivative financial instruments Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Capital instruments Other liabilities Equity Common equity Common shares Retained earnings Accumulated other comprehensive income (loss) Other reserves Total common equity Preferred shares Total equity attributable to equity holders of the Bank Non-controlling interests Non-controlling interests in subsidiaries Capital instrument equity holders Total equity $ 46,344 8,442 $ 73,927 10,550 $ 56,730 7,286 $ 53,338 8,880 $ 47,337 12,387 $ 38,723 9,249 87,287 19,421 1,853 108,561 221 92,129 41,657 72,919 222,888 99,502 162,400 484,790 4,626 480,164 11,978 2,520 4,299 12,141 2,021 12,870 45,829 78,380 18,341 2,419 99,140 320 87,312 41,003 43,216 217,498 91,477 153,850 462,825 4,197 458,628 10,296 2,286 4,033 11,449 2,034 12,303 42,401 95,363 14,508 3,377 113,248 111 93,866 33,439 38,662 212,648 84,204 131,098 427,950 3,641 424,309 9,876 2,272 3,461 10,884 1,763 9,759 38,015 84,196 11,225 1,068 96,489 106 82,533 24,503 34,319 209,865 76,008 119,615 405,488 3,273 402,215 10,556 2,214 5,326 10,704 1,938 10,523 41,261 74,639 12,857 100 87,596 197 66,189 30,338 33,376 175,630 68,277 111,648 355,555 2,977 352,578 8,932 2,218 4,791 8,692 2,273 11,321 38,227 62,192 13,607 – 75,799 375 47,181 37,322 30,176 161,685 63,317 96,743 321,745 2,689 319,056 8,172 2,504 4,434 7,639 2,214 11,579 36,542 $ 896,266 $ 856,497 $ 805,666 $ 743,644 $ 668,225 $ 594,423 $ 199,302 372,303 40,272 611,877 1,459 $ 190,044 375,144 35,731 600,919 1,486 $ 175,163 342,367 36,487 554,017 465 $ 171,048 313,820 33,019 517,887 174 $ 138,051 293,460 34,178 465,689 157 $ 133,025 262,833 25,376 421,234 101 11,978 23,312 42,387 97,083 7,633 – 42,716 225,109 838,445 15,513 34,752 2,240 152 52,657 3,594 56,251 1,570 – 57,821 10,296 20,212 45,270 77,015 6,182 – 41,638 200,613 803,018 15,141 31,316 2,455 173 49,085 2,934 52,019 1,460 – 53,479 9,876 27,050 36,438 88,953 4,871 – 34,785 201,973 756,455 15,231 28,609 949 176 44,965 2,934 47,899 1,312 – 49,211 10,556 24,977 29,267 77,508 5,841 – 32,047 180,196 698,257 14,516 25,068 388 193 40,165 4,084 44,249 1,138 – 45,387 8,932 18,622 35,323 56,968 10,143 – 32,726 162,714 628,560 13,139 21,775 (745) 166 34,335 4,384 38,719 946 – 8,172 15,450 40,236 38,216 6,923 2,003 29,848 140,848 562,183 8,336 18,421 (497) 96 26,356 4,384 30,740 626 874 39,665 32,240 $ 896,266 $ 856,497 $ 805,666 $ 743,644 $ 668,225 $ 594,423 (1) Certain prior period amounts are retrospectively adjusted to reflect the adoption of new and amended IFRS standards (IFRS 10 and IAS 19) in 2014. 120 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T T84 Consolidated Statement of Income IFRS For the year ended October 31 ($ millions) 2016 2015 2014 2013(1) 2012(1) 2011 Revenue Interest income Loans Securities Securities purchased under resale agreements and securities borrowed Deposits with financial institutions Interest expense Deposits Subordinated debentures Capital instruments Other Net interest income Non-interest income Total revenue Provision for credit losses Non-interest expenses Income before taxes Income tax expense Net income Net income attributable to non-controlling interests Non-controlling interests in subsidiaries Capital instrument equity holders Net income attributable to equity holders of the Bank Preferred shareholders Common shareholders Earnings per common share (in dollars) Basic Diluted Dividends per common share (in dollars) $ 20,419 1,237 158 394 $ 18,912 922 161 292 $ 18,176 921 180 263 $ 17,359 1,000 190 279 $ 15,606 1,045 221 287 $ 14,373 986 221 275 22,208 20,287 19,540 18,828 17,159 15,855 6,793 232 – 891 7,916 14,292 12,058 26,350 2,412 14,540 9,398 2,030 7,368 251 251 – 7,117 130 6,987 5.80 5.77 2.88 $ $ $ $ $ $ $ 6,070 187 – 938 7,195 13,092 10,957 24,049 1,942 13,041 9,066 1,853 7,213 199 199 – 7,014 117 6,897 5.70 5.67 2.72 $ $ $ $ $ $ $ 6,173 204 – 858 7,235 12,305 11,299 23,604 1,703 12,601 9,300 2,002 7,298 227 227 – 7,071 155 6,916 5.69 5.66 2.56 $ $ $ $ $ $ $ 6,397 339 – 742 7,478 11,350 9,949 21,299 1,288 11,664 8,347 1,737 6,610 231 231 – 6,379 217 6,162 5.15 5.11 2.39 $ $ $ $ $ $ $ 6,117 381 – 691 7,189 9,970 9,676 19,646 1,252 10,436 7,958 1,568 6,390 196 196 – 6,194 220 5,974 5.27 5.18 2.19 $ $ $ $ $ $ $ 5,589 369 138 745 6,841 9,014 8,296 17,310 1,076 9,481 6,753 1,423 5,330 149 91 58 5,181 216 4,965 4.63 4.53 2.05 $ $ $ $ $ $ $ (1) Certain amounts are retrospectively adjusted to reflect the adoption of new and amended IFRS standards (IFRS 10 and IAS 19) in 2014. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 121 MANAGEMENT’S DISCUSSION AND ANALYSIS T83A Consolidated Balance Sheet – CGAAP As at October 31 ($ millions) Assets Cash resources Securities Trading Available-for-sale Investment Equity accounted investments Securities purchased under resale agreements Loans Residential mortgages Personal and credit cards Business and government Allowance for credit losses Other Customers’ liability under acceptances Derivative instruments Land, buildings and equipment Other assets Liabilities and shareholders’ equity Deposits Personal Business and government Banks Other Acceptances Obligations related to securities sold under repurchase agreements Obligations related to securities sold short Derivative instruments Other liabilities Subordinated debentures Capital instrument liabilities Shareholders’ equity Preferred shares Common shareholders’ equity Common shares and contributed surplus Retained earnings Accumulated other comprehensive income (loss) Total common shareholders’ equity Total equity attributable to equity holders of the Bank Non-controlling interests Total shareholders’ equity 122 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 2010 2009 2008 2007 2006 CGAAP $ 46,027 $ 43,278 $ 37,318 $ 29,195 $ 23,376 64,684 47,228 – 4,651 116,563 27,920 120,482 62,548 103,981 287,011 2,787 58,067 55,699 – 3,528 117,294 17,773 101,604 61,048 106,520 269,172 2,870 48,292 38,823 – 920 88,035 19,451 115,084 50,719 125,503 291,306 2,626 59,685 28,426 – 724 88,835 22,542 102,154 41,734 85,500 229,388 2,241 62,490 – 32,870 142 95,502 25,705 89,590 39,058 76,733 205,381 2,607 284,224 266,302 288,680 227,147 202,774 7,616 26,852 2,450 15,005 51,923 9,583 25,992 2,372 13,922 51,869 11,969 44,810 2,449 14,913 74,141 11,538 21,960 2,061 8,232 43,791 9,555 12,098 2,103 7,893 31,649 $ 526,657 $ 496,516 $ 507,625 $ 411,510 $ 379,006 $ 128,850 210,687 22,113 $ 123,762 203,594 23,063 $ 118,919 200,566 27,095 $ 100,823 161,229 26,406 361,650 350,419 346,580 288,458 $ 93,450 141,072 29,392 263,914 7,616 40,286 21,519 31,990 28,947 9,583 36,568 14,688 28,806 24,682 11,969 36,506 11,700 42,811 31,063 11,538 28,137 16,039 24,689 21,138 130,358 114,327 134,049 101,541 5,939 500 5,944 500 4,352 500 1,710 500 9,555 33,470 13,396 12,869 24,799 94,089 2,271 750 3,975 3,710 2,860 1,635 600 5,775 21,932 (4,051) 23,656 27,631 579 28,210 4,946 19,916 (3,800) 21,062 24,772 554 25,326 3,829 18,549 (3,596) 18,782 21,642 502 22,144 3,566 17,460 (3,857) 17,169 18,804 497 19,301 3,425 15,843 (2,321) 16,947 17,547 435 17,982 $ 526,657 $ 496,516 $ 507,625 $ 411,510 $ 379,006 T84A Consolidated Statement of Income – CGAAP For the year ended October 31 ($ millions) Interest income Loans Securities Securities purchased under resale agreements Deposits with banks Interest expense Deposits Subordinated debentures Capital instrument liabilities Other Net interest income Provision for credit losses Net interest income after provision for credit losses Other income Net interest and other income Non-interest expenses Salaries and employee benefits Other Income before income taxes Provision for income taxes Net income Net income attributable to non-controlling interests Net income attributable to equity holders of the Bank Preferred shareholders Common shareholders Average number of common shares outstanding (millions) Basic Diluted Earnings per common share (in dollars)(1) Basic Diluted Dividends per common share (in dollars) (1) The calculation of earnings per share is based on full dollar and share amounts. M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A CGAAP 2010 2009 2008 2007 2006 $ 12,171 4,227 201 292 $ 13,973 4,090 390 482 $ 15,832 4,615 786 1,083 $ 13,985 4,680 1,258 1,112 $ 11,575 4,124 1,102 881 16,891 18,935 22,316 21,035 17,682 6,768 289 37 1,176 8,270 8,621 1,239 7,382 6,884 8,339 285 37 1,946 10,607 8,328 1,744 6,584 6,129 12,131 166 37 2,408 14,742 7,574 630 6,944 4,302 10,850 116 53 2,918 13,937 7,098 270 6,828 5,392 8,589 130 53 2,502 11,274 6,408 216 6,192 4,800 14,266 12,713 11,246 12,220 10,992 4,647 3,535 8,182 6,084 1,745 4,339 100 4,239 201 4,038 1,032 1,034 3.91 3.91 1.96 $ $ $ $ $ $ 4,344 3,575 7,919 4,794 1,133 3,661 114 3,547 186 3,361 1,013 1,016 3.32 3.31 1.96 $ $ $ $ $ $ 4,109 3,187 7,296 3,950 691 3,259 119 3,140 107 3,033 987 993 3.07 3.05 1.92 $ $ $ $ $ $ 3,983 3,011 6,994 5,226 1,063 4,163 118 4,045 51 3,994 989 997 4.04 4.01 1.74 $ $ $ $ $ $ 3,768 2,675 6,443 4,549 872 3,677 98 3,579 30 3,549 988 1,001 3.59 3.55 1.50 $ $ $ $ $ $ 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 123 MANAGEMENT’S DISCUSSION AND ANALYSIS T85 Consolidated Statement of Changes in Equity For the year ended October 31 ($ millions) 2016 2015 2014 2013(1) 2012(1) 2011 IFRS Common shares Balance at beginning of year Issued Purchased for cancellation Balance at end of year Retained earnings Balance at beginning of year IFRS adjustment Restated balances Adjustments Net income attributable to common shareholders of the Bank(4) Dividends: Preferred(5) Common Purchase of shares for cancellation and premium on redemption Other Balance at end of year Accumulated other comprehensive income (loss) Balance at beginning of year IFRS adjustment Restated balances Cumulative effect of adopting new accounting policies Other comprehensive income (loss) Balance at end of year Other reserves(9) Balance at beginning of year Share-based payments Other Balance at end of year Total common equity Preferred shares Balance at beginning of year Net income attributable to preferred shareholders of the Bank(4) Preferred dividends(5) Issued Redeemed Balance at end of year Non-controlling interests Balance at beginning of year IFRS adjustment Restated balances Net income attributable to non-controlling interests Distributions to non-controlling interests Effect of foreign exchange and others Balance at end of year Total equity at end of year $ 15,141 391 (19) $ 15,513 31,316 – 31,316 – 6,987 – (3,468) (61) (22) $ 34,752 2,455 – 2,455 – (215) 2,240 $ 173 7 (28) $ 152 $ 52,657 2,934 130 (130) 1,350 (690) 3,594 $ 1,460 – 1,460 251 (116) (25) 1,570 $ $ 57,821 $ 15,231 104 (194) $ 15,141 28,609 – 28,609 – 6,897 – (3,289) (761) (140)(6) $ 31,316 949 – 949 (5)(7) 1,511 2,455 $ 176 14 (17) $ 173 $ 49,085 2,934 117 (117) – – 2,934 $ 1,312 – 1,312 199 (86) 35 1,460 $ $ 53,479 $ 14,516 771 (56) $ 15,231 25,315 (247) 25,068 – 6,916 – (3,110) (264) (1) $ 28,609 545 (157) 388 – 561 949 $ 193 30 (47) $ 176 $ 44,965 4,084 155 (155) – (1,150) 2,934 $ 1,155 (17) 1,138 227 (76) 23 1,312 $ $ 49,211 $ 13,139 1,377 – $ 14,516 21,978 (203) 21,775 – 6,162 – (2,858) – (11) $ 25,068 (31) (714) (745) – 1,133 388 $ 166 36 (9) $ 193 $ 40,165 4,384 217 (217) – (300) 4,084 $ 1,743 (797) 946 231 (80) 41 1,138 $ $ 45,387 $ 8,336 4,803 – $ 13,139 18,421 (144) 18,277 – 5,974 – (2,493) – 17 $ 21,775 (497) 32 (465) – (280) (745) $ 96 38 32 $ 166 $ 34,335 4,384 220 (220) – – 4,384 $ 1,500 (891) 609 196 (44) 185 946 $ $ 39,665 $ $ 5,750 2,586 – 8,336 21,932 (6,248) 15,684 – 4,965 – (2,200) – (28) $ 18,421 (4,051) 4,320 269 – (766) (497) $ 25 46 25 $ 96 $ 26,356 3,975 216 (216) 409 – 4,384 $ 579 936 1,515 149 (181) 17 1,500 $ $ 32,240 (1) Certain prior period amounts are retrospectively adjusted to reflect the adoption of new and amended IFRS standards (IFRS 10 and IAS 19) in 2014. (2) Relates to the adoption of new financial instruments accounting standards under CGAAP. (3) Relates to the adoption of new stock-based compensation accounting standard under CGAAP. (4) Under CGAAP, net income attributable to preferred shareholders was included in retained earnings. (5) Under IFRS, preferred dividends are recorded as a reduction to preferred shareholders’ equity. Under CGAAP, dividends are a reduction to retained earnings. (6) Includes retrospective adjustments primarily related to foreign currency translation on Allowance for Credit Losses with respect to periods prior to 2013 ($152). (7) To reflect the adoption of the own credit risk provisions of IFRS 9 pertaining to financial liabilities designated at fair value through profit or loss. (8) Relates to the adoption of the new accounting standard for impairment and classification of financial instruments under CGAAP. (9) Under CGAAP, amounts represent Contributed Surplus. T86 Consolidated Statement of Comprehensive Income For the year ended October 31 ($ millions) Net income Other comprehensive income (loss), net of income taxes: Items that will be reclassified subsequently to net income Net change in unrealized foreign currency translation gains (losses) Net change in unrealized gains (losses) on available-for-sale securities Net change in gains (losses) on derivative instruments designated as cash flow hedges Other comprehensive income from investments in associates Items that will not be reclassified subsequently to net income Net change in remeasurement of employee benefit plan asset and liability Net change in fair value due to change in own credit risk on financial liabilities designated under the fair value option(2) Other comprehensive income from investments in associates Other comprehensive income (loss) Comprehensive income Comprehensive income attributable to: Common shareholders of the Bank Preferred shareholders of the Bank Non-controlling interests in subsidiaries Capital instrument equity holders IFRS 2016 2015 2014 2013(1) 2012(1) 2011 $ 7,368 $ 7,213 $ 7,298 $ 6,610 $ 6,390 $ 5,330 396 (172) 258 31 (716) (16) (10) (229) $ 7,139 $ 6,772 130 237 – $ 7,139 1,855 (480) 55 (9) (1) 15 1 1,436 $ 8,649 $ 8,408 117 124 – $ 8,649 889 (38) (6) 60 (320) N/A (2) 583 $ 7,881 $ 7,477 155 249 – $ 7,881 346 110 93 20 563 N/A – 1,132 $ 7,742 $ 7,298 217 227 – $ 7,742 149 151 116 25 (747) N/A – (306) $ 6,084 $ 5,694 220 170 – $ 6,084 (697) (169) 105 – – N/A – (761) $ 4,569 $ 4,199 216 96 58 $ 4,569 (1) Certain prior period amounts are retrospectively adjusted to reflect the adoption of new and amended IFRS standards (IFRS 10 and IAS 19) in 2014. (2) In accordance with the transition requirements for the own credit risk provisions of IFRS 9, prior year comparatives have not been restated for the adoption of this standard in 2015. 124 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A 2010 4,946 804 – 5,750 $ $ 19,916 – 19,916 – 4,239 (201) (2,023) – 1 $ 21,932 (3,800) – (3,800) – (251) $ (4,051) – 25 – $ 25 $ 23,656 3,710 – – 265 – 3,975 $ 554 – 554 100 (35) (40) 579 $ $ 28,210 2009 3,829 1,117 – 4,946 $ $ 18,549 – 18,549 – 3,547 (186) (1,990) – (4) $ 19,916 (3,596) – (3,596) 595(8) (799) $ (3,800) – – – $ – $ 21,062 2,860 – – 850 – 3,710 $ 502 – 502 114 (36) (26) 554 $ $ 25,326 CGAAP 2008 2007 2006 $ $ 3,425 184 (43) 3,566 $ $ 3,316 135 (26) 3,425 (61)(2) (25)(3) 15,843 – 15,843 4,045 (51) (1,720) (586) (10) $ 17,460 14,126 – 14,126 3,579 (30) (1,483) (324) – $ 15,843 (2,321) – (2,321) 683 (2,219) $ (3,857) – – – $ – $ 17,169 600 – – 1,035 – 1,635 $ N/A – N/A N/A N/A N/A 497 $ $ 19,301 (1,961) – (1,961) – (360) $ (2,321) 1 (1) – $ – $ 16,947 600 – – – – 600 $ N/A – N/A N/A N/A N/A 435 $ $ 17,982 $ $ 3,566 266 (3) 3,829 17,460 – 17,460 – 3,140 (107) (1,896) (37) (11) $ 18,549 (3,857) – (3,857) – 261 $ (3,596) – – – $ – $ 18,782 1,635 – – 1,225 – 2,860 $ N/A – N/A N/A N/A N/A 502 $ $ 22,144 CGAAP 2010 2009 2008 2007 2006 $ 4,339 $ 3,661 $ 3,259 $ 4,163 $ 3,677 (591) 278 62 – – N/A – (251) $ 4,088 $ 3,787 201 100 – $ 4,088 (1,736) 894 43 – – N/A – (799) $ 2,862 $ 2,562 186 114 – $ 2,862 2,368 (1,588) (519) – – N/A – 261 $ 3,520 $ 3,294 107 119 – $ 3,520 (2,228) (67) (360) – 76 – – N/A – (2,219) $ 1,944 $ 1,775 51 118 – $ 1,944 – – – N/A – (360) $ 3,317 $ 3,189 30 98 – $ 3,317 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 125 MANAGEMENT’S DISCUSSION AND ANALYSIS T87 Other statistics For the year ended October 31 2016 2015 2014 2013(1) 2012(1) 2011 IFRS Operating performance Basic earnings per share ($) Diluted earnings per share ($) Return on equity (%) Productivity ratio (%)(2) Return on assets (%) Core banking margin (%)(2)(3) Net interest margin on total average assets (%) Capital measures(4) Common Equity Tier 1 (CET1) capital ratio (%) Tier 1 capital ratio (%) Total capital ratio (%) Leverage ratio (%) Common share information Closing share price ($)(TSX) Number of shares outstanding (millions) Dividends per share ($) Dividend yield (%)(5) Price to earnings multiple (trailing 4 quarters) Book value per common share ($) Other information Average total assets ($ millions) Number of branches and offices Number of employees Number of automated banking machines 5.80 5.77 13.8 55.2 0.81 2.38 N/A 11.0 12.4 14.6 4.5 72.08 1,208 2.88 4.7 12.4 43.59 5.70 5.67 14.6 54.2 0.84 2.39 N/A 10.3 11.5 13.4 4.2 61.49 1,203 2.72 4.4 10.8 40.80 5.69 5.66 16.1 53.4 0.92 2.39 N/A 10.8 12.2 13.9 N/A 69.02 1,217 2.56 3.8 12.1 36.96 5.15 5.11 16.6 54.8 0.88 2.31 N/A 9.1 11.1 13.5 N/A 63.39 1,209 2.39 4.1 12.3 33.23 5.27 5.18 19.9 53.1 0.97 2.31 N/A N/A 13.6 16.7 N/A 54.25 1,184 2.19 4.2 10.3 28.99 4.63 4.53 20.3 54.8 0.91 2.32 N/A N/A 12.2 13.9 N/A 52.53 1,089 2.05 3.7 11.3 24.20 913,844 860,607 795,641 748,901 659,538 586,101 3,113 88,901 8,144 3,177 89,214 8,191 3,288 86,932 8,732 3,330 86,690 8,471 3,123 81,497 7,341 2,926 75,362 6,260 (1) Certain prior period amounts are retrospectively adjusted to reflect the adoption of new and amended IFRS standards (IFRS 10 and IAS 19) in 2014. Capital measures have not been restated for the new IFRS standards as they represent the actual amounts in the period for regulatory purposes. (2) Effective 2016, the taxable equivalent adjustment was no longer included in the calculation. Prior period amounts have been restated. (3) Refer to page 13 for a discussion of non-GAAP measures. (4) Effective November 1, 2012, regulatory capital ratios are determined in accordance with Basel III rules as an all-in basis. Comparative amounts for periods 2012-2007 were determined in accordance with Basel II rules. Amounts prior to 2007 were determined in accordance with Basel I rules and have not been restated. (5) Based on the average of the high and low common share price for the year. 126 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 2010 2009 3.91 3.91 18.3 52.8 0.84 N/A 1.67 N/A 11.8 13.8 N/A 54.67 1,043 1.96 3.9 14.0 22.68 3.32 3.31 16.7 54.8 0.71 N/A 1.62 N/A 10.7 12.9 N/A 45.25 1,025 1.96 5.4 13.6 20.55 CGAAP 2008 3.07 3.05 16.7 61.4 0.72 N/A 1.66 N/A 9.3 11.1 N/A 2007 2006 4.04 4.01 22.0 56.0 1.03 N/A 1.76 N/A 9.3 10.5 N/A 3.59 3.55 22.1 57.5 1.05 N/A 1.83 N/A 10.2 11.7 N/A 40.19 53.48 49.30 992 1.92 4.3 13.1 984 1.74 3.4 13.2 990 1.50 3.3 13.7 18.94 17.45 17.13 515,991 513,149 455,539 403,475 350,709 2,784 70,772 5,978 2,686 67,802 5,778 2,672 69,049 5,609 2,331 58,113 5,283 2,191 54,199 4,937 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S | S U P P L E M E N T A R Y D A T A 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 127 MANAGEMENT’S DISCUSSION AND ANALYSIS Management’s Report on Internal Control Over Financial Reporting The management of The Bank of Nova Scotia (the Bank) is responsible for establishing and maintaining adequate internal control over financial reporting, and have designed such internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards as issued by The International Accounting Standards Board. Management has used the Internal Control – Integrated Framework (2013) to evaluate the effectiveness of internal control over financial reporting, which is a recognized and suitable framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management has evaluated the design and operation of the Bank’s internal control over financial reporting as of October 31, 2016, and has concluded that such internal control over financial reporting is effective. There are no material weaknesses that have been identified by management in this regard. KPMG LLP, the independent auditors appointed by the shareholders of the Bank, who have audited the consolidated financial statements, have also audited internal control over financial reporting and have issued their report below. Brian J. Porter President and Chief Executive Officer Sean McGuckin Chief Financial Officer Toronto, Canada November 29, 2016 Report of Independent Registered Public Accounting Firm To the Shareholders of The Bank of Nova Scotia We have audited The Bank of Nova Scotia’s internal control over financial reporting as of October 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Bank of Nova Scotia’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting”. Our responsibility is to express an opinion on The Bank of Nova Scotia’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, The Bank of Nova Scotia maintained, in all material respects, effective internal control over financial reporting as of October 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position of The Bank of Nova Scotia as at October 31, 2016 and October 31, 2015, the consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the years in the three-year period ended October 31, 2016, and notes, comprising a summary of significant accounting policies and other explanatory information, and our report dated November 29, 2016 expressed an unmodified (unqualified) opinion on those consolidated financial statements. Chartered Professional Accountants, Licensed Public Accountants Toronto, Canada November 29, 2016 128 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S T A B L E O F C O N T E N T S 130 Management’s Responsibility for Financial Information 131 Independent Auditors’ Report of Registered Public Accounting Firm 132 Consolidated Statement of Financial Position 133 Consolidated Statement of Income 134 Consolidated Statement of Comprehensive Income 135 Consolidated Statement of Changes in Equity 136 Consolidated Statement of Cash Flows 137 Notes to the 2016 Consolidated Financial Statements 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 129 CONSOLIDATED FINANCIAL STATEMENTS Management’s Responsibility for Financial Information The management of The Bank of Nova Scotia (the Bank) is responsible for the integrity and fair presentation of the financial information contained in this Annual Report. The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. The consolidated financial statements also comply with the accounting requirements of the Bank Act. The consolidated financial statements, where necessary, include amounts which are based on the best estimates and judgment of management. Financial information presented elsewhere in this Annual Report is consistent with that shown in the consolidated financial statements. Management has always recognized the importance of the Bank maintaining and reinforcing the highest possible standards of conduct in all of its actions, including the preparation and dissemination of statements fairly presenting the financial condition of the Bank. In this regard, management has developed and maintains a system of accounting and reporting which provides for the necessary internal controls to ensure that transactions are properly authorized and recorded, assets are safeguarded against unauthorized use or disposition, and liabilities are recognized. The system is augmented by written policies and procedures, the careful selection and training of qualified staff, the establishment of organizational structures providing an appropriate and well-defined division of responsibilities, and the communication of policies and guidelines of Scotiabank’s Code of Conduct throughout the Bank. Management, under the supervision of and the participation of the President and Chief Executive Officer and the Chief Financial Officer, have a process in place to evaluate disclosure controls and procedures and internal control over financial reporting in line with Canadian and U.S. securities regulations. The system of internal controls is further supported by a professional staff of internal auditors who conduct periodic audits of all aspects of the Bank’s operations. As well, the Bank’s Chief Auditor has full and free access to, and meets periodically with the Audit and Conduct Review Committee of the Board of Directors. In addition, the Bank’s compliance function maintains policies, procedures and programs directed at ensuring compliance with regulatory requirements, including conflict of interest rules. The Office of the Superintendent of Financial Institutions Canada, which is mandated to protect the rights and interests of the depositors and creditors of the Bank, examines and enquires into the business and affairs of the Bank, as deemed necessary, to determine whether the provisions of the Bank Act are being complied with, and that the Bank is in a sound financial condition. The Audit and Conduct Review Committee, composed entirely of outside directors, reviews the consolidated financial statements with both management and the independent auditors before such statements are approved by the Board of Directors and submitted to the shareholders of the Bank. The Audit and Conduct Review Committee reviews and reports its findings to the Board of Directors on all related party transactions that may have a material impact on the Bank. KPMG LLP, the independent auditors appointed by the shareholders of the Bank, have audited the consolidated financial position of the Bank as at October 31, 2016 and October 31, 2015 and its consolidated financial performance and its consolidated cash flows for each of the years in the three- year period ended October 31, 2016 prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board in accordance with Canadian Generally Accepted Auditing Standards and the standards of the Public Company Accounting Oversight Board (United States) and the effectiveness of internal control over financial reporting and have expressed their opinions upon completion of such audits in the following report to the shareholders. The Shareholders’ Auditors have full and free access to, and meet periodically with, the Audit and Conduct Review Committee to discuss their audits, including any findings as to the integrity of the Bank’s accounting, financial reporting and related matters. Brian J. Porter President and Chief Executive Officer Sean McGuckin Chief Financial Officer Toronto, Canada November 29, 2016 130 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Independent Auditors’ Report of Registered Public Accounting Firm To the Shareholders of The Bank of Nova Scotia We have audited the accompanying consolidated financial statements of The Bank of Nova Scotia, which comprise the consolidated statements of financial position as at October 31, 2016 and October 31, 2015, the consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the years in the three-year period ended October 31, 2016, and notes, comprising a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Bank’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of The Bank of Nova Scotia as at October 31, 2016 and October 31, 2015 and its consolidated financial performance and its consolidated cash flows for each of the years in the three-year period ended October 31, 2016 in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. Other Matter We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), The Bank of Nova Scotia’s internal control over financial reporting as of October 31, 2016, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated November 29, 2016 expressed an unmodified (unqualified) opinion on the effectiveness of The Bank of Nova Scotia’s internal control over financial reporting. Chartered Professional Accountants, Licensed Public Accountants Toronto, Canada November 29, 2016 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 131 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statement of Financial Position As at October 31 ($ millions) Assets Cash and deposits with financial institutions Precious metals Trading assets Securities Loans Other Financial instruments designated at fair value through profit or loss Securities purchased under resale agreements and securities borrowed Derivative financial instruments Investment securities Loans Residential mortgages Personal and credit cards Business and government Allowance for credit losses Other Customers’ liability under acceptances Property and equipment Investments in associates Goodwill and other intangible assets Deferred tax assets Other assets Liabilities Deposits Personal Business and government Financial institutions Financial instruments designated at fair value through profit or loss Other Acceptances Obligations related to securities sold short Derivative financial instruments Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Other liabilities Equity Common equity Common shares Retained earnings Accumulated other comprehensive income (loss) Other reserves Total common equity Preferred shares Total equity attributable to equity holders of the Bank Non-controlling interests in subsidiaries Thomas C. O’Neill Chairman of the Board Brian J. Porter President and Chief Executive Officer The accompanying notes are an integral part of these consolidated financial statements. 132 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Note 2016 2015 5 7(a) 7(b) 8 9 11 12 12 12 12(d) 15 16 17 26(c) 18 19 19 19 8 9 20 21 23(a) 23(b) 30(b) $ 46,344 8,442 $ 73,927 10,550 87,287 19,421 1,853 108,561 221 92,129 41,657 72,919 222,888 99,502 162,400 484,790 4,626 480,164 11,978 2,520 4,299 12,141 2,021 12,870 45,829 78,380 18,341 2,419 99,140 320 87,312 41,003 43,216 217,498 91,477 153,850 462,825 4,197 458,628 10,296 2,286 4,033 11,449 2,034 12,303 42,401 $ 896,266 $ 856,497 $ 199,302 372,303 40,272 611,877 1,459 $ 190,044 375,144 35,731 600,919 1,486 11,978 23,312 42,387 97,083 7,633 42,716 225,109 838,445 15,513 34,752 2,240 152 52,657 3,594 56,251 1,570 57,821 10,296 20,212 45,270 77,015 6,182 41,638 200,613 803,018 15,141 31,316 2,455 173 49,085 2,934 52,019 1,460 53,479 $ 896,266 $ 856,497 Consolidated Statement of Income For the year ended October 31 ($ millions) Revenue Interest income Loans Securities Securities purchased under resale agreements and securities borrowed Deposits with financial institutions Interest expense Deposits Subordinated debentures Other Net interest income Non-interest income Banking Wealth management Underwriting and other advisory Non-trading foreign exchange Trading revenues Net gain on sale of investment securities Net income from investments in associated corporations Insurance underwriting income, net of claims Other Total revenue Provision for credit losses Non-interest expenses Salaries and employee benefits Premises and technology Depreciation and amortization Communications Advertising and business development Professional Business and capital taxes Other Income before taxes Income tax expense Net income C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Note 2016 2015 2014 31 31 32 11(e) 16 12(d) $ 20,419 1,237 158 394 22,208 $ 18,912 922 161 292 20,287 $ 18,176 921 180 263 19,540 6,793 232 891 7,916 6,070 187 938 7,195 6,173 204 858 7,235 14,292 13,092 12,305 3,669 3,282 594 540 1,403 534 414 603 1,019 12,058 26,350 2,412 23,938 7,025 2,238 684 442 617 693 403 2,438 3,360 3,269 525 492 1,185 639 405 556 526 10,957 24,049 1,942 22,107 6,681 2,086 584 434 592 548 361 1,755 3,170 3,023 712 420 1,114 741 428 474 1,217 11,299 23,604 1,703 21,901 6,547 1,936 526 417 571 471 314 1,819 14,540 13,041 12,601 9,398 2,030 9,066 1,853 9,300 2,002 $ 7,368 $ 7,213 $ 7,298 Net income attributable to non-controlling interests in subsidiaries 30(b) $ 251 $ 199 $ 227 Net income attributable to equity holders of the Bank Preferred shareholders Common shareholders Earnings per common share (in dollars) Basic Diluted Dividends per common share (in dollars) The accompanying notes are an integral part of these consolidated financial statements. $ 7,117 130 $ 6,987 $ 7,014 117 $ 6,897 $ 7,071 155 $ 6,916 33 33 23(a) $ $ $ 5.80 5.77 2.88 $ $ $ 5.70 5.67 2.72 $ $ $ 5.69 5.66 2.56 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 133 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statement of Comprehensive Income For the year ended October 31 ($ millions) Net income Other comprehensive income (loss) Items that will be reclassified subsequently to net income Net change in unrealized foreign currency translation gains (losses): Net unrealized foreign currency translation gains (losses) Net gains (losses) on hedges of net investments in foreign operations Income tax expense (benefit): Net unrealized foreign currency translation gains (losses) Net gains (losses) on hedges of net investments in foreign operations Net change in unrealized gains (losses) on available-for-sale securities: Net unrealized gains (losses) on available-for-sale securities Reclassification of net (gains) losses to net income(1) Income tax expense (benefit): Net unrealized gains (losses) on available-for-sale securities Reclassification of net (gains) losses to net income Net change in gains (losses) on derivative instruments designated as cash flow hedges: Net gains (losses) on derivative instruments designated as cash flow hedges Reclassification of net (gains) losses Income tax expense (benefit): Net gains (losses) on derivative instruments designated as cash flow hedges Reclassification of net (gains) losses Other comprehensive income (loss) from investments in associates Items that will not be reclassified subsequently to net income Net change in remeasurement of employee benefit plan asset and liability: Actuarial gains (losses) on employee benefit plans Income tax expense (benefit) Net change in fair value due to change in own credit risk on financial liabilities designated under the fair value option: Change in fair value due to change in own credit risk on financial liabilities designated under the fair value option Income tax expense (benefit) Other comprehensive income (loss) from investments in associates Other comprehensive income (loss) Comprehensive income Comprehensive income attributable to non-controlling interests Comprehensive income attributable to equity holders of the Bank Preferred shareholders Common shareholders (1) Includes amounts related to qualifying hedges. The accompanying notes are an integral part of these consolidated financial statements. 2016 2015 2014 $ 7,368 $ 7,213 $ 7,298 614 (300) (3) (79) 396 308 (549) 82 (151) (172) (7) 357 9 83 258 31 (972) (256) (716) (23) (7) (16) (10) 3,145 (1,677) 46 (433) 1,855 386 (966) 161 (261) (480) 1,519 (1,444) 450 (430) 55 (9) (3) (2) (1) 20 5 15 1 (229) 1,436 1,607 (943) 25 (250) 889 801 (934) 186 (281) (38) 441 (447) 137 (137) (6) 60 (432) (112) (320) – – – (2) 583 $ 7,139 $ 8,649 $ 7,881 $ 237 $ 124 $ 249 $ 6,902 130 $ 6,772 $ 8,525 117 $ 8,408 $ 7,632 155 $ 7,477 134 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T l a t o T 9 7 4 , 3 5 $ ) 9 2 2 ( 8 6 3 , 7 9 3 1 , 7 3 1 7 , 1 ) 0 7 7 ( ) 8 6 4 , 3 ( ) 0 3 1 ( ) 6 1 1 ( 7 ) 3 3 ( $ 1 2 8 , 7 5 $ 3 1 2 , 7 6 3 4 , 1 1 1 2 , 9 4 $ 9 4 6 , 8 $ 7 8 ) 7 1 1 ( ) 5 5 9 ( ) 9 8 2 , 3 ( ) 6 8 ( 4 1 ) 5 3 ( 9 7 4 , 3 5 $ – – – – – – – – – – – – – – – – – – – – – – – – 0 4 7 ) 5 5 1 ( ) 0 7 4 , 1 ( ) 0 1 1 , 3 ( ) 6 7 ( 0 3 ) 6 1 ( 3 8 5 8 9 2 , 7 7 8 3 , 5 4 1 8 8 , 7 $ 1 1 2 , 9 4 $ – – – – – – – – – – – – ) 4 6 1 , 1 ( 1 5 5 , 6 4 $ 3 4 7 ) 3 4 7 ( $ $ $ $ $ $ $ $ – – – – ) 4 ( ) 1 1 ( – ) 6 1 1 ( ) 4 1 ( 1 5 2 7 3 2 $ ) 5 1 2 ( 7 1 1 , 7 2 0 9 , 6 3 1 7 , 1 ) 0 3 1 ( ) 0 7 7 ( ) 8 6 4 , 3 ( – 7 ) 2 2 ( $ – 0 3 1 ) 0 9 6 ( 0 3 1 0 5 3 , 1 – ) 0 3 1 ( – – – ) 5 1 2 ( 7 8 9 6 , $ 2 7 7 6 , $ – – 7 ) 2 2 ( ) 0 8 ( 3 6 3 ) 8 6 4 3 ( , – – – ) 8 2 ( – – – – 7 – – ) 4 1 7 ( 7 – 7 5 2 – ) 0 8 1 ( – – – – – – – – – – – – – – – – – – – – – $ ) 4 1 7 ( $ 7 5 2 $ ) 0 8 1 ( $ – 2 2 4 2 2 4 – – – – – – – – 7 8 9 6 , $ 7 8 9 6 , $ – – – ) 2 2 ( – ) 1 6 ( ) 8 6 4 3 ( , – – – ) 9 1 ( 1 9 3 – – – – – $ e m o c n i e v i s n e h e r p m o c l a t o T ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t O e m o c n i t e N s t s e r e t n i g n i l l o r t n o c - n o n o t s n o i t u b i r t s i D s t n e m y a p d e s a b - e r a h S r e h t O d e m e e d e r / d e s a h c r u p e r s e r a h S i d a p s d n e d i v i d n o m m o C i d a p s d n e d i v i d d e r r e f e r P d e u s s i s e r a h S 0 6 4 , 1 $ 9 1 0 , 2 5 $ 4 3 9 , 2 $ 5 8 0 9 4 , $ 3 7 1 $ ) 9 7 3 ( $ $ 4 9 1 $ 3 3 6 2 , $ 6 1 3 1 3 , $ 1 4 1 , 5 1 $ 5 1 0 2 , 1 r e b m e v o N t a s a e c n a l a B 0 7 5 , 1 $ 1 5 2 , 6 5 $ 4 9 5 , 3 $ 7 5 6 2 5 , $ 2 5 1 $ ) 3 9 0 1 ( $ , 4 6 2 $ 4 1 $ 5 5 0 3 , $ 2 5 7 4 3 , $ 3 1 5 , 5 1 $ 6 1 0 2 , 1 3 r e b o t c O t a s a e c n a l a B ) 5 7 ( 9 9 1 4 2 1 – – – – – ) 6 8 ( ) 4 ( 0 1 1 $ 5 2 5 , 8 $ 4 1 0 , 7 1 1 5 , 1 7 8 ) 7 1 1 ( ) 5 5 9 ( ) 9 8 2 , 3 ( – 4 1 ) 5 4 1 ( – 7 1 1 7 1 1 – – – ) 7 1 1 ( – – – 7 9 8 6 , 1 1 5 1 , $ 8 0 4 8 , $ 7 8 ) 5 5 9 ( ) 9 8 2 3 , ( – – 4 1 ) 5 4 1 ( – – – ) 7 1 ( – – – – – 4 1 $ – ) 7 ( ) 7 ( – – – – – – ) 6 ( ) 5 ( $ 0 6 4 , 1 $ 9 1 0 , 2 5 $ 4 3 9 , 2 $ 5 8 0 9 4 , $ 3 7 1 $ ) 9 7 3 ( $ – 5 5 5 5 – – – – – – – 7 – ) 0 7 4 ( – 0 0 7 3 3 9 1 , – 7 9 8 6 , $ ) 0 7 4 ( $ 3 3 9 1 , $ 7 9 8 6 , $ – – – – – – – – – – – – – – – – – ) 5 ( ) 0 4 1 ( – ) 1 6 7 ( ) 9 8 2 3 , ( – – – 4 0 1 ) 4 9 1 ( – – – – – $ e m o c n i e v i s n e h e r p m o c l a t o T ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t O e m o c n i t e N s t s e r e t n i g n i l l o r t n o c - n o n o t s n o i t u b i r t s i D s t n e m y a p d e s a b - e r a h S r e h t O d e m e e d e r / d e s a h c r u p e r e r a h S i d a p s d n e d i v i d n o m m o C i d a p s d n e d i v i d d e r r e f e r P d e u s s i s e r a h S $ 4 9 1 $ 3 3 6 2 , $ 6 1 3 , 1 3 $ 1 4 1 , 5 1 $ 5 1 0 2 , 1 3 r e b o t c O t a s a e c n a l a B 2 1 3 , 1 $ 9 9 8 , 7 4 $ 4 3 9 , 2 $ 5 6 9 4 4 , $ 6 7 1 $ ) 7 6 3 ( $ ) 8 4 ( $ 4 6 6 $ $ 9 0 6 , 8 2 $ 1 3 2 , 5 1 $ 4 1 0 2 , 1 r e b m e v o N t a s a e c n a l a B ) 7 1 ( 8 3 1 , 1 2 2 7 2 2 9 4 2 – – – – ) 4 ( 1 – ) 6 7 ( $ 2 3 6 , 7 $ ) 4 0 4 ( 1 6 5 1 7 0 , 7 9 4 2 , 4 4 0 4 7 ) 5 5 1 ( ) 0 7 4 , 1 ( ) 0 1 1 , 3 ( – 0 3 ) 7 1 ( – 5 5 1 4 8 0 , 4 – – 5 5 1 – ) 5 5 1 ( ) 0 5 1 , 1 ( – – – ) 4 0 4 ( 1 6 5 6 1 9 6 , 5 6 1 0 4 , $ 7 7 4 7 , $ – – 0 3 ) 7 1 ( 0 4 7 ) 0 2 3 ( ) 0 1 1 3 , ( – 3 9 1 – – – ) 4 3 ( – – – – ) 8 ( ) 3 1 ( 0 3 5 5 ) 7 5 1 ( ) 2 0 1 ( – ) 5 6 2 ( $ ) 5 6 2 ( $ – ) 2 4 ( – ) 6 ( ) 6 ( $ – – 5 0 7 ) 1 4 ( ) 1 4 ( $ – ) 3 7 1 ( – 3 7 8 3 7 8 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 6 1 9 6 , 8 6 0 5 2 , $ 6 1 9 6 , $ – – – ) 4 ( 3 ) 4 6 2 ( ) 0 1 1 3 , ( – – – ) 6 5 ( 1 7 7 – – – – – 6 1 5 , 4 1 $ e m o c n i e v i s n e h e r p m o c l a t o T ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t O l s e c n a a b d e t a t s e R e m o c n i t e N s t s e r e t n i g n i l l o r t n o c - n o n o t s n o i t u b i r t s i D s t n e m y a p d e s a b - e r a h S r e h t O d e m e e d e r / d e s a h c r u p e r s e r a h S i d a p s d n e d i v i d n o m m o C i d a p s d n e d i v i d d e r r e f e r P d e u s s i s e r a h S ) 7 4 2 ( – ) 7 ( t n e m j t s u d a g n n e p O i 5 5 1 , 1 $ 3 5 6 , 4 4 $ 4 8 0 , 4 $ 9 6 5 0 4 , $ 3 9 1 $ $ ) 2 4 ( $ 5 0 7 $ ) 3 7 1 ( $ 5 1 3 , 5 2 $ 6 1 5 , 4 1 $ 3 1 0 2 , 1 r e b m e v o N d e t r o p e r s a e c n a l a B $ 2 1 3 , 1 $ 9 9 8 , 7 4 $ 4 3 9 , 2 $ 5 6 9 4 4 , $ 6 7 1 $ ) 7 6 3 ( $ ) 8 4 ( $ 4 6 6 $ 0 0 7 $ 9 0 6 , 8 2 $ 1 3 2 , 5 1 $ 4 1 0 2 , 1 3 r e b o t c O t a s a e c n a l a B s t s e r e t n i g n i l l o r t n o c - n o N l a t i p a C t n e m u r t s n i s r e d o h l y t i u q e n i s t s e r e t n i i s e i r a d i s b u s ) ) b ( 0 3 e t o N ( g n i l l o r t n o c - n o N y t i u q e n o m m o c l a t o T d e r r e f e r p d n a s e r a h s d e r r e f e r P ) 3 2 e t o N ( l a t o T y t i u q e n o m m o c r e h t O ) 3 ( s e v r e s e r ) 2 ( r e h t O s e g d e h w o l f h s a C l - e b a l i a v A l e a s - r o f s e i t i r u c e s i n g e r o F y c n e r r u c i d e n a t e R n o i t a l s n a r t ) 1 ( s g n n r a e i n o m m o C s e r a h s ) 3 2 e t o N ( ) s n o i l l i m $ ( r e h t o l d e t a u m u c c A ) s s o l ( e m o c n i e v i s n e h e r p m o c y t i u q E n i s e g n a h C f o t n e m e t a t S d e t a d i l o s n o C C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S . s e r a h s r o f n o i t p o g n d n o p s e r r o c i . 5 1 0 2 n i s s o l r o t i f o r p h g u o r h t e u a v l r i a f t a d e t a n g i s e d s e i t i l i b a i l l i a c n a n i f o t g n n a t r e p 9 S R F i i I f o s n o i s i v o r p k s i r t i d e r c n w o e h t f o n o i t p o d a e h t t c e l f e r o t s t n e m t s u d a j e v i t c e p s o r t e r s t n e s e r p e R . ) 2 5 1 $ ( 3 1 0 2 o t r o i r p s d o i r e p o t t c e p s e r h t i w s e s s o L t i d e r C r o f e c n a w o l l A n o n o i t a l s n a r t i y c n e r r u c n g e r o f o t d e t a e r l y l i r a m i r p s t n e m t s u d a j e v i t c e p s o r t e r s e d u l c n I . 4 1 0 2 n i ) 9 1 S A I d n a 0 1 S R F I ( s d r a d n a t s S R F I d e d n e m a d n a w e n f o n o i t p o d a e h t t c e l f e r o t d e t s u d a j y l e v i t c e p s o r t e r e r a s t n u o m a d o i r e p r o i r p n a t r e C i . n o i t c i r t s e r y r o t a u g e r l l a c o l o t j t c e b u s s i i h c h w , n o i t a r o p r o c i d e t a c o s s a n g e r o f i a o t d e t a e r l ) 2 5 $ – 4 1 0 2 ; 1 6 $ – 5 1 0 2 ( i 3 6 $ f o s g n n r a e d e n a t e r d e t u b i r t s i d n u i s e d u l c n I . ) 5 2 e t o N o t r e f e r ( s t n e m y a p d e s a b - e r a h s f o t n u o c c a n o s t n u o m a s t n e s e r p e R . k s i r t i d e r c n w O d n a s t i f e n e b e e y o p m E l , s e t a i c o s s a m o r f e r a h S s e d u l c n I . r e h t o d n a s n o i t a n b m o c i s s e n i s u b m o r f g n i s i r a s t s e r e t n i g n i l l o r t n o c - n o n o t s e g n a h c s e d u l c n I r i e h t g n n a t e r i i e l i l h w s e e y o p m e n a t r e c i y b d e c n u o n e r y l i r a t n u o v l s R A S m e d n a T f o t c a p m i s e d u l c n I s t n e m e t a t s l i a c n a n i f d e t a d i l o s n o c e s e h t f o t r a p l a r g e t n i n a e r a s e t o n g n i y n a p m o c c a e h T ) 1 ( ) 2 ( ) 3 ( ) 4 ( ) 5 ( ) 6 ( ) 7 ( ) 8 ( 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 135 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statement of Cash Flows Sources (uses) of cash flows for the year ended October 31 ($ millions) Cash flows from operating activities Net income Adjustment for: Net interest income Depreciation and amortization Provisions for credit losses Equity-settled share-based payment expense Net gain on sale of investment securities Net gain on disposition of business Realized gain on sale of an investment in an associate Unrealized gain on reclassification of an investment in an associate Net income from investments in associated corporations Income tax expense Restructuring charge Changes in operating assets and liabilities: Trading assets Securities purchased under resale agreements and securities borrowed Loans Deposits Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities lent Net derivative financial instruments Other, net Dividends received Interest received Interest paid Income tax paid Net cash from/(used in) operating activities Cash flows from investing activities Interest-bearing deposits with financial institutions Purchase of investment securities Proceeds from sale and maturity of investment securities Acquisition/sale of subsidiaries, associated corporations or business units, net of cash acquired Property and equipment, net of disposals Other, net Net cash from/(used in) investing activities Cash flows from financing activities Proceeds from issue of subordinated debentures Redemption/repayment of subordinated debentures Proceeds from common shares issued Proceeds from preferred shares issued Redemption of preferred shares Common shares purchased for cancellation Cash dividends paid Distributions to non-controlling interests Other, net Net cash from/(used in) financing activities Effect of exchange rate changes on cash and cash equivalents Net change in cash and cash equivalents Cash and cash equivalents at beginning of year(1) Cash and cash equivalents at end of year(1) (1) Represents cash and non-interest bearing deposits with financial institutions (refer to Note 5). The accompanying notes are an integral part of these consolidated financial statements. 136 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 2016 2015 2014 $ 7,368 $ 7,213 $ 7,298 (14,292) 684 2,412 7 (534) (116) – – (414) 2,030 378 (10,044) (5,363) (20,355) 6,702 4,007 20,865 (3,806) 1,856 873 21,099 (7,787) (1,471) 4,099 28,447 (94,441) 65,069 (1,050) (348) (431) (2,754) 2,465 (1,035) 391 1,350 (690) (80) (3,598) (116) 117 (1,196) (18) 131 6,724 $ 6,855 $ (13,092) 584 1,942 14 (639) – – – (405) 1,853 – 20,302 13,991 (22,942) 13,915 (8,101) (18,982) 2,442 4,707 1,147 19,145 (7,262) (1,985) 13,847 (8,448) (44,684) 41,649 (701) (282) (1,053) (13,519) 1,248 (18) 101 – – (955) (3,406) (86) 3,379 263 305 896 5,828 6,724 (12,305) 526 1,703 30 (741) – (469) (174) (428) 2,002 148 (13,848) (7,526) (16,785) 20,224 1,506 7,306 (1,147) 7,033 1,063 18,438 (7,509) (1,401) 4,944 213 (47,328) 44,876 2,045 (277) (115) (586) – (1,000) 753 – (1,150) (320) (3,265) (76) 872 (4,186) 207 379 5,449 5,828 $ N O T E S T O T H E 2 0 1 6 C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S T A B L E O F C O N T E N T S Reporting entity Basis of preparation Page Note 180 19 Deposits 180 20 Subordinated debentures Significant accounting policies 181 21 Other liabilities Future accounting developments 181 22 Provisions Cash and deposits with financial institutions 182 23 Common and preferred shares Fair value of financial instruments 185 24 Capital management Trading assets 185 25 Share-based payments Page Note 138 138 139 151 153 153 159 160 161 1 2 3 4 5 6 7 8 9 Financial instruments designated at fair value through profit or loss Derivative financial instruments 165 10 Offsetting financial assets and financial liabilities 167 170 173 174 177 177 178 11 12 13 14 15 16 17 Investment securities Loans, impaired loans and allowance for credit losses Derecognition of financial assets Structured entities Property and equipment Investments in associates Goodwill and other intangible assets 179 18 Other assets 188 26 Corporate income taxes 190 27 Employee benefits 195 28 Operating segments 197 29 Related party transactions 198 30 Principal subsidiaries and non-controlling interests in subsidiaries 199 31 Non-interest income 200 32 Trading revenues 200 33 Earnings per share 200 34 Guarantees, commitments and pledged assets 202 35 Financial instruments – risk management 210 36 Business combinations and divestitures 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 137 CONSOLIDATED FINANCIAL STATEMENTS 1 Reporting Entity The Bank of Nova Scotia (the Bank) is a chartered schedule I bank under the Bank Act (Canada) (the Bank Act) and is regulated by the Office of the Superintendent of Financial Institutions (OSFI). The Bank is a global financial services provider offering a diverse range of products and services, including personal, commercial, corporate and investment banking. The head office of the Bank is located at 1709 Hollis Street, Halifax, Nova Scotia, Canada and its executive offices are at Scotia Plaza, 44 King Street West, Toronto, Canada. The common shares of the Bank are listed on the Toronto Stock Exchange and the New York Stock Exchange. 2 Basis of Preparation Statement of compliance These consolidated financial statements were prepared in accordance with International Financial Reporting Standards (IFRS) as issued by International Accounting Standards Board (IASB) and accounting requirements of OSFI in accordance with Section 308 of the Bank Act. Section 308 states that, except as otherwise specified by OSFI, the financial statements are to be prepared in accordance with IFRS. The consolidated financial statements for the year ended October 31, 2016 have been approved by the Board of Directors for issue on November 29, 2016. Basis of measurement The consolidated financial statements have been prepared on the historical cost basis except for the following material items that are measured at fair value in the Consolidated Statement of Financial Position: Š Financial assets and liabilities held-for-trading Š Financial assets and liabilities designated at fair value through profit or loss Š Derivative financial instruments Š Available-for-sale investment securities Functional and presentation currency These consolidated financial statements are presented in Canadian dollars, which is the Bank’s functional currency. All financial information presented in Canadian dollars has been rounded to the nearest million unless otherwise stated. Management’s use of estimates, assumptions and judgments The Bank’s accounting policies require estimates, assumptions and judgments that relate to matters that are inherently uncertain. The Bank has established procedures to ensure that accounting policies are applied consistently. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the year in which the estimates are revised and in any future years affected. Use of estimates and assumptions The preparation of these consolidated financial statements, in conformity with IFRS, requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the consolidated financial statements, and income and expenses during the reporting period. Estimates made by management are based on historical experience and other assumptions that are believed to be reasonable. Key areas of estimation uncertainty include those relating to the allowance for credit losses, the fair value of financial instruments (including derivatives), corporate income taxes, employee benefits, goodwill, provisions, the fair value of all identifiable assets and liabilities as a result of business combinations, impairment of investment securities, impairment of non-financial assets and derecognition of financial assets and liabilities. While management makes its best estimates and assumptions, actual results could differ from these and other estimates. Significant judgments In the preparation of these consolidated financial statements, management is required to make significant judgments in the classification and presentation of transactions and instruments and accounting for involvement with other entities. 138 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Significant estimates, assumptions and judgments have been made in the following areas and are discussed as noted in the consolidated financial statements: Allowance for credit losses Fair value of financial instruments Corporate income taxes Employee benefits Goodwill and intangible assets Fair value of all identifiable assets and liabilities as a result of business combinations Impairment of investment securities Impairment of non-financial assets Structured entities De facto control of other entities Derecognition of financial assets and liabilities Provisions 3 Significant Accounting Policies Note 3 Note 12(d) Note 3 Note 6 Note 3 Note 26 Note 3 Note 27 Note 3 Note 17 Note 3 Note 36 Note 3 Note 11 Note 3 Note 15 Note 3 Note 14 Note 3 Note 30 Note 3 Note 13 Note 3 Note 22 The significant accounting policies used in the preparation of these consolidated financial statements, including any additional accounting requirements of OSFI, as set out below, have been applied consistently to all periods presented in these consolidated financial statements. Basis of consolidation The consolidated financial statements include the assets, liabilities, financial performance and cash flows of the Bank and all of its subsidiaries, after elimination of intercompany transactions and balances. Subsidiaries are defined as entities controlled by the Bank and exclude associates and joint arrangements. The Bank’s subsidiaries can be classified as entities controlled through voting interests or structured entities. The Bank consolidates a subsidiary from the date it obtains control. The Bank controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. For the Bank to control an entity, all of the three elements of control should be in existence: Š power over the investee; Š exposure, or rights, to variable returns from involvement with the investee; and Š the ability to use power over the investee to affect the amount of the Bank’s returns. The Bank does not control an investee when it is acting as an agent. The Bank assesses whether it is an agent by determining whether it is primarily engaged to act on behalf of and for the benefit of another party or parties. The Bank reassesses whether it controls an investee if facts and circumstances indicate that one or more of the elements of control has changed. Non-controlling interests are presented within equity in the Consolidated Statement of Financial Position separate from equity attributable to common and preferred shareholders of the Bank. Partial sales and incremental purchases of interests in subsidiaries that do not result in a change of control are accounted for as equity transactions with non-controlling interest holders. Any difference between the carrying amount of the interest and the transaction amount is recorded as an adjustment to retained earnings. Voting-interest subsidiaries Control is presumed with an ownership interest of more than 50% of the voting rights in an entity unless there are other factors that indicate that the Bank does not control the entity despite having more than 50% of voting rights. The Bank may consolidate an entity when it owns less than 50% of the voting rights when it has one or more other attributes of power: Š by virtue of an agreement, over more than half of the voting rights; Š to govern the financial and operating policies of the entity under a statute or an agreement; Š to appoint or remove the majority of the members of the board of directors or equivalent governing body and control of the entity is by that board or body; or Š to govern the financial and operating policies of the entity through the size of its holding of voting rights relative to the size and dispersion of holding of the other vote holders and voting patterns at shareholder meetings (i.e., de facto control). Structured entities Structured entities are designed to accomplish certain well-defined objectives and for which voting or similar rights are not the dominant factor in deciding who controls the entity. The Bank may become involved with structured entities either at the formation stage or at a later date. The Bank controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 139 CONSOLIDATED FINANCIAL STATEMENTS The Bank consolidates all structured entities that it controls. Investments in associates An associate is an entity in which the Bank has significant influence, but not control, over the operating and financial policies of the entity. Significant influence is ordinarily presumed to exist when the Bank holds between 20% and 50% of the voting rights. The Bank may also be able to exercise significant influence through board representation. The effects of potential voting rights that are currently exercisable or convertible are considered in assessing whether the Bank has significant influence. Investments in associates are recognized initially at cost, which includes the purchase price and other costs directly attributable to the purchase. Associates are accounted for using the equity method which reflects the Bank’s share of the increase or decrease of the post-acquisition earnings and other movements in the associate’s equity. If there is a loss of significant influence and the investment ceases to be an associate, equity accounting is discontinued from the date of loss of significant influence. If the retained interest on the date of loss of significant influence is a financial asset, it is measured at fair value and the difference between the fair value and the carrying value is recorded as an unrealized gain or loss in the Consolidated Statement of Income. Investments in associates are evaluated for impairment at the end of each financial reporting period, or more frequently if events or changes in circumstances indicate the existence of objective evidence of impairment. For purposes of applying the equity method for an investment that has a different reporting period from the Bank, adjustments are made for the effects of any significant events or transactions that occur between the reporting date of the investment and the reporting date of the Bank. Joint arrangements A joint arrangement is an arrangement over which two or more parties have joint control. Joint control exists only when decisions about the relevant activities (i.e., those that significantly affect the returns of the arrangement) require the unanimous consent of the parties sharing the control of the arrangement. Investments in joint arrangements are classified as either joint operations or joint ventures depending on the contractual rights and obligations of each investor, rather than the legal structure of the joint arrangement. Similar to accounting for investment in associates, for joint ventures, investments are recognized initially at cost and accounted for using the equity method which reflects the Bank’s share of the increase or decrease of the post-acquisition earnings and other movements in the joint venture’s equity. Investments in joint ventures are evaluated for impairment at the end of each financial reporting period, or more frequently if events or changes in circumstances indicate the existence of objective evidence of impairment. If there is a loss of joint control and it does not result in the Bank having significant influence over the joint venture, equity accounting is discontinued from the date of loss of joint control. If the retained interest in the former joint venture on the date of loss of joint control is a financial asset, it is measured at fair value and the difference between the fair value and the carrying value is recorded as an unrealized gain or loss in the Consolidated Statement of Income. Translation of foreign currencies The financial statements of each of the Bank’s foreign operations are measured using its functional currency, being the currency of the primary economic environment of the foreign operation. Translation gains and losses related to the Bank’s monetary items are recognized in non-interest income in the Consolidated Statement of Income. Revenues and expenses denominated in foreign currencies are translated using average exchange rates, except for depreciation and amortization of buildings, equipment and leasehold improvements of the Bank, purchased in foreign currency, which are translated using historical rates. Foreign currency non-monetary items that are measured at historical cost are translated into the functional currency at historical rates. Foreign currency non-monetary items measured at fair value are translated into functional currency using the rate of exchange at the date the fair value was determined. Foreign currency gains and losses on non-monetary items are recognized in the Consolidated Statement of Income or Consolidated Statement of Comprehensive Income consistent with the gain or loss on the non-monetary item. Unrealized gains and losses arising upon translation of foreign operations, together with any gains or losses arising from hedges of those net investment positions to the extent effective, are credited or charged to net change in unrealized foreign currency translation gains/losses in the Consolidated Statement of Comprehensive Income. On disposal or partial disposal of a foreign operation, resulting in a loss of control, an appropriate portion of the translation differences previously recognized in other comprehensive income are recognized in the Consolidated Statement of Income. Financial assets and liabilities Date of recognition The Bank initially recognizes loans, deposits, subordinated debentures and debt securities issued on the date at which they are originated or purchased. Regular-way purchases and sales of financial assets are recognized on the settlement date. All other financial assets and liabilities, including derivatives, are initially recognized on the trade date at which the Bank becomes a party to the contractual provisions of the instrument. Initial classification and measurement The classification of financial assets and liabilities at initial recognition depends on the purpose and intention for which the financial assets are acquired and liabilities issued and their characteristics. The initial measurement of a financial asset or liability is at fair value. Determination of fair value Fair value of a financial asset or liability is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal, or in its absence, the most advantageous market to which the Bank has access at the measurement date. The Bank values instruments carried at fair value using quoted market prices, where available. Quoted market prices represent a Level 1 valuation. When quoted market prices are not available, the Bank maximizes the use of observable inputs within valuation models. When all significant inputs are observable, the valuation is classified as Level 2. Valuations that require the significant use of unobservable inputs are considered Level 3. 140 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Inception gains and losses are only recognized where the valuation is dependent only on observable market data, otherwise, they are deferred and amortized over the life of the related contract or until the valuation inputs become observable. IFRS 13 permits a measurement exception that allows an entity to determine the fair value of a group of financial assets and liabilities with offsetting risks based on the sale or transfer of its net exposure to a particular risk (or risks). The Bank has adopted this exception through an accounting policy choice. Consequently, the fair values of certain portfolios of financial instruments are determined based on the net exposure of those instruments to particular market, credit or funding risk. In determining fair value for certain instruments or portfolios of instruments, valuation adjustments or reserves may be required to arrive at a more accurate representation of fair value. These adjustments include those made for credit risk, bid-offer spreads, unobservable parameters, constraints on prices in inactive or illiquid markets and when applicable funding costs. Derecognition of financial assets and liabilities Derecognition of financial assets The derecognition criteria are applied to the transfer of part of an asset, rather than the asset as a whole, only if such part comprises specifically identified cash flows from the asset, a fully proportionate share of the cash flows from the asset, or a fully proportionate share of specifically identified cash flows from the asset. A financial asset is derecognized when the contractual rights to the cash flows from the asset have expired; or the Bank transfers the contractual rights to receive the cash flows from the financial asset; or has assumed an obligation to pay those cash flows to an independent third-party; and the Bank has transferred substantially all the risks and rewards of ownership of that asset to an independent third-party. Management determines whether substantially all the risk and rewards of ownership have been transferred by quantitatively comparing the variability in cash flows before and after the transfer. If the variability in cash flows remains significantly similar subsequent to the transfer, the Bank has retained substantially all of the risks and rewards of ownership. Where substantially all the risks and rewards of ownership of the financial asset are neither retained nor transferred, the Bank derecognizes the transferred asset only if it has lost control over that asset. Control over the asset is represented by the practical ability to sell the transferred asset. If the Bank retains control over the asset, it will continue to recognize the asset to the extent of its continuing involvement. At times such continuing involvement may be in the form of investment in senior or subordinated tranches of notes issued by non-consolidated structured entities. On derecognition of a financial asset, the difference between the carrying amount and the sum of (i) the consideration received (including any new asset obtained less any new liability assumed) and (ii) any cumulative gain or loss that had been recognized in other comprehensive income is recognized in the Consolidated Statement of Income. Transfers of financial assets that do not qualify for derecognition are reported as secured financings in the Consolidated Statement of Financial Position. Derecognition of financial liabilities A financial liability is derecognized when the obligation under the liability is discharged, canceled or expires. If an existing financial liability is replaced by another from the same counterparty on substantially different terms, or the terms of the existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability at fair value. The difference in the respective carrying amount of the existing liability and the new liability is recognized as a gain/loss in the Consolidated Statement of Income. Offsetting of financial instruments Financial assets and financial liabilities with the same counterparty are offset, with the net amount reported in the Consolidated Statement of Financial Position, only if there is currently a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the assets and settle the liabilities simultaneously. When financial assets and financial liabilities are offset in the Consolidated Statement of Financial Position, the related income and expense items will also be offset in the Consolidated Statement of Income, unless specifically prohibited by an applicable accounting standard. Cash and deposits with financial institutions Cash and deposits with financial institutions comprises cash, cash equivalents, demand deposits with banks and other financial institutions, highly liquid investments that are readily convertible to cash, subject to insignificant risk of changes in value. These investments are those with less than three months’ maturity from the date of acquisition. Precious metals Precious metals are carried at fair value less costs to sell, and any changes in fair value less costs to sell are credited or charged to non-interest income – trading revenues in the Consolidated Statement of Income. Trading assets and liabilities Trading assets and liabilities are measured at fair value in the Consolidated Statement of Financial Position, with transaction costs recognized immediately in the Consolidated Statement of Income as part of non-interest income – trading revenues. Gains and losses realized on disposal and unrealized gains and losses due to fair value changes on trading assets and liabilities, other than certain derivatives, are recognized as part of non- interest income – trading revenues in the Consolidated Statement of Income. Trading assets and liabilities are not reclassified subsequent to their initial recognition. Financial assets and liabilities designated at fair value through profit or loss Financial assets and financial liabilities classified in this category are those that have been designated by the Bank on initial recognition. The Bank may only designate an instrument at fair value through profit or loss when one of the following criteria is met, and designation is determined on an instrument by instrument basis: Š The designation eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets or liabilities on a different basis; or 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 141 CONSOLIDATED FINANCIAL STATEMENTS Š The assets and liabilities are part of a group of financial assets, financial liabilities or both which are managed together and their performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy and the information about the group is provided to key management personnel and it can be demonstrated that significant financial risks are eliminated or significantly reduced; or Š The financial instrument contains one or more embedded derivatives which significantly modify the cash flows otherwise required. Financial assets and financial liabilities designated at fair value through profit or loss are recorded in the Consolidated Statement of Financial Position at fair value. For assets designated at fair value through profit or loss, changes in fair value are recognized in the Consolidated Statement of Income. For liabilities designated at fair value through profit or loss, changes in fair value arising from changes in the Bank’s own credit risk are recognized in the Consolidated Statement of Comprehensive Income (OCI), without subsequent reclassification to the Consolidated Statement of Income, unless doing so would create or increase an accounting mismatch. All other changes in fair value are recognized in the Consolidated Statement of Income. Securities purchased and sold under resale agreements Securities purchased under resale agreements (reverse repurchase agreements) and securities sold under agreements to repurchase (repurchase agreements) are treated as collateralized financing arrangements and are recorded at amortized cost. The party disbursing the cash takes possession of the securities serving as collateral for the financing and having a market value equal to, or in excess of, the principal amount loaned. The securities received under reverse repurchase agreements and securities delivered under repurchase agreements are not recognized on, or derecognized from, the Consolidated Statement of Financial Position, unless the risks and rewards of ownership are obtained or relinquished. The related income and interest expense are recorded on an accrual basis in the Consolidated Statement of Income. Obligations related to securities sold short Obligations related to securities sold short arise in dealing and market-making activities where debt securities and equity shares are sold without possessing such securities. Similarly, if securities purchased under an agreement to resell are subsequently sold to third parties, the obligation to return the securities is recorded as a short sale within obligations related to securities sold short in the Consolidated Statement of Financial Position. These trading liabilities are measured at fair value with any gains or losses included in non-interest income – trading revenues in the Consolidated Statement of Income. Interest expense accruing on debt securities sold short is recorded in interest expense – other, in the Consolidated Statement of Income. Securities lending and borrowing Securities lending and borrowing transactions are usually collateralized by securities or cash. The transfer of the securities to counterparties is only reflected on the Consolidated Statement of Financial Position if the risks and rewards of ownership are also transferred. Cash advanced or received as collateral is recorded as an asset or liability. Fees received and paid are reported as fee and commission revenues and expenses in the Consolidated Statement of Income, respectively. Securities borrowed are not recognized on the Consolidated Statement of Financial Position, unless they are then sold to third parties, in which case the obligation to return the securities is recorded as a trading liability and measured at fair value with any gains or losses included in non-interest income – trading revenues, in the Consolidated Statement of Income. Derivative instruments Derivative instruments are contracts whose value is derived from interest rates, foreign exchange rates, commodities, equity prices or other financial variables. Most derivative instruments can be characterized as interest rate contracts, foreign exchange and gold contracts, commodity contracts, equity contracts or credit contracts. Derivative instruments are either exchange-traded contracts or negotiated over-the-counter contracts. Negotiated over-the-counter contracts include swaps, forwards and options. The Bank enters into these derivative contracts for trading purposes, as well as to manage its risk exposures (i.e., to manage the Bank’s non-trading interest rate, foreign currency and other exposures). Trading activities are undertaken to meet the needs of the Bank’s customers, as well as for the Bank’s own account to generate income from trading operations. Derivatives embedded in other financial instruments or host contracts are treated as separate derivatives when the following conditions are met: Š their economic characteristics and risks are not closely related to those of the host contract; Š a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and Š the combined contract is not held for trading or designated at fair value through profit or loss. Where an embedded derivative is separable from the host contract but the fair value, as at the acquisition or reporting date, cannot be reliably measured separately, the entire combined contract is measured at fair value. All embedded derivatives are presented on a combined basis with the host contracts although they are separated for measurement purposes when conditions requiring separation are met. Subsequent changes in fair value of embedded derivatives are recognized in non-interest income in the Consolidated Statement of Income. All derivatives, including embedded derivatives that must be separately accounted for, are recorded at fair value in the Consolidated Statement of Financial Position. The determination of the fair value of derivatives includes consideration of credit risk, estimated funding costs and ongoing direct costs over the life of the instruments. Inception gains or losses on derivatives are only recognized where the valuation is dependent only on observable market data, otherwise, they are deferred and amortized over the life of the related contract, or until the valuation inputs become observable. The gains and losses resulting from changes in fair values of trading derivatives are included in non-interest income – trading revenues in the Consolidated Statement of Income. Changes in the fair value of non-trading derivatives that do not qualify for hedge accounting are recorded in the Consolidated Statement of Income in non-interest income – other. Where derivative instruments are used to manage the volatility of share-based payment expense, these derivatives are carried at fair value with changes in the fair value in relation to units hedged included in non-interest expenses – salaries and employee benefits in the Consolidated Statement of Income. 142 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Changes in the fair value of derivatives that qualify for hedge accounting are recorded as non-interest income – other in the Consolidated Statement of Income for fair value hedges and other comprehensive income in the Consolidated Statement of Comprehensive Income for cash flow hedges and net investment hedges. Investment securities Investment securities are comprised of available-for-sale and held-to-maturity securities. Available-for-sale investment securities Available-for-sale investment securities include equity and debt securities. Equity investments classified as available-for-sale are those which are neither classified as held-for-trading nor designated at fair value through profit or loss. Debt securities in this category are those which are intended to be held for an indefinite period of time and which may be sold in response to needs for liquidity or in response to changes in the market conditions. Available- for-sale investment securities are recorded at fair value with unrealized gains and losses recorded in other comprehensive income. When realized, these gains and losses are reclassified from the Consolidated Statement of Comprehensive Income and recorded in the Consolidated Statement of Income on an average cost basis. For non-monetary investment securities designated as available-for-sale, the gain or loss recognized in other comprehensive income includes any related foreign exchange gains or losses. Foreign exchange gains and losses that relate to the amortized cost of an available-for-sale debt security are recognized in the Consolidated Statement of Income. Premiums, discounts and related transaction costs on available-for-sale debt securities are amortized over the expected life of the instrument to interest income – securities in the Consolidated Statement of Income using the effective interest method. Transaction costs on available-for-sale equity securities are initially capitalized and then recognized as part of the net realized gain/loss on subsequent sale of the instrument in the Consolidated Statement of Income. Held-to-maturity investment securities Held-to-maturity investment securities are non-derivative assets with fixed or determinable payments and fixed maturity that the Bank has the positive intent and ability to hold to maturity, and which do not meet the definition of a loan, are not held-for-trading, and are not designated at fair value through profit or loss or as available-for-sale. After initial measurement, held-to-maturity investment securities are carried at amortized cost using the effective interest method, less impairment. Amortized cost is calculated by taking into account any discount or premium on acquisition, transaction costs and fees that are an integral part of the effective interest rate. The amortization is included in interest income – securities in the Consolidated Statement of Income. A sale or reclassification of a more than an insignificant amount of held-to-maturity investments would result in the reclassification of all held-to- maturity investments as available-for-sale, and would prevent the Bank from classifying investment securities as held-to-maturity for the current and the following two financial years. However, sales and reclassifications in any of the following circumstances would not trigger a reclassification: Š Sales or reclassifications that are so close to maturity that changes in the market rate of interest would not have a significant effect on the financial asset’s fair value; Š Sales or reclassifications after the Bank has collected substantially all of the asset’s original principal; or Š Sales or reclassifications attributable to non-recurring isolated events beyond the Bank’s control that could not have been reasonably anticipated. Impairment of investment securities Investment securities are evaluated for impairment at the end of each reporting period, or more frequently if events or changes in circumstances indicate the existence of objective evidence of impairment. In the case of equity instruments classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its original cost is objective evidence of impairment. In the case of debt instruments classified as available-for-sale and held-to-maturity investment securities, impairment is assessed based on the same criteria as impairment of loans. When a decline in value of available-for-sale debt or equity instrument is due to impairment, the carrying value of the security continues to reflect fair value. Losses arising from impairment are reclassified from accumulated other comprehensive income and included in net gain on investment securities within non-interest income in the Consolidated Statement of Income. The losses arising from impairment of held-to-maturity investment securities are recognized in net gain on investment securities within non-interest income in the Consolidated Statement of Income. Reversals of impairment losses on available-for-sale debt instruments resulting from increases in fair value related to events occurring after the date of impairment are included in net gain on investment securities within non-interest income in the Consolidated Statement of Income, to a maximum of the original impairment charge. Reversals of impairment on available-for-sale equity instruments are not recognized in the Consolidated Statement of Income; increases in fair value of such instruments after impairment are recognized in accumulated other comprehensive income. Reversals of impairment losses on held-to-maturity investment securities are included in net gain on investment securities within non-interest income in the Consolidated Statement of Income, to a maximum of the amortized cost of the investment before the original impairment charge. Loans Loans include loans and advances originated or purchased by the Bank which are not classified as held-for-trading, held-to-maturity or designated at fair value. Debt securities, which are not trading securities or have not been designated as available-for-sale securities and that are not quoted in an active market, are also classified as loans. Loans originated by the Bank are recognized when cash is advanced to a borrower. Loans purchased are recognized when cash consideration is paid by the Bank. Loans are measured at amortized cost using the effective interest method, less any impairment losses. Loans are stated net of allowance for credit losses. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 143 CONSOLIDATED FINANCIAL STATEMENTS Purchased loans All purchased loans are initially measured at fair value on the date of acquisition. In arriving at the fair value, the Bank considers interest rate mark adjustments and credit mark adjustments. As a result of recording all purchased loans at fair value, no allowances for credit losses are recorded in the Consolidated Statement of Financial Position on the date of acquisition. Consequently none of the purchased loans are considered to be impaired on the date of acquisition. The interest rate mark on the date of acquisition is principally set up for fixed interest rate loans and captures the impact of the interest rate differential between the contractual rate of interest on the loan and the prevailing interest rate on the loan on the date of acquisition for the remaining term. The interest rate mark is fully amortized into interest income in the Consolidated Statement of Income over the expected life of the loan using the effective interest method. An aggregate credit mark adjustment is established to capture management’s best estimate of cash flow shortfalls on the loans over their life time as determined at the date of acquisition. The credit mark adjustment comprises of both an incurred loss mark and a future expected loss mark. For individually assessed loans, the credit mark established at the date of acquisition is tracked over the life of the loan. Changes to the expected cash flows of these loans from those expected at the date of acquisition are recorded as a charge/recovery in the provision for credit losses in the Consolidated Statement of Income. Where loans are not individually assessed for determining losses, a portfolio approach is taken to determine expected losses at the date of acquisition. The portfolio approach will result in both an incurred loss mark and a future expected loss mark. The incurred loss mark is assessed at the end of each reporting period against the performance of the loan portfolio and an increase in expected cash flows will result in recovery in provision for credit losses in the Consolidated Statement of Income while any cash flows lower than expected will result in an additional provision for credit losses. The future expected loss mark is amortized into income as losses are recognized or as the portfolio of loans winds down over its expected life. An assessment is required at the end of each reporting period to determine the reasonableness of the unamortized balance in relation to the loan portfolio. An overall benefit is only recognized to the extent that the amortized amount is greater than the actual losses incurred. A net charge is recorded if the actual losses exceed the amortized amounts. Loan impairment and allowance for credit losses The Bank considers a loan to be impaired when there is objective evidence of impairment as a result of one or more loss events that occurred after the date of initial recognition of the loan and the loss event has an impact on the estimated future cash flows of the loan that can be reliably estimated. Objective evidence is represented by observable data that comes to the attention of the Bank and includes events that indicate: Š significant financial difficulty of the borrower; Š a default or delinquency in interest or principal payments; Š a high probability of the borrower entering a phase of bankruptcy or a financial reorganization; Š a measurable decrease in the estimated future cash flows from the loan or the underlying assets that back the loan. If a payment on a loan is contractually 90 days in arrears, the loan will be classified as impaired, if not already classified as such, unless the loan is fully secured, the collection of the debt is in process, and the collection efforts are reasonably expected to result in repayment of the loan or in restoring it to a current status within 180 days from the date a payment has become contractually in arrears. Finally, a loan that is contractually 180 days in arrears is classified as impaired in all situations, except when it is guaranteed or insured by the Canadian government, the provinces or a Canadian government agency; such loans are classified as impaired if the loan is contractually in arrears for 365 days. Any credit card loan that has a payment that is contractually 180 days in arrears is written off. Losses expected as a result of future events are not recognized. The Bank considers evidence of impairment for loans and advances at both an individual and collective level. Individual impairment allowance For all loans that are considered individually significant, the Bank assesses on a case-by-case basis at each reporting period whether an individual allowance for loan losses is required. For those loans where objective evidence of impairment exists and the Bank has determined the loan to be impaired, impairment losses are determined based on the Bank’s aggregate exposure to the customer considering the following factors: Š the customer’s ability to generate sufficient cash flow to service debt obligations; Š the extent of other creditors’ commitments ranking ahead of, or pari passu with, the Bank and the likelihood of other creditors continuing to support the company; Š the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident; and Š the realizable value of security (or other credit mitigants) and likelihood of successful repossession. Impairment losses are calculated by discounting the expected future cash flows of a loan at its original effective interest rate, and comparing the resultant present value with the loan’s current carrying amount. This results in interest income being recognized using the original effective interest rate. Collective impairment allowance For loans that have not been individually assessed as being impaired, the Bank pools them into groups to assess them on a collective basis. Collective allowances are calculated for impaired loans and performing loans. Allowances related to performing loans estimate probable incurred losses that are inherent in the portfolio but have not yet been specifically identified as impaired. 144 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Internal risk rating parameters are used in the calculation of the collective impairment allowance. For non-retail loan portfolios, internal risk rating parameters form the basis for calculating the quantitative portion of the collective allowance for performing loans: Š Probability of Default rates (PD) which are based upon the internal risk rating for each borrower; Š Loss Given Default rates (LGD); and Š Exposure at Default factors (EAD). Funded exposures are multiplied by the borrower’s PD and by the relevant LGD parameter. Committed but undrawn exposures are multiplied by the borrower’s PD, by the relevant LGD parameter, and by the relevant EAD parameter. A model stress component is also applied to recognize uncertainty in the credit risk parameters and the fact that current actual loss rates may differ from the long-term averages included in the model. Retail loans Retail loans represented by residential mortgages, credit cards and other personal loans are considered by the Bank to be homogeneous groups of loans that are not considered individually significant. All homogeneous groups of loans are assessed for impairment on a collective basis. Mortgages are collectively assessed for impairment, taking into account number of days past due, historical loss experience and incorporating both quantitative and qualitative factors including the current business and economic environment and the realizable value of collateral to determine the appropriate level of the collective impairment allowance. A roll rate methodology is used to determine impairment losses on a collective basis for credit cards and other personal loans because individual loan assessment is impracticable. Under this methodology, loans with similar credit characteristics are grouped into ranges according to the number of days past due and statistical analysis is used to estimate the likelihood that loans in each range will progress through the various stages of delinquency and ultimately prove irrecoverable. This methodology employs statistical analyses of historical data and experience of delinquency and default to estimate the amount of loans that will eventually be written off as a result of the events not identifiable on an individual loan basis. When the portfolio size is small or when information is insufficient or not reliable enough to adopt a roll rate methodology, the Bank adopts a basic formulaic approach based on historical loss rate experience. Performing loans Over and above the individually assessed and retail roll rate allowances, loans that were subject to individual assessment for which no evidence of impairment existed, are grouped together according to their credit risk characteristics for the purpose of reassessing them on a collective basis. This reflects impairment losses that the Bank has incurred as a result of events that have occurred but where the individual loss has not been identified. The collective impairment allowance for such loans is determined after taking into account: (a) historical loss experience in portfolios of similar credit risk characteristics (for example, by industry sector, loan grade or product); (b) the estimated period between impairment occurring and the loss being identified and evidenced by the establishment of an appropriate allowance against the individual loan; and (c) management’s experienced judgment as to whether current economic and credit conditions are such that the actual level of inherent losses at the reporting date is likely to be greater or less than that suggested by historical experience. As soon as information becomes available which identifies losses on individual loans within the group, those loans are removed from the group and assessed on an individual basis for impairment. Provision for credit losses on off-balance sheet positions A provision is set up for the Bank’s off-balance sheet positions and recorded in other liabilities on the Consolidated Statement of Financial Position. The process to determine the provision for off-balance sheet positions is similar to the methodology used for loans. Any change in the provision is recorded in the Consolidated Statement of Income as provision for credit losses. Write-off of loans Loans (and the related impairment allowance accounts) are normally written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, write-off is generally after receipt of any proceeds from the realization of security. In circumstances where the net realizable value of any collateral has been determined and there is no reasonable expectation of further recovery, write-off may be earlier. Reversals of impairment If the amount of an impairment loss related to loans decreases in a subsequent period, and the decrease can be related objectively to an event occurring after the impairment was recognized, the excess is written back by reducing the loan impairment allowance account accordingly. The write- back is recognized in the provision for credit losses in the Consolidated Statement of Income. Restructured loans Restructured loans include loans where the Bank has renegotiated the original terms of a loan by granting a concession to the borrower (concessions). These concessions include interest rate adjustments, deferral or extension of principal or interest payments and forgiveness of a portion of principal or interest. Once the terms of the loan have been renegotiated and agreed upon with the borrower the loan is considered a restructured loan. The investment in the loan is reduced as of the date of the restructuring to the amount of the net expected cash flows receivable under the modified terms, discounted at the original effective interest rate inherent in the loan. The loan is no longer considered past due and the reduction in the carrying value of the loan is recognized as a charge for loan impairment in the Consolidated Statement of Income in the period in which the loan is restructured. In other cases, restructuring may be considered substantial enough to result in recognition of a new loan. Customer’s liability under acceptances The Bank’s potential liability under acceptances is reported as a liability in the Consolidated Statement of Financial Position. The Bank has equivalent claims against its customers in the event of a call on these commitments, which are reported as an asset. Fees earned are reported in fee and commission revenues – banking fees in the Consolidated Statement of Income. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 145 CONSOLIDATED FINANCIAL STATEMENTS Hedge accounting The Bank formally documents all hedging relationships and its risk management objective and strategy for undertaking these hedge transactions at inception. The hedge documentation includes identification of the asset, liability, firm commitment or highly probable forecasted transaction being hedged, the nature of the risk being hedged, the hedging instrument used and the method used to assess the effectiveness of the hedge. The Bank also formally assesses, both at each hedge’s inception and on an ongoing basis, whether the hedging instruments are highly effective in offsetting changes in fair value or cash flows of hedged items. Hedge ineffectiveness is measured and recorded in non-interest income – other in the Consolidated Statement of Income. There are three types of hedges: (i) fair value hedges, (ii) cash flow hedges and (iii) net investment hedges. Fair value hedges For fair value hedges, the change in fair value of the hedging instrument is offset in the Consolidated Statement of Income by the change in fair value of the hedged item attributable to the hedged risk. The Bank utilizes fair value hedges primarily to convert fixed rate financial instruments to floating rate financial instruments. Hedged items include available-for-sale debt and equity securities, loans, deposit liabilities and subordinated debentures. Hedging instruments include single-currency interest rate swaps, cross-currency interest rate swaps, foreign currency forwards and foreign currency liabilities. Cash flow hedges For cash flow hedges, the change in fair value of the hedging instrument, to the extent effective, is recorded in other comprehensive income until the corresponding gains and losses on the hedged item is recognized in income. The Bank utilizes cash flow hedges primarily to hedge the variability in cash flows relating to floating rate financial instruments and highly probable forecasted revenues. Hedged items include available-for-sale debt securities, loans, deposit liabilities and highly probable forecasted transactions. Hedging instruments include single-currency interest rate swaps, cross- currency interest rate swaps, total return swaps and foreign currency forwards. Net investment hedges For net investment hedges, the change in fair value of the hedging instrument, to the extent effective, is recorded in other comprehensive income until the corresponding cumulative translation adjustments on the hedged net investment are recognized in income. The Bank designates foreign currency liabilities and foreign currency forwards as hedging instruments to manage the foreign currency exposure and impact on capital ratios arising from foreign operations. Property and equipment Land, buildings and equipment Land is carried at cost. Buildings (including building fittings), equipment, and leasehold improvements are carried at cost less accumulated depreciation and accumulated impairment losses, if any. Cost includes expenditures that are directly attributable to the acquisition of the asset. Depreciation is calculated using the straight-line method over the estimated useful life of the related asset less any residual value as follows: buildings – 40 years, building fittings – 15 years, equipment 3 to 10 years, and leasehold improvements – lease term determined by the Bank. Depreciation expense is included in the Consolidated Statement of Income under non-interest expenses – depreciation and amortization. Depreciation methods, useful lives and residual values are reassessed at each financial year-end and adjusted as appropriate. When major components of building and equipment have different useful lives, they are accounted for separately and depreciated over each component’s estimated useful life. Net gains and losses on disposal are included in non-interest income – other in the Consolidated Statement of Income in the year of disposal. Investment property Investment property is property held either for rental income or for capital appreciation or for both. The Bank holds certain investment properties which are presented in property and equipment on the Consolidated Statement of Financial Position. Investment property is carried at cost less accumulated depreciation and any accumulated impairment losses. Depreciation is calculated using the straight-line method over the estimated useful life of 40 years. Depreciation methods, useful lives and residual values are reassessed at each financial year-end and adjusted as appropriate. Assets held-for-sale Non-current non-financial assets (and disposal groups) are classified as held-for-sale if their carrying amount will be recovered principally through a sale transaction rather than through continuing use. These assets meet the criteria for classification as held-for-sale if they are available for immediate sale in their present condition and their sale is considered highly probable to occur within one year. Non-current non-financial assets classified as held-for-sale are measured at the lower of their carrying amount and fair value (less costs to sell) and are presented within other assets in the Consolidated Statement of Financial Position. Any subsequent write-down to fair value less costs to sell is recognized in the Consolidated Statement of Income, in non-interest income. Any subsequent increase in the fair value less costs to sell, to the extent this does not exceed the cumulative write-down, is also recognized in non-interest income, together with any realized gains or losses on disposal. Non-financial assets acquired in exchange for loans as part of an orderly realization are recorded as assets held-for-sale or assets held-for-use. If the acquired asset does not meet the requirement to be considered held-for-sale, the asset is considered held-for-use, measured initially at cost which equals the carrying value of the loan and accounted for in the same manner as a similar asset acquired in the normal course of business. Business combinations and goodwill The Bank follows the acquisition method of accounting for the acquisition of subsidiaries. The Bank considers the date on which control is obtained and it legally transfers the consideration for the acquired assets and assumed liabilities of the subsidiary to be the date of acquisition. The cost of an acquisition is measured at the fair value of the consideration paid. The fair value of the consideration transferred by the Bank in a business 146 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S combination is calculated as the sum of the acquisition date fair value of the assets transferred by the Bank, the liabilities incurred by the Bank to former owners of the acquiree, and the equity interests, including any options, issued by the Bank. The Bank recognizes the acquisition date fair values of any previously held investment in the subsidiary and contingent consideration as part of the consideration transferred in exchange for the acquisition. A gain or loss on any previously held investments of an acquiree is recognized in non-interest income – other in the Consolidated Statement of Income. In general, all identifiable assets acquired (including intangible assets) and liabilities assumed (including any contingent liabilities) are measured at the acquisition date fair value. The Bank records identifiable intangible assets irrespective of whether the assets have been recognized by the acquiree before the business combination. Non-controlling interests, if any, are recognized at their proportionate share of the fair value of identifiable assets and liabilities, unless otherwise indicated. Where the Bank has an obligation to purchase a non-controlling interest for cash or another financial asset, a portion of the non-controlling interest is recognized as a financial liability based on management’s best estimate of the present value of the redemption amount. Where the Bank has a corresponding option to settle the purchase of a non-controlling interest by issuing its own common shares, no financial liability is recorded. Any excess of the cost of acquisition over the Bank’s share of the net fair value of the identifiable assets acquired and liabilities assumed is recorded as goodwill. If the cost of acquisition is less than the fair value of the Bank’s share of the identifiable assets acquired and liabilities assumed, the resulting gain is recognized immediately in non-interest income – other in the Consolidated Statement of Income. During the measurement period (which is within one year from the acquisition date), the Bank may, on a retrospective basis, adjust the amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date. The Bank accounts for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received. Subsequent to acquisition, the Bank accounts for the following assets and liabilities recognized in a business combination as described below: Š Contingent liabilities, until resolved, are measured at the higher of the amount that would be recognized as a provision or the amount initially recognized, with any change recognized in the Consolidated Statement of Income. Š Indemnification assets are measured on the same basis as the item to which the indemnification relates. Š Contingent consideration classified as a liability is measured at fair value, with any change recognized in the Consolidated Statement of Income. Š Liabilities to non-controlling interest holders when remeasured at the end of each reporting period, a corresponding change is recorded in equity. After initial recognition of goodwill in a business combination, goodwill in aggregate is measured at cost less any accumulated impairment losses. Goodwill is not amortized but tested for impairment annually and when circumstances indicate that the carrying value may be impaired. Goodwill is reviewed at each reporting date to determine whether there is any indication of impairment. For the purpose of impairment testing, goodwill acquired in a business combination is, on the acquisition date, allocated to each of the Bank’s group of cash-generating units (CGUs) that is expected to benefit from the combination. CGUs to which goodwill has been allocated are aggregated so that the level at which impairment is tested reflects the lowest level at which goodwill is monitored for internal management purposes. Goodwill impairment, at a standalone subsidiary level, may not in itself result in an impairment at the consolidated Bank level. The Bank determines the carrying value of the CGU using a regulatory capital approach based on credit, market, and operational risks, and leverage, consistent with the Bank’s capital attribution for business line performance measurement. The recoverable amount is the greater of fair value less costs of disposal and value in use. If either fair value less costs of disposal or value in use exceeds the carrying amount, there is no need to determine the other. The recoverable amount of the CGU has been determined using the fair value less costs of disposal method. The estimation of fair value less costs of disposal involves significant judgment in the determination of inputs. In determining fair value less costs of disposal, an appropriate valuation model is used which considers various factors including normalized net income, control premiums and price earnings multiples. These calculations are corroborated by valuation multiples, quoted share prices for publicly traded subsidiaries or other available fair value indicators. An impairment loss is recognized if the carrying amount of the CGU exceeds the recoverable amount. An impairment loss, in respect of goodwill, is not reversed. Intangible assets Intangible assets represent identifiable non-monetary assets and are acquired either separately or through a business combination or generated internally. The Bank’s intangible assets are mainly comprised of computer software, customer relationships, contract intangibles, core deposit intangibles and fund management contracts. The cost of a separately acquired intangible asset includes its purchase price and directly attributable costs of preparing the asset for its intended use. Intangibles acquired as part of a business combination are initially recognized at fair value. In respect of internally generated intangible assets, cost includes all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. After initial recognition, an intangible asset is carried at its cost less any accumulated amortization and accumulated impairment losses. Intangible assets that have finite useful lives are initially measured at cost and are amortized on a straight-line basis over their useful lives as follows: computer software – 5 to 10 years; and other intangible assets – 5 to 20 years. Amortization expense is included in the Consolidated Statement of Income under operating expenses – depreciation and amortization. As intangible assets are considered to be non-financial assets, the impairment model for non-financial assets is applied. Intangible assets with indefinite useful lives are not amortized but are tested for impairment annually and when circumstances indicate that the carrying value may be impaired. Impairment of non-financial assets The carrying amount of the Bank’s non-financial assets, other than goodwill and indefinite life intangible assets and deferred tax assets which are separately addressed, is reviewed at each reporting date to determine whether there is any indication of impairment. For the purpose of impairment testing, non-financial assets that cannot be tested individually are grouped together into the smallest group of assets that generate cash inflows from continuing use that are largely independent from the cash inflows of other assets or groups of assets. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 147 CONSOLIDATED FINANCIAL STATEMENTS If any indication of impairment exists then the asset’s recoverable amount is estimated. The recoverable amount of an asset or CGU is the greater of its value in use and its fair value less costs of disposal. The Bank’s corporate assets do not generate separate cash inflows. If there is an indication that a corporate asset may be impaired, then the recoverable amount is determined for the CGU to which the corporate asset belongs. An impairment loss is recognized if the carrying amount of an asset or a CGU exceeds its recoverable amount. Impairment losses of continuing operations are recognized in the Consolidated Statement of Income in those expense categories consistent with the nature of the impaired asset. Impairment losses recognized in prior periods are reassessed at each reporting date for any indication that the loss had decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. Such reversal is recognized in the Consolidated Statement of Income. Significant judgment is applied in determining the non-financial asset’s recoverable amount and assessing whether certain events or circumstances constitute objective evidence of impairment. Corporate income taxes The Bank follows the balance sheet liability method for corporate income taxes. Under this method, deferred tax assets and liabilities represent the cumulative amount of tax applicable to temporary differences which are the differences between the carrying amount of the assets and liabilities, and their values for tax purposes. Deferred tax assets are recognized only to the extent it is probable that sufficient taxable profits will be available against which the benefit of these deferred tax assets can be utilized. Deferred tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred and current tax assets and liabilities are only offset when they arise in the same tax reporting group and where the Bank has both the legal right and the intention to settle on a net basis or to realize the asset and settle the liability simultaneously. The Bank maintains provisions for uncertain tax positions that it believes appropriately reflect the risk of tax positions under discussion, audit, dispute, or appeal with tax authorities, or which are otherwise considered to involve uncertainty. These provisions are made using the Bank’s best estimate of the amount expected to be paid based on an assessment of all relevant factors, which are reviewed at the end of each reporting period. Income tax is recognized in the Consolidated Statement of Income except where it relates to items recognized in other comprehensive income or directly in equity, in which case income tax is recognized in the same line as the related item. Leases Bank as a lessor Assets leased to customers under agreements which transfer substantially all the risks and rewards of ownership, with or without ultimate legal title, are classified as finance leases and presented within loans in the Consolidated Statement of Financial Position. When assets held are subject to a finance lease, the leased assets are derecognized and a receivable is recognized which is equal to the present value of the minimum lease payments, discounted at the interest rate implicit in the lease. Initial direct costs incurred in negotiating and arranging a finance lease are incorporated into the receivable through the discount rate applied to the lease. Finance lease income is recognized over the lease term based on a pattern reflecting a constant periodic rate of return on the net investment in the finance lease. Finance lease income is included in the Consolidated Statement of Income under interest income from loans. Assets leased to customers under agreements which do not transfer substantially all the risks and rewards of ownership are classified as operating leases. The leased assets are included within property and equipment on the Bank’s Consolidated Statement of Financial Position. Rental income is recognized on a straight-line basis over the period of the lease in non-interest income – other in the Consolidated Statement of Income. Initial direct costs incurred in negotiating and arranging an operating lease are added to the carrying amount of the leased asset and recognized as an expense on a straight-line basis over the lease term. Bank as a lessee Assets held under finance leases are initially recognized as property and equipment in the Consolidated Statement of Financial Position at an amount equal to the fair value of the leased asset or, if lower, the present value of the minimum lease payments. The corresponding finance lease obligation is included in other liabilities in the Consolidated Statement of Financial Position. The discount rate used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease. Contingent rentals are recognized as expense in the periods in which they are incurred. Operating lease rentals payable are recognized as an expense on a straight-line basis over the lease term, which commences when the lessee controls the physical use of the asset. Lease incentives are treated as a reduction of rental expense and are also recognized over the lease term on a straight- line basis. Contingent rentals arising under operating leases are recognized as an expense in the period in which they are incurred. Sale and lease-back Where the Bank enters into a sale leaseback transaction for a non-financial asset at fair market value that results in the Bank retaining an operating lease (where the buyer/lessor retains substantially all risks and rewards of ownership), any gains and losses are recognized immediately in net income. Where the sale leaseback transaction results in a finance lease, any gain on sale is deferred and recognized in net income over the remaining term of the lease. Leasehold improvements Leasehold improvements are investments made to customize buildings and offices occupied under operating lease contracts to make them suitable for their intended purpose. The present value of estimated reinstatement costs to bring a leased property into its original condition at the end of the lease, if required, is capitalized as part of the total leasehold improvements costs. At the same time, a corresponding liability is recognized to reflect the obligation incurred. Reinstatement costs are recognized in net income through depreciation of the capitalized leasehold improvements over their estimated useful life. 148 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Provisions A provision, including for restructuring, is recognized if, as a result of a past event, the Bank has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. The amount recognized as a provision is the Bank’s best estimate of the consideration required to settle the present obligation, taking into account the risks and uncertainties surrounding the obligation. If the effect of the time value of money is considered material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. The increase in the provision due to the passage of time is recorded as interest expense – other in the Consolidated Statement of Income. Insurance contracts Gross premiums for life insurance contracts are recognized as income when due. Gross premiums for non-life insurance business primarily property and casualty are recognized as income over the term of the insurance contracts. Unearned premiums represent the portion of premiums written in the current year that relate to the period of risk after the reporting date. Insurance claims recoveries are accounted as income in the same period as the related claims. Gross insurance claims for life insurance contracts reflect the cost of all claims arising during the year. Gross insurance claims for property and casualty insurance contracts include paid claims and movements in outstanding claim liabilities. Insurance premiums ceded to reinsurers are accounted as an expense in the same period as the premiums for the direct insurance contracts to which they relate. Guarantees A guarantee is a contract that contingently requires the Bank to make specified payments to reimburse the holder for a loss it incurs because a specified debtor failed to make payment when due in accordance with the original or modified terms of a debt instrument. Guarantees include standby letters of credit, letters of guarantee, indemnifications, credit enhancements and other similar contracts. Guarantees that qualify as a derivative are accounted for in accordance with the policy for derivative instruments. For guarantees that do not qualify as a derivative, a liability is recorded for the fair value of the obligation assumed at inception. The fair value of the obligation at inception is generally based on the discounted cash flow of the premium to be received for the guarantee, resulting in a corresponding asset. Subsequent to initial recognition, such guarantees are measured at the higher of the initial amount, less amortization to recognize any fee income earned over the period, and the best estimate of the amount required to settle any financial obligation arising as a result of the guarantee. Any increase in the liability is reported in the Consolidated Statement of Income. Employee benefits The Bank provides pension and other benefit plans for eligible employees in Canada, the United States and other international operations. Pension benefits are offered in the form of defined benefit pension plans (generally based on an employee’s length of service and the final five years’ average salary), and in the form of defined contribution pension plans (where the Bank’s contribution is fixed and there is no legal or constructive obligation to pay further amounts). Other benefits provided include post-retirement health care, dental care and life insurance, along with other long-term employee benefits such as long-term disability benefits. Defined benefit pension plans and other post-retirement benefit plans The cost of these employee benefits is actuarially determined each year using the projected unit credit method. The calculation uses management’s best estimate of a number of assumptions – including the discount rate, future compensation, health care costs, mortality, as well as the retirement age of employees. The discount rate used to determine the defined benefit obligation is based on the yield at the reporting date on high quality corporate bonds that have durations that match the terms of the Bank’s obligations. Prior to 2016, the discount rate used to determine the annual benefit expense was the same as the rate used to determine the defined benefit obligation. Beginning in 2016, separate discount rates were used to determine the annual benefit expense in Canada and the U.S. These rates were determined with reference to the yields on high quality corporate bonds with durations that match the various components of the annual defined benefit expense. The discount rate used to determine the annual benefit expense for all other plans continues to be same as the rate used to determine the defined benefit obligation. The Bank’s net asset or liability in respect of employee benefit plans is calculated separately for each plan as the difference between the present value of future benefits earned in respect of service for prior periods and the fair value of plan assets. The net asset or liability is included in other assets and other liabilities, as appropriate, in the Consolidated Statement of Financial Position. When the net amount in the Consolidated Statement of Financial Position is an asset, the recognized asset is limited to the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan. The current service cost, net interest expense (income), past service cost, and administrative expense are recognized in net income. Net interest income or expense is calculated by applying the discount rate at the beginning of the annual period to the net defined benefit asset or liability. When the benefits of a plan are improved (reduced), a past service cost (credit) is recognized immediately in net income. Remeasurements comprising of actuarial gains and losses, the effect of the asset ceiling and the change in the return on plan assets are recognized immediately in the Consolidated Statement of Financial Position with a charge or credit to the Statement of Comprehensive Income (OCI) in the period in which they occur. Amounts recorded in OCI are not recycled to the Consolidated Statement of Income. Other long-term employee benefits Other long-term employee benefits are accounted for similarly to defined benefit pension plans and other post-retirement benefit plans described above except that remeasurements are recognized in the Consolidated Statement of Income in the period in which they arise. Defined contribution plans The cost of such plans are equal to contributions payable by the Bank to employees’ accounts for service rendered during the period and expensed. Short-term employee benefits Short-term employee benefits are expensed as the related service is provided and a liability is measured on an undiscounted basis net of payments made. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 149 CONSOLIDATED FINANCIAL STATEMENTS Recognition of income and expenses Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Bank and the revenue can be reliably measured. The following specific criteria must also be met before revenue is recognized: Interest and similar income and expenses For all non-trading interest-bearing financial instruments, interest income or expense is recorded in net interest income using the effective interest rate. This is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or a shorter period, where appropriate, to the net carrying amount of the financial asset or financial liability. The calculation takes into account all the contractual terms of the financial instrument (for example, prepayment options) and includes any fees or incremental costs that are directly attributable to the instrument and are an integral part of the effective interest rate, but not future credit losses. For trading financial instruments, mark-to-market changes including related interest income or expense are recorded in trading revenues. The carrying amount of interest-bearing financial instruments, measured at amortized cost or classified as available-for-sale, is adjusted if the Bank revises its estimates of payments or receipts. The adjusted carrying amount is calculated based on the original effective interest rate and the change in carrying amount is recorded as non-interest income in the Consolidated Statement of Income. Once the carrying value of a financial asset or a group of similar financial assets has been reduced due to an impairment loss, interest income continues to be recognized based on net effective interest rate inherent in the investment. Loan origination costs are deferred and amortized into interest income using the effective interest method over the expected term of the loan. Loan fees are recognized in interest income over the appropriate lending or commitment period. Mortgage prepayment fees are recognized in interest income when received, unless they relate to a minor modification to the terms of the mortgage, in which case the fees are deferred and amortized using the effective interest method over the remaining period of the original mortgage. Loan syndication fees are recognized when no other services are required of the Bank and the fees are non-refundable unless the yield we retain is less than that of comparable lenders in the syndicate. In such cases, an appropriate portion will be deferred and amortized in interest income over the term of the loan. Loan commitment fees for loans that are likely to be drawn down and other credit related fees are deferred (together with any incremental costs) and recognized as part of the effective interest on the loan. When it is unlikely that a loan will be drawn down, the loan commitment fees are recognized over the commitment period on a straight-line basis. Fee and commission revenues The Bank earns fee and commission revenues from a diverse range of services it provides to its customers. Fee income can be divided into the following two categories: Fees earned for the provision of services over a period of time are accrued over that period the services are provided. These fees include commission income, investment management, custody and other management and advisory fees. Investment management fees and custodial fees are mainly calculated as a percentage of daily or period-end market value of the assets under management (AUM) or assets under administration (AUA) and are received monthly, quarterly, semi-annually, or annually based on the underlying investment management contracts. Performance-based fees related to AUM are earned based on exceeding certain benchmarks or other performance targets, are recognized at the end of the performance period in which the target is met. Fees arising from negotiating or participating in the negotiation of a transaction for a third-party, such as the arrangement of the acquisition of shares or other securities or the purchase or sale of businesses, are recognized on completion of the underlying transaction. Fees or components of fees that are linked to a certain performance are recognized after fulfilling the corresponding criteria. Fee and commission expenses Fee and commission expenses relate to transaction and service fees which are expensed as the services are received. Dividend income Dividend income on equity securities is recognized in interest income when the Bank’s right to receive payment is established. Share-based payments Share-based payments awarded to employees are recognized as compensation expense in the Consolidated Statement of Income over the vesting period based on the number of awards expected to vest including the impact of expected forfeitures. For awards that are delivered in tranches, each tranche is considered a separate award and accounted for separately. Stock appreciation rights and other awards that must be settled for cash are classified as liabilities. Liability-classified awards are re-measured to fair value at each reporting date while they remain outstanding, with any changes in fair value recognized in compensation expense in the period. The liability is expensed over the vesting period which incorporates the re-measurement of the fair value and a revised forfeiture rate that anticipates units expected to vest. Employee stock options with tandem stock appreciation rights give the employee the right to exercise for shares or settle in cash. These options are classified as liabilities and are re-measured to fair value at each reporting date while they remain outstanding. If an option is exercised, thereby cancelling the tandem stock appreciation right, both the exercise price proceeds together with the accrued liability and associated taxes are credited to equity – common shares in the Consolidated Statement of Financial Position. Plain vanilla options and other awards that must be settled for shares are classified as equity awards. Equity-classified awards are expensed based on the grant date fair value with a corresponding increase to equity – other reserves in the Consolidated Statement of Financial Position. If an option is exercised, both the exercise price proceeds together with the amount recorded in other reserves is credited to equity – common shares in the Consolidated Statement of Financial Position. 150 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S For tandem stock appreciation rights, stock appreciation rights and plain vanilla options, the Bank estimates fair value using an option pricing model. The option pricing model requires inputs such as the exercise price of the option, the current share price, the risk free interest rate, expected dividends, expected volatility (calculated using an equal weighting of implied and historical volatility) and specific employee exercise behaviour patterns based on statistical data. For other awards, fair value is the quoted market price of the Bank’s common shares at the reporting date. Where derivatives are used to economically hedge share-based payment expense, related mark-to-market gains and losses are included in non-interest expenses – salaries and employee benefits in the Consolidated Statement of Income. A voluntary renouncement of a tandem stock appreciation right where an employee retains the corresponding option for shares with no change in the overall fair value of the award, results in a reclassification of the accrued liability and associated tax to equity – other reserves in the Consolidated Statement of Financial Position. This reclassification is measured at the fair value of the renounced awards as of the renouncement date. Subsequent to the voluntary renouncement, these awards are accounted for as plain vanilla options, based on the fair value as of the renouncement date. Customer loyalty programs The Bank operates loyalty points programs, which allow customers to accumulate points when they use the Bank’s products and services. The points can then be redeemed for free or discounted products or services, subject to certain conditions. Consideration received is allocated between the products sold or services rendered and points issued, with the consideration allocated to points equal to their fair value. The fair value of points is generally based on equivalent retail prices for the mix of awards expected to be redeemed. The fair value of the points issued is deferred in other liabilities and recognized as banking revenues when the points are redeemed or lapsed. Management judgment is involved in determining the redemption rate to be used in the estimate of points to be redeemed. Dividends on shares Dividends on common and preferred shares are recognized as a liability and deducted from equity when they are approved by the Bank’s Board. Dividends are deducted from equity when they are declared and no longer at the discretion of the Bank. Segment reporting Management’s internal view is the basis for the determination of operating segments. The operating segments are those whose operating results are regularly reviewed by the Bank’s chief operating decision-maker to make decisions about resources to be allocated to the segment and assess its performance. The Bank has three operating segments: Canadian Banking, International Banking, and Global Banking and Markets. The other category represents smaller operating segments, including Group Treasury and other corporate items, which are not allocated to an operating segment. These segments offer different products and services and are managed separately based on the Bank’s management and internal reporting structure. The results of these business segments are based upon the internal financial reporting systems of the Bank. The accounting policies used in these segments are generally consistent with those followed in the preparation of the consolidated financial statements by the Bank. The only notable accounting measurement difference is the grossing up of revenues which are tax-exempt and income from associate corporations to an equivalent before-tax basis for those affected segments. This change in measurement enables comparison of income arising from taxable and tax-exempt sources. Because of the complexity of the Bank, various estimates and allocation methodologies are used in the preparation of the business segment financial information. The funding value of assets and liabilities is transfer-priced at wholesale market rates, and corporate expenses are allocated to each segment on an equitable basis using various parameters. As well, capital is apportioned to the business segments on a risk-based methodology. Transactions between segments are recorded within segment results as if conducted with a third-party and are eliminated on consolidation. Earnings per share (EPS) Basic EPS is computed by dividing net income for the period attributable to the Bank’s common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is calculated by dividing adjusted net income for the period attributable to common shareholders by the weighted-average number of diluted common shares outstanding for the period. In the calculation of diluted earnings per share, earnings are adjusted for changes in income or expenses that would result from the issuance of dilutive shares. The weighted-average number of diluted common shares outstanding for the period reflects the potential dilution that would occur if options, securities or other contracts that entitle their holders to obtain common shares had been outstanding from the beginning of the period (or a later date) to the end of the period (or an earlier date). Instruments determined to have an antidilutive impact for the period are excluded from the calculation of diluted EPS. Earnings are adjusted by the after-tax amount of distributions related to dilutive capital instruments recognized in the period. For tandem stock appreciation rights that are carried as liabilities, the after-tax re-measurement included in salaries and employee benefits expense, net of related hedges, is adjusted to reflect the expense had these rights been equity-classified. The number of additional shares for inclusion in diluted EPS for share-based payment options is determined using the treasury share method. Under this method, the net number of incremental common shares is determined by assuming that in-the-money stock options are exercised and the proceeds are used to purchase common shares at the average market price during the period. The number of additional shares associated with capital instruments that potentially result in the issuance of common shares is based on the terms of the contract. 4 Future Accounting Developments The Bank actively monitors developments and changes in accounting standards from the IASB, as well as requirements from the other regulatory bodies, including OSFI. The Bank is currently assessing the measurement impact the adoption of new standards issued by the IASB will have on its consolidated financial statements and also evaluating the alternative elections available on transition. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 151 CONSOLIDATED FINANCIAL STATEMENTS Effective November 1, 2017 Financial instruments On July 24, 2014, the IASB issued IFRS 9 Financial Instruments, which will replace IAS 39. The standard covers three broad topics: Classification and Measurement, Impairment and Hedging. IFRS 9 must be adopted retrospectively. Restatement of comparatives is not required, though it is permitted. On January 9, 2015, the Office of the Superintendent of Financial Institutions (OSFI) issued an advisory on the early adoption of IFRS 9 for Domestic Systematically Important Banks (D-SIBs) for annual reporting periods beginning on November 1, 2017. On June 21, 2016, OSFI issued revised accounting and disclosure guidelines for IFRS 9 Financial Instruments, that provide application guidance for federally regulated entities. The guidelines are effective for the Bank with the adoption of IFRS 9 on November 1, 2017 and are consistent with Basel Committee on Banking Supervision (BCBS) Guidance on credit risk and accounting for expected credit losses issued in December 2015. On October 11, 2016, BCBS published a consultative document: Regulatory treatment of accounting provisions – interim approach and transitional arrangements and a discussion document: Regulatory treatment of accounting provisions on the policy considerations related to the regulatory treatment of accounting provisions under the Basel III capital framework. BCBS is seeking comments on these documents by January 13, 2017. Classification and measurement The standard requires the Bank to consider two criteria when determining the measurement basis for debt instruments held as financial assets; i) its business model for managing those financial assets and ii) the cash flow characteristics of the assets. Based on these criteria, debt instruments are measured at amortized cost, fair value through OCI, or fair value through the Consolidated Statement of Income. Equity investments are measured at fair value through the Consolidated Statement of Income. However, the Bank may, at initial recognition of a non- trading equity investment, irrevocably elect to designate the investment as fair value through OCI, with no subsequent recycling to the Consolidated Statement of Income and dividend income recognized in the Consolidated Statement of Income. This designation is also available to existing non- trading equity investments at the date of adoption of IFRS 9. In addition, the Bank may, at initial recognition, irrevocably elect to designate a financial asset as fair value through the Consolidated Statement of Income, if doing so eliminates or significantly reduces an accounting mismatch which would otherwise arise. This designation is also available to existing financial assets at the date of adoption of IFRS 9. IFRS 9 requirements related to financial liabilities have been carried forward substantially unchanged from IAS 39, apart from the requirements on own credit risk of liabilities designated at fair value through the Consolidated Statement of Income. At the date of transition, the Bank is permitted to make a one-time irrevocable reassessment of its fair value through the Consolidated Statement of Income designations for its financial assets and liabilities. The Bank is currently evaluating the extent to which it will apply these designations to its financial instruments upon transition. Impairment The standard introduces a new single model for the measurement of impairment losses on all financial instruments including loans and debt securities measured at amortized cost or at fair value through OCI. The IFRS 9 expected credit loss (ECL) model replaces the current “incurred loss” model of IAS 39. The ECL model contains a three stage approach which is based on the change in credit quality of loans since initial recognition. Under the first stage, where there has not been a significant increase in credit risk since initial recognition, an amount equal to 12 months ECL will be recorded. Under the second stage, where there has been a significant increase in credit risk since initial recognition and the financial instruments are not considered credit impaired, an amount equal to the lifetime ECL will be recorded. Under the third stage, where there is an objective evidence of impairment at the reporting date these financial assets will be classified as credit impaired and an amount equal to the lifetime expected credit losses will be recorded for the financial assets. The ECL model is forward looking and requires the use of reasonable and supportable forecasts of future economic conditions in the determination of significant increases in credit risk and measurement of expected credit losses. Hedging The standard expands the scope of hedged items and hedging items to which hedge accounting can be applied and aims to better align the accounting with risk management activities. The Bank is permitted to adopt the hedge accounting requirements of IFRS 9 concurrently or to defer the adoption to a future period and continue to apply the hedge accounting requirements of IAS 39. However, the hedging disclosure requirements of IFRS 9 will continue to apply to the Bank regardless of the choice made. Financial instruments: disclosures (IFRS 7) IFRS 7 Financial Instruments: Disclosures, has been amended to include more extensive qualitative and quantitative disclosure relating to IFRS 9 such as new classification categories, three stage impairment model, new hedge accounting requirements and transition provisions. 152 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Effective November 1, 2018 Revenue from contracts with customers On May 28, 2014, the IASB issued IFRS 15 Revenue from Contracts with Customers, which provides a single principle based framework to be applied to all contracts with customers. IFRS 15 replaces the previous revenue standard IAS 18 Revenue, and the related Interpretations on revenue recognition. The standard scopes out contracts that are considered to be lease contracts, insurance contracts and financial instruments, and as such will impact the businesses that earn fee and commission revenues. The new standard is a control-based model as compared to the existing revenue standard which is primarily focused on risks and rewards. Under the new standard revenue is recognized when a customer obtains control of a good or service. Transfer of control occurs when the customer has the ability to direct the use of and obtain the benefits of the good or service. The standard is effective for the Bank on November 1, 2018, with early adoption permitted, using either a full retrospective approach or a modified retrospective approach. A majority of the Bank’s revenue generating instruments meet the definition of financial instruments and remain out of scope. The areas of focus for the Bank’s assessment will be fees and commission revenues from wealth management and other banking services. On April 12, 2016, the IASB issued amendments to the revenue standard, IFRS 15 Revenue From Contracts with Customers. The amendments provide additional clarification on the identification of a performance obligation in a contract, determining the principal and agent in an agreement, and determining whether the licensing revenues should be recognized at a point in time or over a specific period. The amendments also provide additional practical expedients upon transition to IFRS 15. The amendments are effective for the Bank on November 1, 2018, consistent with the effective date of the standard. Effective November 1, 2019 Leases On January 13, 2016, the IASB issued IFRS 16 Leases, which requires a lessee to recognize an asset for the right to use the leased item and a liability for the present value of its future lease payments. IFRS 16 will result in leases being recorded on the Bank’s balance sheet, including those currently classified as operating leases except for short-term leases and leases with low value of the underlying asset. IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17. IFRS 16 is effective for the Bank on November 1, 2019, with early adoption permitted from the date the Bank applies IFRS 15 Revenue from Contracts with Customers on or before the date of initial application of IFRS 16. On transition there are practical expedients available whereby the Bank will not need to reassess whether a contract is, or contains a lease, or reassess the accounting of sale leaseback transactions recognized prior to the date of initial application. A lessee will apply IFRS 16 to its leases either retrospectively to each prior reporting period presented; or retrospectively with the cumulative effect of initially applying IFRS 16 being recognized at the date of initial application. Cash and Deposits with Financial Institutions 5 As at October 31 ($ millions) Cash and non-interest-bearing deposits with financial institutions Interest-bearing deposits with financial institutions Total 2016 2015 $ 6,855 $ 6,724 39,489 67,203 $ 46,344 $ 73,927 The Bank is required to maintain balances with central banks, other regulatory authorities and certain counterparties and these amounted to $7,616 million (2015 – $6,219 million). 6 Fair Value of Financial Instruments Determination of fair value The calculation of fair value is based on market conditions at a specific point in time and therefore may not be reflective of future fair values. The Bank has controls and processes in place to ensure that the valuation of financial instruments is appropriately determined. The best evidence of fair value for a financial instrument is the quoted price in an active market. Quoted market prices represent a Level 1 valuation. Where possible, valuations are based on quoted prices or observable inputs obtained from active markets. Independent Price Verification (IPV) is undertaken to assess the reliability and accuracy of prices and inputs used in the determination of fair value. The IPV process is performed by price verification groups that are independent from the business. The Bank maintains a list of pricing sources that are used in the IPV process. These sources include, but are not limited to, brokers, dealers and consensus pricing services. The valuation policies relating to the IPV process require that all pricing or rate sources used be external to the Bank. On a periodic basis, an independent assessment of pricing or rate sources is performed to determine market presence or market representative levels. Quoted prices are not always available for over-the-counter transactions, as well as transactions in inactive or illiquid markets. In these instances, internal models that maximize the use of observable inputs are used to estimate fair value. The chosen valuation technique incorporates all the factors that market participants would take into account in pricing a transaction. When all significant inputs to models are observable, the valuation is classified as Level 2. Financial instruments traded in a less active market are valued using indicative market prices, present value of cash-flows or other valuation techniques. Fair value estimates normally do not consider forced or liquidation sales. Where financial instruments trade in inactive markets or when using models where observable parameters do not exist, greater management judgment is required for valuation purposes. Valuations that require the significant use of unobservable inputs are considered Level 3. The specific inputs and valuation techniques used in determining the fair value of financial instruments are noted below. For Level 3 instruments, additional information is disclosed in the Level 3 sensitivity analysis on page 158. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 153 CONSOLIDATED FINANCIAL STATEMENTS The fair values of cash and deposits with banks, securities purchased under resale agreements and securities borrowed, customers’ liability under acceptances, obligations related to securities sold under repurchase agreements and securities lent, acceptances, and obligations related to securities sold short are assumed to approximate their carrying values, either due to their short-term nature or because they are frequently repriced to current market rates. Trading loans Trading loans as they relate to precious metals (primarily gold and silver) are valued using a discounted cash flow model incorporating market- observable inputs, including precious metals spot and forward prices and interest rate curves (Level 2). Other trading loans that serve as hedges to loan-based credit total return swaps are valued using consensus prices from Bank approved independent pricing services (Level 2). Government issued or guaranteed securities The fair values of government issued or guaranteed debt securities are primarily based on quoted prices in active markets, where available. Where quoted prices are not available, the fair value is determined by utilizing recent transaction prices, broker quotes, or pricing services (Level 2). For securities that are not actively traded, the Bank uses a discounted cash flow method, using the effective yield of a similar instrument adjusted for instrument-specific risk factors such as credit spread and contracted features (Level 2). Corporate and other debt Corporate and other debt securities are valued using prices from independent market data providers or third-party broker quotes. Where prices are not available consistently, the last available data is used and verified with a yield-based valuation approach (Level 2). In some instances, interpolated yields of similar bonds are used to price securities (Level 2). The Bank uses pricing models with observable inputs from market sources such as credit spread, interest rate curves, and recovery rates (Level 2). These inputs are verified through an IPV process on a monthly basis. For certain securities where there is no active market, no consensus market pricing and no indicative or executable independent third-party quotes, the Bank uses pricing by third-party providers or internal pricing models and cannot readily observe the market inputs used to price such instruments (Level 3). Mortgage-backed securities The fair value of residential mortgage-backed securities is primarily determined using third-party broker quotes and independent market data providers, where the market is more active (Level 2). Where the market is inactive, an internal price-based model is used (Level 3). Equity securities The fair value of equity securities is based on quoted prices in active markets, where available. Where equity securities are less frequently traded, the most recent exchange-quoted pricing is used to determine fair value. Where there is a wide bid-offer spread, fair value is determined based on quoted market prices for similar securities (Level 2). Where quoted prices in active markets are not readily available, such as for private equity securities, the fair value is determined as a multiple of the underlying earnings or percentage of underlying assets obtained from third-party general partner statements (Level 3). Income funds and hedge funds The fair value of income funds and hedge funds is based on observable quoted prices where available. Where quoted or active market prices are unavailable, the last available Net Asset Value, fund statements and other financial information available from third-party fund managers at the fund level are used in arriving at the fair value. These inputs are not considered observable because the Bank cannot redeem these funds at Net Asset Value (Level 3). Derivatives Fair values of exchange-traded derivatives are based on quoted market prices. Fair values of over-the-counter (OTC) derivatives or inactive exchange- traded derivatives are determined using pricing models, which take into account input factors such as current market and contractual prices of the underlying instruments, as well as time value and yield curve or volatility factors underlying the positions (Level 2). The determination of the fair value of derivatives includes consideration of credit risk, estimated funding costs and ongoing direct costs over the life of the instruments. Derivative products valued using a valuation technique with market-observable inputs mainly include interest rate swaps and options, currency swaps and forward foreign exchange contracts. The most frequently applied valuation techniques include forward pricing and swap models, using present value calculations. The models incorporate various inputs including foreign exchange spot and forward rates and interest rate curves (Level 2). Derivative products valued using a valuation technique with significant unobservable inputs are long dated contracts (interest rate swaps, currency swaps, forward foreign exchange contracts, option contracts and certain credit default swaps) and other derivative products that reference a basket of assets, commodities or currencies. These models incorporate certain significant non-observable inputs such as volatility and correlation (Level 3). Loans The estimated fair value of loans carried at amortized cost reflects changes in the general level of interest rates and credit worthiness of borrowers that have occurred since the loans were originated or purchased. The particular valuation methods used are as follows: (a) Canadian fixed rate residential mortgages are fair valued by discounting the expected future contractual cash flows, taking into account expected prepayments and using management’s best estimate of average market interest rates currently offered for mortgages with similar remaining terms (Level 3). (b) For fixed rate business and government loans, fair value is determined by discounting the expected future contractual cash flows of these loans at interest rates estimated by using the appropriate currency swap curves for the remaining term, adjusted for a credit mark of the expected losses in the portfolio (Level 3). 154 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (c) For all other fixed rate loans, fair value is determined by discounting the expected future contractual cash flows of these loans at interest rates estimated by using the appropriate currency swap curves for the remaining term (Level 3). (d) For all floating rate loans fair value is assumed to equal book value. The fair value of loans is not adjusted for the value of any credit protection the Bank has purchased to mitigate credit risk. Deposits The fair values of deposits payable on demand or after notice or floating rate deposits payable on a fixed date is assumed to equal book value. The estimated fair values of Canadian personal fixed rate deposits payable on a fixed date are fair valued by discounting the expected future contractual cash outflows, using management’s best estimate of average market interest rates currently offered for deposits with similar remaining terms (Level 2). Deposits under the Canada Mortgage Bond (CMB) program are fair valued by discounting expected future contractual cash flows using market observable inputs (Level 2). For all other fixed rate deposits, fair value is determined by discounting the expected future contractual cash flows of these deposits at interest rates estimated by using the appropriate currency swap curves for the remaining term (Level 2). For structured deposit notes containing embedded features that are bifurcated from the deposit notes, the fair value of the embedded derivatives is determined using option pricing models with inputs similar to other interest rate or equity derivative contracts (Level 2). The fair value of certain embedded derivatives is determined using net asset values (Level 3). Subordinated debentures and other liabilities The fair values of subordinated debentures, including debentures issued by subsidiaries which are included in other liabilities, are determined by reference to quoted market prices where available or market prices for debt with similar terms and risks (Level 2). The fair values of other liabilities is determined by the discounted contractual cash flow method with appropriate currency swap curves for the remaining term (Level 2). Fair value of financial instruments The following table sets out the fair values of financial instruments of the Bank using the valuation methods and assumptions described above. The fair values disclosed do not include non-financial assets, such as property and equipment, investments in associates, precious metals, goodwill and other intangible assets. As at October 31 ($ millions) Assets: Cash and deposits with financial institutions Trading assets Financial instruments designated at fair value through profit or loss Securities purchased under resale agreements and securities borrowed Derivative financial instruments Investment securities – available-for-sale Investment securities – held-to-maturity Loans Customers’ liability under acceptances Other financial assets Liabilities: Deposits Financial instruments designated at fair value through profit or loss Acceptances Obligations related to securities sold short Derivative financial instruments Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Other financial liabilities 2016 Total fair value Total carrying value Favourable/ (Unfavourable) Total fair value 2015 Total carrying value Favourable/ (Unfavourable) $ 46,344 108,561 $ 46,344 108,561 $ 221 221 92,129 41,657 50,509 22,567 484,815 11,978 9,973 92,129 41,657 50,509 22,410 480,164 11,978 9,973 – – – – – – 157 4,651 – – $ 73,927 99,140 $ 73,927 99,140 $ 320 320 87,312 41,003 42,565 716 463,047 10,296 9,024 87,312 41,003 42,565 651 458,628 10,296 9,024 – – – – – – 65 4,419 – – 613,858 611,877 (1,981) 602,606 600,919 (1,687) 1,459 11,978 23,312 42,387 97,083 7,804 24,304 1,459 11,978 23,312 42,387 97,083 7,633 23,796 – – – – – (171) (508) 1,486 10,296 20,212 45,270 77,015 6,234 25,778 1,486 10,296 20,212 45,270 77,015 6,182 25,443 – – – – – (52) (335) Changes in interest rates, credit spreads and liquidity costs are the main cause of changes in the fair value of the Bank’s financial instruments resulting in a favourable or unfavourable variance compared to carrying value. For the Bank’s financial instruments carried at cost or amortized cost, the carrying value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes. For available-for-sale investment securities, derivatives and financial instruments held for trading purposes or designated as fair value through profit or loss, the carrying value is adjusted regularly to reflect the fair value. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 155 CONSOLIDATED FINANCIAL STATEMENTS Fair value hierarchy The following table outlines the fair value hierarchy of instruments carried at fair value on a recurring basis and of instruments not carried at fair value. As at October 31 ($ millions) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total 2016 2015 Instruments carried at fair value on a recurring basis: Assets: Precious metals(1) Trading assets Loans Canadian federal government and government guaranteed debt Canadian provincial and municipal debt US treasury and other US agencies’ debt Other foreign governments’ debt Corporate and other debt Income funds Equity securities Other(2) Financial assets designated at fair value through profit or loss Investment securities(3) Canadian federal government and government guaranteed debt Canadian provincial and municipal debt US treasury and other US agencies’ debt Other foreign governments’ debt Corporate and other debt Mortgage-backed securities Equity securities Derivative financial instruments Interest rate contracts Foreign exchange and gold contracts Equity contracts Credit contracts Commodity contracts Liabilities: Deposits(4) Financial liabilities designated at fair value through profit or loss Obligations related to securities sold $ $ $ $ – 17 321 – 321 659 – – short $ 19,870 – 3 327 – 312 642 Derivative financial instruments Interest rate contracts Foreign exchange and gold contracts Equity contracts Credit contracts Commodity contracts Instruments not carried at fair value(5): Assets: Investment securities – Held to maturity Loans(6) $ $ $ Liabilities: Deposits(6)(7) Subordinated debt Other liabilities $ – – 10,830 – 10,182 4,724 75 1,424 36,814 1,853 $ 8,442 $ 19,421 – 9,608 – 1,783 9,844 648 133 – – – – – – – 31 1,186 5 – $ 8,442 $ 19,421 10,830 9,608 10,182 6,507 9,950 3,258 36,952 1,853 – – 7,295 – 5,313 9,512 163 93 32,553 2,419 1,222 $ 117,003 $ 57,348 – $ 221 $ 16 $ 65,902 $ 49,879 $ 16 $ 205 $ 11,464 934 9,901 6,703 745 276 1,411 $ 2,157 2,558 176 8,473 3,852 751 199 $ 31,434 $ 18,166 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 13,621 3,492 10,077 15,531 4,678 1,027 2,083 $ 5,752 1,085 9,678 6,003 921 97 1,665 50,509 $ 25,201 15,707 21,659 1,931 148 2,212 41,657 1,127 1,459 $ $ $ $ – 1 173 – 1,656 1,830 – – 23,312 $ 17,073 14,486 21,643 2,380 1,475 2,403 $ – 3 233 – 1,201 – – – 355 81 – 473 909 54 – 64 – – – – 187 – 167 – – 354 $ 40,880 $ 118 (36) $ 1,163 $ 15,653 21,642 1,546 148 1,891 $ $ $ 1,459 3,442 $ 14,299 21,640 1,886 1,475 2,091 $ 10,550 $ 18,341 – 5,281 368 1,515 13,162 1,728 107 – 51,052 279 1,997 2,621 150 6,233 4,212 187 224 15,624 14,584 19,741 2,032 850 1,828 39,035 43 1,486 3,139 13,443 21,470 2,172 2,542 3,943 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ – – – – – – 67 1,218 5 – $ 10,550 18,341 7,295 5,281 5,681 11,027 13,392 3,039 32,665 2,419 1,290 $ 109,690 25 $ 320 – – – 447 137 23 1,133 1,740 36 – 102 – – 138 1,192 – – 81 – 170 12 – 263 $ $ $ $ $ $ $ $ 7,749 3,706 9,828 12,683 5,270 307 3,022 42,565 14,620 19,742 2,307 850 3,484 41,003 1,235 1,486 20,212 13,524 21,473 2,575 2,554 5,144 $ 45,270 $ 41,391 $ $ 42,387 $ 1,437 $ 43,570 $ 4,972 – $ 17,595 – $ – 276,462 $ 22,567 276,462 $ $ 131 – 585 – $ – 260,583 $ 716 260,583 – – – 271,170 7,804 11,303 – – – 271,170 7,804 11,303 – – – 252,382 6,234 11,041 – – – 252,382 6,234 11,041 (1) The fair value of precious metals is determined based on quoted market prices and forward spot prices. (2) Consists primarily of base metal positions. The fair value of these positions is determined based on quoted prices in active markets. (3) Excludes investments which are held-to-maturity of $22,410 (2015 – $651). (4) These amounts represent embedded derivatives bifurcated from structured deposit notes. (5) Represents the fair value of financial assets and liabilities where the carrying amount is not a reasonable approximation of fair value. (6) Excludes floating rate instruments as carrying value approximates fair value. (7) Excludes embedded derivatives bifurcated from structured deposit notes. 156 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Level 3 instrument fair value changes Financial instruments categorized as Level 3 in the fair value hierarchy comprise certain illiquid government bonds, highly-structured corporate bonds, mortgage-backed securities, illiquid investments in private equity securities, income funds, complex derivatives, and embedded derivatives in structured deposit notes. The following table summarizes the changes in Level 3 instruments carried at fair value for the year ended October 31, 2016. All positive balances represent assets and negative balances represent liabilities. Consequently, positive amounts indicate purchases of assets or settlements of liabilities and negative amounts indicate sales of assets or issuances of liabilities. As at October 31, 2016 Fair value November 1 2015 Gains/(losses) recorded in Gains/(losses) recorded in income(1) OCI(2) Purchases/ Issuances Sales/ Settlements Transfers into/out of Level 3 Fair value October 31 2016 Change in unrealized gains/(losses) recorded in income for instruments still held(3) $ 67 1,243 5 1,315 $ 1 (23) – (22) $ $ – – – – 447 137 23 1,133 1,740 36 102 (81) (170) (12) (125) (1,192) 1,738 5 5 – 185 195 4 (20) 54 (127) 4 (85) 29 117 (17) 14 (1) (213) (217) – – – – – – – (217) – – – – 579 49 – 78 706 23 22 (170) (14) – (139) – 567 $ $ (37) (34) – (71) (659) (124) (22) (710) (1,515) (9) (202) 10 348 – 147 – (1,439) – – – – – – – – – – 162 – (204) 8 (34) – (34) $ 31 1,186 5 1,222 $ (1) (23)(5) – (24) 355 81 – 473 909 54 64 (187) (167) – (236) (1,163) 732 n/a n/a n/a n/a n/a 6 (14)(6) 52 (71)(6) 4 (23) 29(5) (18) ($ millions) Trading assets(4) Corporate and other debt Income funds Equity securities Investment securities Other foreign governments’ debt Corporate and other debt Mortgage-backed securities Equity securities Derivative financial instruments – assets Interest rate contracts Equity contracts Derivative financial instruments – liabilities Interest rate contracts Equity contracts Credit contracts Deposits(7) Total (1) Gains and losses on trading assets and all derivative financial instruments are included in trading revenues in the Consolidated Statement of Income. Gains and losses on disposal of investment securities are included in net gain on sale of investment securities in the Consolidated Statement of Income. (2) Gains and losses from fair value changes of investment securities are presented in the net change in unrealized gains (losses) on available-for-sale securities in the Consolidated Statement of Comprehensive Income. (3) These amounts represent the gains and losses from fair value changes of Level 3 instruments still held at the end of the period that are recorded in the Consolidated Statement of Income. (4) Trading assets include an insignificant amount of financial assets designated at fair value through profit or loss. (5) The unrealized gains on income fund units are mostly offset by the mark-to-market changes in an equity-linked deposit note and certain other derivative instruments in structured transactions. Both gains and offsetting losses are included in trading revenues in the Consolidated Statement of Income. (6) Certain unrealized gains and losses on derivative assets and liabilities are largely offset by mark-to-market changes on other instruments included in trading revenues in the Consolidated Statement of Income, since these instruments act as an economic hedge to certain derivative assets and liabilities. (7) These amounts represent embedded derivatives bifurcated from structured deposit notes. The following table summarizes the changes in Level 3 instruments carried at fair value for the year ended October 31, 2015. ($ millions) Trading assets(2) Investment securities Derivative financial instruments Deposits(3) As at October 31, 2015 Fair value November 1 2014 Gains/(losses) recorded in income(1) Gains/(losses) recorded in OCI $ 1,386 1,956 254 (1,011) $ 196 145 12 (181) $ – 90 – – Purchases/ Issuances Sales/ Settlements $ 54 838 (26) – $ (321) (1,289) 298 – Transfers into/out of Level 3 $ – – (663) – Fair value October 31 2015 $ 1,315 1,740 (125) (1,192) (1) Gains or losses for items in Level 3 may be offset with losses or gains on related hedges in Level 1 or Level 2. (2) Trading assets include an insignificant amount of financial assets designated at fair value through profit or loss. (3) These amounts represent embedded derivatives bifurcated from structured deposit notes. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 157 CONSOLIDATED FINANCIAL STATEMENTS Significant transfers Significant transfers can occur between the fair value hierarchy levels when additional or new information regarding valuation inputs and their refinement and observability become available. The Bank recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period during which the change has occurred. The following significant transfers were made among Levels 1, 2 and 3 for the year ended October 31, 2016: A net amount of derivative assets of $162 million was transferred into Level 3 from Level 2 for equity derivatives. A net amount of derivative liabilities of $196 million was transferred into Level 3 from Level 2 primarily for equity derivatives. The following significant transfers were made among Levels 1, 2 and 3 for the year ended October 31, 2015: A net amount of derivative assets of $595 million was transferred out of Level 3 into Level 2 primarily for equity derivatives. A net amount of derivative liabilities of $68 million was transferred into Level 3. $67 million was transferred out of Level 2 and $1 million was transferred out of Level 1. All transfers were as a result of new information being obtained regarding the observability of inputs used in the valuation. Level 3 sensitivity analysis The table below sets out information about significant unobservable inputs used in measuring financial instruments categorized as Level 3 in the fair value hierarchy. Valuation technique Significant unobservable inputs Range of estimates for unobservable inputs(1) Changes in fair value from reasonably possible alternatives ($ millions) Investment securities(2) Other foreign governments’ debt Price based Price 100% (1)/– Derivative financial instruments Interest rate contracts Option pricing model Interest rate volatility Equity contracts Option pricing Equity volatility 13% - 98% 5% - 124% (53)/53 (1) The range of estimates represents the actual lowest and highest level inputs used to fair value financial instruments within each financial statement category. (2) The valuation of private equity and income fund investments utilize net asset values as reported by fund managers. Net asset values are not considered observable as the Bank cannot redeem these instruments at such values. The range for net asset values per unit or price per share has not been disclosed for these instruments since the valuations are not model based. model Single stock correlation (77)% - 98% (6)/6 The Bank applies judgment in determining unobservable inputs used to calculate the fair value of Level 3 instruments. The following section discusses the significant unobservable inputs for Level 3 instruments. Correlation Correlation in a credit derivative or debt instrument refers to the likelihood of a single default causing a succession of defaults. It affects the distribution of the defaults throughout the portfolio and therefore affects the valuation of instruments such as collateralized debt obligation tranches. A higher correlation may increase or decrease fair value depending on the seniority of the instrument. Correlation becomes an input into equity derivative pricing when the relationship between price movements of two or more of the underlying assets is relevant. Volatility Volatility is a measure of security price fluctuation. Historic volatility is often calculated as the annualized standard deviation of daily price variation for a given time period. Implied volatility is volatility, when input into an option pricing model, that returns a value equal to the current market value of the option. 158 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 7 Trading Assets (a) Trading securities An analysis of the carrying value of trading securities is as follows: As at October 31, 2016 ($ millions) Remaining term to maturity Trading securities: Canadian federal government issued or guaranteed debt Canadian provincial and municipal debt U.S. treasury and other U.S. agency debt Other foreign government debt Common shares Other Total Total by currency (in Canadian equivalent): Canadian dollar U.S. dollar Mexican peso Other currencies Total trading securities Within three months Three to twelve months One to five years Five to ten years Over ten years No specific maturity Carrying value $ 235 1,713 2,688 1,346 – 913 $ 6,895 $ 2,161 3,199 176 1,359 $ 6,895 $ 2,620 950 400 760 – 1,504 $ 6,234 $ 3,714 1,502 82 936 $ 6,234 $ 4,651 1,483 4,304 1,924 – 4,853 $ 17,215 $ 6,832 7,792 160 2,431 $ 17,215 $ 1,079 2,907 957 1,369 – 1,693 $ 8,005 $ 4,442 2,156 6 1,401 $ 8,005 $ 2,245 2,555 1,833 1,108 – 987 $ 8,728 $ 5,185 2,448 8 1,087 $ 8,728 $ – – – – 40,210 – $ 40,210 $ 15,033 8,178 1,536 15,463 $ 40,210 $ 10,830 9,608 10,182 6,507 40,210 9,950 $ 87,287 $ 37,367 25,275 1,968 22,677 $ 87,287 As at October 31, 2015 ($ millions) Remaining term to maturity Within three months Three to twelve months One to five years Five to ten years Over ten years No specific maturity Carrying value C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Trading securities: Canadian federal government issued or guaranteed debt Canadian provincial and municipal debt U.S. treasury and other U.S. agency debt Other foreign government debt Common shares Other Total Total by currency (in Canadian equivalent): Canadian dollar U.S. dollar Mexican peso Other currencies Total trading securities $ 338 420 728 1,902 – 1,294 $ 4,682 $ 1,429 1,289 389 1,575 $ 4,682 $ 1,054 594 455 2,501 – 2,212 $ 6,816 $ 1,971 2,348 689 1,808 $ 6,816 $ 3,154 1,422 1,314 3,142 – 6,137 $ 15,169 $ 5,457 6,312 959 2,441 $ 15,169 $ 991 1,169 1,555 1,631 – 1,963 $ 7,309 $ 2,633 2,995 28 1,653 $ 7,309 $ 1,758 1,676 1,629 1,851 – 1,751 $ 8,665 $ 3,937 2,906 84 1,738 $ 8,665 $ – – – – 35,704 35 $ 35,739 $ 18,992 5,918 680 10,149 $ 35,739 $ 7,295 5,281 5,681 11,027 35,704 13,392 $ 78,380 $ 34,419 21,768 2,829 19,364 $ 78,380 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 159 CONSOLIDATED FINANCIAL STATEMENTS (b) Trading loans The following table provides the geographic breakdown of trading loans: As at October 31 ($ millions) Trading loans(1)(2) U.S.(3) Europe(4) Asia Pacific(4) Canada(4) Other(4) Total 2016 2015 $ 11,235 4,163 2,555 340 1,128 $ 19,421 $ 9,990 3,525 3,657 394 775 $ 18,341 (1) Geographic segmentation of trading loans is based upon the location of the ultimate risk of the underlying asset. (2) Loans are denominated in U.S. dollars. (3) Includes trading loans that serve as a hedge to loan-based credit total return swaps of $7,098 (2015 – $7,094), while the remaining relates to short-term precious metals trading and lending activities. (4) These loans are primarily related to short-term precious metals trading and lending activities. 8 Financial Instruments Designated at Fair Value Through Profit or Loss In accordance with its risk management strategy, the Bank has elected to designate certain investments, loans and deposit note liabilities at fair value through profit or loss to reduce an accounting mismatch between fair value changes in these instruments and fair value changes in related derivatives, and where a hybrid instrument contains one or more embedded derivatives that are not closely related to the host contract. Changes in fair value arising from changes in the Bank’s own credit risk are recognized in other comprehensive income, without subsequent reclassification to net income. The cumulative fair value adjustment due to own credit risk is determined at a point in time by comparing the present value of expected future cash flows over the term of these liabilities discounted at the Bank’s effective funding rate, and the present value of expected future cash flows discounted under a benchmark rate. The change in fair value attributable to change in credit risk is determined by the change in the cumulative fair value adjustment due to own credit risk. The following table presents the fair value of financial assets and liabilities designated at fair value through profit or loss and their changes in fair value. October 31 ($ millions) Investment securities(2) Loans(3) Deposit note liabilities(4) Fair value As at Change in fair value Cumulative change in FV(1) For the year ended $ 2016 16 205 1,459 2015 2016 $ 107 213 1,486 $ (1) (9) 245 $ 2015 (1) 18 106 2016 2015 $ 11 8 15 $ 12 18 124 (1) The cumulative change in fair value is measured from the instruments’ date of initial recognition. (2) Changes in fair value are recorded in non-interest income – other. (3) Changes in fair value are recorded in non-interest income – trading revenues. (4) Changes in fair value attributable to changes in the Bank’s own credit risk are recorded in other comprehensive income. Other changes in fair value are recorded in non-interest income – trading revenues. The following tables present the changes in fair value attributable to changes in the Bank’s own credit risk for financial liabilities designated at fair value through profit or loss as well as their contractual maturity and carrying amounts. Deposit Note Liabilities Difference between carrying value and contractual maturity amount $ 15 $ 124 Changes in fair value for the period attributable to changes in own credit risk recorded in other comprehensive income Cumulative changes in fair value attributable to changes in own credit risk(1) $ (23) $ 20 $ (8) $ 15 Contractual maturity amount(1) $ 1,474 $ 1,610 Carrying Value $ 1,459 $ 1,486 As at October 31, 2016 As at October 31, 2015 (1) The cumulative change in fair value is measured from the instruments’ date of initial recognition. 160 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 9 Derivative Financial Instruments (a) Notional amounts(1) The following table provides the aggregate notional amounts of derivative financial instruments outstanding by type and segregated between those used by the Bank in its dealer capacity (Trading) and those derivatives designated in hedging relationships. The notional amounts of these contracts represent the derivatives volume outstanding and do not represent the potential gain or loss associated with the market risk or credit risk of such instruments. Credit derivatives within other derivative contracts are comprised primarily of purchased and sold credit default swap transactions. To a lesser extent, this category also includes total return swaps referenced to loans and debt securities. Other derivative contracts – other includes precious metals other than gold, and other commodities including energy and base metal derivatives. As at October 31 ($ millions) Interest rate contracts Exchange-traded: Futures Options purchased Options written Over-the-counter: Forward rate agreements Swaps Options purchased Options written Over-the-counter (settled through central counterparties): Forward rate agreements Swaps Options purchased Options written Total Foreign exchange and gold contracts Exchange-traded: Futures Options purchased Options written Over-the-counter: Spot and forwards Swaps Options purchased Options written Over-the-counter (settled through central counterparties): Spot and forwards Swaps Options purchased Options written Total Other derivative contracts Exchange-traded: Equity Credit Commodity and other contracts Over-the-counter: Equity Credit Commodity and other contracts Over-the-counter (settled through central counterparties): Equity Credit Commodity and other contracts Total Total notional amounts outstanding 2016 2015 Trading Hedging Total Trading Hedging Total $ – – – – $ 112,196 15,427 3,283 130,906 1,721 479,029 35,404 36,864 553,018 $ $ – – – – – 25,537 – – 25,537 112,196 15,427 3,283 130,906 1,721 504,566 35,404 36,864 578,555 $ 140,240 29,670 28,755 198,665 4,613 582,414 31,734 32,900 651,661 308,186 1,702,488 – – 2,010,674 $ 2,694,598 – 87,480 – – 87,480 $ 113,017 308,186 1,789,968 – – 2,098,154 $ 2,807,615 852,416 2,136,724 – – 2,989,140 $ 3,839,466 $ $ $ 35,862 257 – 36,119 425,033 302,107 16,359 16,245 759,744 13 – – – 13 795,876 19,625 – 41,888 61,513 67,604 37,910 36,508 142,022 $ $ $ – – – – 24,244 51,355 – – 75,599 – – – – – 75,599 – – – – 679 – – 679 $ $ $ 35,862 257 – 36,119 449,277 353,462 16,359 16,245 835,343 13 – – – 13 871,475 19,625 – 41,888 61,513 68,283 37,910 36,508 142,701 $ $ $ 6,626 251 – 6,877 431,211 296,670 5,382 4,884 738,147 – – – – – 745,024 13,594 – 106,181 119,775 47,152 54,020 43,524 144,696 $ $ $ $ $ – 31,280 – – 31,280 – 64,994 – – 64,994 96,274 – – – – 20,419 41,658 – – 62,077 – – – – – 62,077 – – – – 605 – – 605 140,240 29,670 28,755 198,665 4,613 613,694 31,734 32,900 682,941 852,416 2,201,718 – – 3,054,134 $ 3,935,740 $ $ $ 6,626 251 – 6,877 451,630 338,328 5,382 4,884 800,224 – – – – – 807,101 13,594 – 106,181 119,775 47,757 54,020 43,524 145,301 – 11,148 357 11,505 $ 215,040 $ 3,705,514 – – – – $ 679 $ 189,295 – 11,148 357 11,505 $ 215,719 $ 3,894,809 1,198 9,913 101 11,212 $ 275,683 $ 4,860,173 – – – – $ 605 $ 158,956 1,198 9,913 101 11,212 $ 276,288 $ 5,019,129 (1) The notional amounts represent the amount to which a rate or price is applied to determine the amount of cash flows to be exchanged. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 161 CONSOLIDATED FINANCIAL STATEMENTS (b) Remaining term to maturity The following table summarizes the remaining term to maturity of the notional amounts of the Bank’s derivative financial instruments by type: As at October 31, 2016 ($ millions) Interest rate contracts Futures Forward rate agreements Swaps Options purchased Options written Foreign exchange and gold contracts Futures Spot and forwards Swaps Options purchased Options written Other derivative contracts Equity Credit Commodity and other contracts Total As at October 31, 2015 ($ millions) Interest rate contracts Futures Forward rate agreements Swaps Options purchased Options written Foreign exchange and gold contracts Futures Spot and forwards Swaps Options purchased Options written Other derivative contracts Equity Credit Commodity and other contracts Within one year One to five years Over five years Total $ 112,183 279,035 663,184 13,169 6,956 1,074,527 $ – 30,872 1,114,988 29,392 24,700 1,199,952 $ 13 – 516,362 8,270 8,491 533,136 $ 112,196 309,907 2,294,534 50,831 40,147 2,807,615 858 400,914 61,029 8,375 9,690 480,866 63,485 22,911 37,001 123,397 35,004 47,590 203,554 8,241 6,555 300,944 24,265 22,852 41,612 88,729 – 786 88,879 – – 89,665 158 3,295 140 3,593 35,862 449,290 353,462 16,616 16,245 871,475 87,908 49,058 78,753 215,719 $ 1,678,790 $ 1,589,625 $ 626,394 $ 3,894,809 Within one year One to five years Over five years Total $ 140,106 735,756 945,149 32,246 31,630 1,884,887 $ 133 121,273 1,264,240 22,636 23,269 1,431,551 $ 1 – 606,023 6,522 6,756 619,302 $ 140,240 857,029 2,815,412 61,404 61,655 3,935,740 1,535 420,551 69,370 3,657 3,638 498,751 34,689 22,747 89,482 146,918 5,091 30,622 187,566 1,926 1,198 226,403 26,792 37,526 60,324 124,642 – 457 81,392 50 48 81,947 1,068 3,660 – 4,728 6,626 451,630 338,328 5,633 4,884 807,101 62,549 63,933 149,806 276,288 Total $ 2,530,556 $ 1,782,596 $ 705,977 $ 5,019,129 (c) Credit risk As with other financial assets, derivative instruments are subject to credit risk. Credit risk arises from the possibility that counterparties may default on their obligations to the Bank. However, whereas the credit risk of other financial assets is represented by the principal amount net of any applicable allowance for credit losses, the credit risk associated with derivatives is normally a small fraction of the notional amount of the derivative instrument. Derivative contracts generally expose the Bank to credit loss if changes in market rates affect a counterparty’s position unfavourably and the counterparty defaults on payment. Accordingly, exposure to credit risk of derivatives is represented by the positive fair value of the instrument. Negotiated over-the-counter derivatives generally present greater credit exposure than exchange-traded contracts. The net change in the exchange- traded contracts is normally settled daily in cash with the exchange. Holders of these contracts look to the exchange for performance under the contract. The Bank strives to limit credit risk by dealing with counterparties that it believes are creditworthy, and investment grade counterparties account for a significant portion of the credit risk exposure arising from the Bank’s derivative transactions as at October 31, 2016. To control credit risk associated with derivatives, the Bank uses the same credit risk management activities and procedures that are used in the lending business in assessing and adjudicating potential credit exposure. The Bank applies limits to each counterparty, measures exposure as the current positive fair value plus potential future exposure, and uses credit mitigation techniques, such as netting and collateralization. 162 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T The Bank obtains the benefit of netting by entering into master netting arrangements with counterparties (typically industry standard International Swaps and Derivatives Association (ISDA) agreements), which allow for a single net settlement of all transactions covered by that agreement in the event of a default or early termination of the transactions. In this manner, the credit risk associated with favourable contracts is eliminated by the master netting arrangement to the extent that unfavourable contracts with the same counterparty are not settled before favourable contracts. Collateralization is typically documented by way of an ISDA Credit Support Annex (CSA), the terms of which may vary according to each party’s view of the other party’s creditworthiness. CSAs can require one party to post initial margin at the onset of each transaction. CSAs also allow for variation margin to be called if total uncollateralized mark-to-market exposure exceeds an agreed upon threshold. Such variation margin provisions can be one way (only one party will ever post collateral) or bi-lateral (either party may post collateral depending upon which party is in-the-money). The CSA will also detail the types of collateral that are acceptable to each party, and the adjustments that will be applied against each collateral type. The terms of the ISDA master netting agreements and CSAs are taken into consideration in the calculation of counterparty credit risk exposure (see also page 73 of the 2016 Annual Report). Derivatives instruments used by the Bank include credit derivatives in its investment and loan portfolios: credit protection is sold as an alternative to acquiring exposure to bond or loan assets, while credit protection is bought to manage or mitigate credit exposures. The following table summarizes the credit exposure of the Bank’s derivative financial instruments. The credit risk amount (CRA) represents the estimated replacement cost, or positive fair value, for all contracts taking into account master netting or collateral arrangements that have been made. The CRA does not reflect actual or expected losses. The credit equivalent amount (CEA) is the CRA plus an add-on for potential future exposure. The add-on amount is based on a formula prescribed in the Capital Adequacy Requirements (CAR) Guideline of the Superintendent. The risk-weighted balance is calculated by multiplying the CEA by the capital requirement (K) times 12.5, where K is a function of the probability of default (PD), loss given default (LGD), maturity and prescribed correlation factors. Other derivative contracts – other includes precious metals other than gold, and other commodities, including energy and base metal derivatives. C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S As at October 31 ($ millions) Notional amount (CRA)(1) (CEA)(1) Assets(2) Notional amount (CRA)(1) (CEA)(1) 2016 Credit risk amount Credit equivalent amount CET1 Risk Weighted 2015 Credit risk amount Credit equivalent amount Risk Weighted Assets(1) Interest rate contracts Futures Forward rate agreements Swaps Options purchased Options written Foreign exchange and gold contracts Futures Spot and forwards Swaps Options purchased Options written Other derivative contracts Equity Credit Commodity and other contracts Credit Valuation Adjustment(2) $ 112,196 $ – $ – $ – $ 140,240 $ – $ 3 $ – 309,907 2,294,534 50,831 40,147 2,807,615 35,862 449,290 353,462 16,616 16,245 871,475 87,908 49,058 78,753 215,719 9 2,703 6 – 2,718 – 2,057 2,596 322 – 4,975 871 32 1,109 2,012 100 7,331 107 1 7,539 38 5,420 5,919 532 127 12,036 5,308 2,032 6,493 13,833 17 2,125 52 – 2,194 16 1,326 1,585 129 19 3,075 1,677 340 645 2,662 857,029 2,815,412 61,404 61,655 3,935,740 6,626 451,630 338,328 5,633 4,884 807,101 62,549 63,933 149,806 276,288 250 2,222 – – 2,472 – 2,328 1,759 199 – 4,286 1,228 261 2,288 3,777 525 10,416 149 – 11,093 249 6,742 8,592 328 – 15,911 6,534 2,643 11,347 20,524 45 1,871 138 – 2,054 5 1,860 2,214 98 – 4,177 2,049 608 1,945 4,602 – – – 4,165 – – – 7,183 Total derivatives $ 3,894,809 $ 9,705 $ 33,408 $ 12,096 $ 5,019,129 $ 10,535 $ 47,528 $ 18,016 Amount settled through central counterparties(3) Exchange-traded Over-the-counter 228,538 2,109,672 $ 2,338,210 $ – – – 5,521 2,174 7,695 $ 110 43 153 $ 325,317 3,065,346 $ 3,390,663 $ – – – 8,172 6,331 $ 14,503 163 127 290 $ (1) The amounts presented are net of collateral and master netting agreements at the product level. The total amounts relating to netting and collateral were $31,952 (2015 – $30,467) for CRA, and $51,072 (2015 – $50,078) for CEA. (2) As per OSFI guideline, effective 2014, Credit Valuation Adjustment (CVA) to CET1 RWA for derivatives was phased-in at 0.57. In 2016, the CVA was 0.64 (2015 – 0.64). (3) Amounts are included under total derivatives above. Amounts include exposures settled directly through central counterparties and exposures settled through clearing members of central counterparties. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 163 CONSOLIDATED FINANCIAL STATEMENTS Fair value (d) The following table summarizes the fair value of derivatives segregated by type and segregated between trading and those derivatives designated in hedging relationships. As at October 31 ($ millions) 2016 2016 2015 Trading Interest rate contracts Forward rate agreements Swaps Options Foreign exchange and gold contracts Forwards Swaps Options Other derivative contracts Equity Credit Commodity and other contracts Trading derivatives’ market valuation Hedging Interest rate contracts Swaps Foreign exchange and gold contracts Forwards Swaps Other derivative contracts Equity Hedging derivatives’ market valuation Total derivative financial instruments as per Statement of Financial Position Less: impact of master netting and collateral(2) Net derivative financial instruments(2) Average fair value Year-end fair value Year-end fair value(1) Favourable Unfavourable Favourable Unfavourable Favourable Unfavourable $ 155 15,198 91 15,444 $ 3 14,566 92 14,661 $ 63 14,153 65 14,281 $ 3 13,814 82 13,899 $ 250 12,871 107 13,228 $ 3 12,770 104 12,877 6,163 10,985 248 17,396 2,248 674 2,861 5,783 $ 38,623 6,294 13,141 232 19,667 2,490 1,840 3,993 8,323 $ 42,651 5,939 11,506 410 17,855 1,905 148 2,212 4,265 $ 36,401 5,362 12,369 325 18,056 2,380 1,475 2,403 6,258 $ 38,213 5,358 10,694 227 16,279 2,276 841 3,507 6,624 $ 36,131 5,192 13,517 131 18,840 2,574 2,554 5,143 10,271 $ 41,988 $ 1,426 $ 587 $ 1,316 $ 679 333 3,471 3,804 26 5,256 $ $ $ 241 3,346 3,587 – 4,174 $ $ $ 301 3,223 3,524 32 4,872 $ $ $ 578 2,025 $ 2,603 $ – $ 3,282 $ 41,657 $ 42,387 $ 41,003 $ 45,270 31,952 9,705 $ 31,952 $ 10,435 30,468 $ 10,535 30,468 $ 14,802 (1) The average fair value of trading derivatives’ market valuation for the year ended October 31, 2015 was: favourable $38,950 and unfavourable $43,019. Average fair value amounts are based on the latest 13 month-end balances. (2) Master netting agreement amounts are based on the capital adequacy criteria of the Basel Committee on Banking Supervision (BCBS) and OSFI. These criteria allow netting where there are legally enforceable contracts which enable net settlement in the event of a default, bankruptcy, liquidation or similar circumstances. (e) Hedging activities The Bank’s hedging activities that qualify for hedge accounting consist of fair value hedges, cash flow hedges, and net investment hedges. Ineffectiveness of hedge relationships Due to the ineffective portion of designated hedges, the Bank recorded the following amounts in non-interest income – other: For the year ended October 31 ($ millions) Fair value hedges Gain (loss) recorded on hedged items Gain (loss) recorded on hedging instruments Ineffectiveness Cash flow hedges Ineffectiveness Hedging instruments Market valuation is disclosed by the type of relationship: 2016 2015 $ $ $ 11 (51) (40) 11 $ $ $ (220) 198 (22) (27) As at October 31 ($ millions) Derivatives designated in fair value hedging relationships(1) Derivatives designated in cash flow hedging relationships Derivatives designated in net investment hedging relationships(1) Total derivatives designated in hedging relationships 2016 2015 Favourable Unfavourable Favourable Unfavourable $ $ 1,622 3,568 66 5,256 $ $ 643 3,291 240 4,174 $ $ 1,557 3,205 110 4,872 $ $ 715 2,055 512 3,282 (1) As at October 31, 2016, the fair value of non-derivative instruments designated as net investment hedges and fair value hedges was $6,905 (2015 – $7,428). These non-derivative hedging instruments are presented as deposits – financial institutions on the Consolidated Statement of Financial Position. 164 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Cash flow hedges The period when cash flows of designated hedged items are expected to occur and impact the Consolidated Statement of Income are as follows: As at October 31, 2016 ($ millions) Cash inflows from assets Cash outflows from liabilities Net cash flows As at October 31, 2015 ($ millions) Cash inflows from assets Cash outflows from liabilities Net cash flows Within one year Within one to five years More than five years $ 12,672 (22,187) $ 26,838 (30,870) $ 8,998 (7,666) $ (9,515) $ (4,032) $ 1,332 Within one year Within one to five years More than five years $ 1,431 (14,803) $ (13,372) $ $ 9,543 (18,172) $ 3,801 (3,296) (8,629) $ 505 Income related to interest cash flows is recognized using the effective interest method over the life of the underlying instrument. Foreign currency gains and losses related to future cash flows of on-balance sheet monetary items are recognized as incurred. Forecasted revenue is recognized over the period to which it relates. 10 Offsetting Financial Assets and Financial Liabilities The Bank is eligible to present certain financial assets and financial liabilities as listed in the table below on a net basis on the Consolidated Statement of Financial Position pursuant to criteria described in Note 3 – Significant accounting policies. The following tables provide information on the impact of offsetting on the Bank’s Consolidated Statement of Financial Position, as well as the financial impact of netting for instruments that are subject to enforceable master netting arrangements or similar agreements, but do not qualify for offsetting in the Consolidated Statement of Financial Position, as well as available cash and financial instrument collateral. As at October 31, 2016 ($ millions) Gross amounts of recognized financial liabilities offset in the consolidated statement of financial position Net amounts of financial assets presented in the consolidated statement of financial position Gross amounts of recognized financial assets Related amounts not offset in the consolidated statement of financial position Impact of master netting arrangements or similar agreements(1) Collateral(2) Net amount(3) $ 63,329 $ (21,672) $ 41,657 $ (25,115) $ (7,184) $ 9,358 Types of financial assets Derivative financial instruments(4) Securities purchased under resale agreements and securities borrowed 98,909 (6,780) 92,129 (9,447) (75,365) 7,317 Total $ 162,238 $ (28,452) $ 133,786 $ (34,562) $ (82,549) $ 16,675 As at October 31, 2016 ($ millions) Types of financial liabilities Derivative financial instruments(4) Obligations related to securities sold under Gross amounts of recognized financial assets offset in the consolidated statement of financial position Net amounts of financial liabilities presented in the consolidated statement of financial position Gross amounts of recognized financial liabilities Related amounts not offset in the consolidated statement of financial position Impact of master netting arrangements or similar agreements(1) Collateral(2) Net amount $ 64,059 $ (21,672) $ 42,387 $ (25,115) $ (7,318) $ 9,954 repurchase agreements and securities lent 103,863 (6,780) 97,083 (9,447) (73,929) 13,707 Total $ 167,922 $ (28,452) $ 139,470 $ (34,562) $ (81,247) $ 23,661 (1) Amounts that are subject to master netting arrangements or similar agreements but were not offset in the Consolidated Statement of Financial Position because they did not meet the net settlement/simultaneous settlement criteria; or because the rights of set off are conditional upon the default of the counterparty only. (2) Cash and financial instrument collateral amounts received or pledged in relation to the total amounts of financial assets and financial liabilities, including those that were not offset in the Consolidated Statement of Financial Position. These amounts are disclosed at fair value and the rights of set off are conditional upon the default of the counterparty. (3) Not intended to represent the Bank’s actual exposure to credit risk, as a variety of credit mitigation strategies are employed in addition to offsetting and collateral arrangements. For fiscal 2016, the cash collateral received against the positive market values of derivative financial instruments of $1,398 and the cash collateral pledged towards the negative (4) mark to market of derivative financial instruments of $875 are recorded within other liabilities and other assets, respectively. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 165 CONSOLIDATED FINANCIAL STATEMENTS As at October 31, 2015 ($ millions) Types of financial assets Derivative financial instruments(4) Securities purchased under resale agreements Gross amounts of recognized financial liabilities offset in the consolidated statement of financial position Net amounts of financial assets presented in the consolidated statement of financial position Gross amounts of recognized financial assets Related amounts not offset in the consolidated statement of financial position Impact of master netting arrangements or similar agreements(1) Collateral(2) Net amount(3) $ 65,026 $ (24,023) $ 41,003 $ (22,357) $ (8,451) $ 10,195 and securities borrowed 95,757 (8,445) 87,312 (8,107) (74,308) 4,897 Total $ 160,783 $ (32,468) $ 128,315 $ (30,464) $ (82,759) $ 15,092 As at October 31, 2015 ($ millions) Types of financial liabilities Derivative financial instruments(4) Obligations related to securities sold under Gross amounts of recognized financial assets offset in the consolidated statement of financial position Net amounts of financial liabilities presented in the consolidated statement of financial position Gross amounts of recognized financial liabilities Related amounts not offset in the consolidated statement of financial position Impact of master netting arrangements or similar agreements(1) Collateral(2) Net amount $ 69,293 $ (24,023) $ 45,270 $ (22,357) $ (8,560) $ 14,353 repurchase agreements and securities lent 85,460 (8,445) 77,015 (8,107) (58,090) 10,818 Total $ 154,753 $ (32,468) $ 122,285 $ (30,464) $ (66,650) $ 25,171 (1) Amounts that are subject to master netting arrangements or similar agreements but were not offset in the Consolidated Statement of Financial Position because they did not meet the net settlement/simultaneous settlement criteria; or because the rights of set off are conditional upon the default of the counterparty only. (2) Cash and financial instrument collateral amounts received or pledged in relation to the total amounts of financial assets and financial liabilities, including those that were not offset in the Consolidated Statement of Financial Position. These amounts are disclosed at fair value and the rights of set off are conditional upon the default of the counterparty. (3) Not intended to represent the Bank’s actual exposure to credit risk, as a variety of credit mitigation strategies are employed in addition to offsetting and collateral arrangements. (4) For fiscal 2015, the cash collateral received against the positive market values of derivative financial instruments of $1,173 and the cash collateral pledged towards the negative mark to market of derivative financial instruments of $675 are recorded within other liabilities and other assets, respectively. 166 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 11 Investment Securities Investment securities includes held-to-maturity securities and available-for-sale securities. (a) An analysis of the carrying value of investment securities is as follows: As at October 31, 2016 ($ millions) Available-for-sale Canadian federal government issued or guaranteed debt Yield(1) % Canadian provincial and municipal debt Yield(1) % U.S. treasury and other U.S. agency debt Yield(1) % Other foreign government debt Yield(1) % Other debt Yield(1) % Preferred shares Common shares Total available-for-sale securities Held-to-maturity Canadian federal and provincial government issued or guaranteed debt U.S. treasury and other U.S. agency debt Other foreign government debt Corporate debt Total held-to-maturity securities Remaining term to maturity Within three months Three to twelve months One to five years Five to ten years Over ten years No specific maturity Carrying value $ 51 0.8 – 0.0 481 0.3 4,645 1.7 846 1.7 – – 6,023 123 – – 523 646 $ 53 1.0 252 1.0 2,134 0.6 3,620 3.0 1,145 0.1 – – 7,204 432 335 344 1,578 2,689 $ 11,507 1.0 2,869 1.4 5,823 1.0 5,602 3.2 3,454 1.4 – – 29,255 5,335 4,281 2,547 6,617 18,780 $ 857 2.5 352 2.1 1,296 0.9 1,424 4.4 81 3.0 – – 4,010 281 – 7 7 295 $ 1,153 3.0 19 2.9 343 1.2 240 5.2 179 2.5 – – 1,934 – – – – – $ – – – – – – – – – – 264 1,819 2,083 – – – – – $ 13,621 1.3 3,492 1.5 10,077 0.9 15,531 2.9 5,705 1.2 264 1,819 50,509 6,171 4,616 2,898 8,725 22,410 Total investment securities $ 6,669 $ 9,893 $ 48,035 $ 4,305 $ 1,934 $ 2,083 $ 72,919 Total by currency (in Canadian equivalent): Canadian dollar U.S. dollar Mexican peso Other currencies $ 8 1,485 878 4,298 $ 430 5,146 264 4,053 $ 16,588 26,959 1,496 2,992 $ 1,239 2,086 247 733 $ 1,192 514 77 151 $ 721 930 12 420 $ 20,178 37,120 2,974 12,647 Total investment securities $ 6,669 $ 9,893 $ 48,035 $ 4,305 $ 1,934 $ 2,083 $ 72,919 (1) Represents the weighted-average yield of fixed income securities. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 167 CONSOLIDATED FINANCIAL STATEMENTS As at October 31, 2015 ($ millions) Available-for-sale Canadian federal government issued or guaranteed debt Yield(1) % Canadian provincial and municipal debt Yield(1) % U.S. treasury and other U.S. agency debt Yield(1) % Other foreign government debt Yield(1) % Other debt Yield(1) % Preferred shares Common shares Total available-for-sale securities Held-to-maturity Canadian federal and provincial government issued or guaranteed debt U.S. treasury and other U.S. agency debt Other foreign government debt Corporate debt Total held-to-maturity securities Total investment securities Total by currency (in Canadian equivalent): Canadian dollar U.S. dollar Mexican peso Other currencies Total investment securities Remaining term to maturity Within three months Three to twelve months One to five years Five to ten years Over ten years No specific maturity Carrying value $ 2 0.6 12 0.1 373 0.2 2,274 2.4 846 1.2 – – 3,507 – – – – – $ 199 1.0 1,034 1.3 1,118 0.3 4,838 2.0 947 0.7 – – 8,136 – – 69 – 69 $ 5,105 1.3 2,482 1.3 8,197 1.1 4,323 3.3 3,503 1.5 – – 23,610 74 131 107 262 574 $ 1,279 2.2 166 2.3 140 1.6 1,053 4.3 67 1.7 – – 2,705 – – 8 – 8 $ 1,164 3.1 12 2.9 – – 195 5.4 214 2.3 – – 1,585 – – – – – $ – – – – – – – – – – 255 2,767 3,022 $ 7,749 1.7 3,706 1.3 9,828 1.0 12,683 2.8 5,577 1.4 255 2,767 42,565 – – – – – 74 131 184 262 651 $ 3,507 $ 8,205 $ 24,184 $ 2,713 $ 1,585 $ 3,022 $ 43,216 $ 5 674 161 2,667 $ 761 2,033 997 4,414 $ 5,899 13,796 1,259 3,230 $ 3,507 $ 8,205 $ 24,184 $ 1,359 498 120 736 $ 2,713 $ 1,207 193 83 102 $ 1,585 $ 956 1,536 40 490 $ 3,022 $ 10,187 18,730 2,660 11,639 $ 43,216 (1) Represents the weighted-average yield of fixed income securities. (b) An analysis of unrealized gains and losses on available-for-sale securities is as follows: As at October 31, 2016 ($ millions) Canadian federal government issued or guaranteed debt Canadian provincial and municipal debt U.S. treasury and other U.S. agency debt Other foreign government debt Other debt Preferred shares Common shares Total available-for-sale securities As at October 31, 2015 ($ millions) Canadian federal government issued or guaranteed debt Canadian provincial and municipal debt U.S. treasury and other U.S. agency debt Other foreign government debt Other debt Preferred shares Common shares Total available-for-sale securities 168 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Cost $ 13,347 3,469 10,050 15,490 5,650 414 1,634 $ 50,054 $ Cost 7,558 3,685 9,806 12,701 5,531 413 2,104 Gross unrealized gains Gross unrealized losses $ $ 280 33 53 62 59 10 243 740 Gross unrealized gains $ 202 25 29 32 58 6 706 $ 6 10 26 21 4 160 58 $ 285 Gross unrealized losses $ 11 4 7 50 12 164 43 Fair value $ 13,621 3,492 10,077 15,531 5,705 264 1,819 $ 50,509 $ Fair value 7,749 3,706 9,828 12,683 5,577 255 2,767 $ 41,798 $ 1,058 $ 291 $ 42,565 The net unrealized gain on available-for-sale securities of $455 million (2015 – gain of $767 million) decreases to a net unrealized gain of $26 million (2015 – gain of $267 million) after the impact of qualifying hedges is taken into account. The net unrealized gain on available-for-sale securities is recorded in Accumulated Other Comprehensive Income. (c) An analysis of the fair value and carrying value of held-to-maturity securities is as follows: As at October 31 ($ millions) Canadian federal and provincial government issued or guaranteed debt U.S. treasury and other U.S. agency debt Other foreign government debt Corporate debt Total held-to-maturity securities (d) An analysis of available-for-sale securities with continuous unrealized losses: Fair value Carrying value $ 2016 6,207 4,672 2,901 8,787 $ 2015 74 131 189 322 $ 22,567 $ 716 2016 $ 6,171 4,616 2,898 8,725 $22,410 $ 2015 74 131 184 262 $ 651 C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S As at October 31, 2016 ($ millions) Canadian federal government issued or guaranteed debt $ Canadian provincial and municipal debt U.S. treasury and other U.S. agency debt Other foreign government debt Other debt Preferred shares Common shares Less than twelve months Twelve months or greater Total Cost Fair value Unrealized losses Cost Fair value Unrealized losses Cost Fair value Unrealized losses $ 1,867 $ 807 2,238 2,812 877 6 303 1,861 798 2,212 2,799 875 6 280 6 9 26 13 2 – 23 79 $ 1,104 $ 1,104 192 – 567 407 222 105 193 – 575 409 382 140 $ – 1 – 8 2 160 35 $ 2,971 $ 1,000 2,238 3,387 1,286 388 443 2,965 990 2,212 3,366 1,282 228 385 $ 6 10 26 21 4 160 58 $ 2,803 $ 2,597 $ 206 $ 11,713 $ 11,428 $ 285 Total available-for-sale securities $ 8,910 $ 8,831 $ As at October 31, 2015 ($ millions) Canadian federal government issued or guaranteed debt Canadian provincial and municipal debt U.S. treasury and other U.S. agency debt Other foreign government debt Other debt Preferred shares Common shares Total available-for-sale securities Less than twelve months Twelve months or greater Total Cost Fair value Unrealized losses Cost Fair value Unrealized losses Cost Fair value Unrealized losses $ 2,362 $ 1,302 977 3,532 1,625 1 419 2,351 1,298 973 3,499 1,617 1 379 $ 10,218 $ 10,118 $ 11 4 4 33 8 – 40 $ 100 $ – $ – 10 1,140 132 383 39 – – 7 1,123 128 219 36 $ 1,704 $ 1,513 $ – – 3 17 4 164 3 $ 191 $ 2,362 $ 1,302 987 4,672 1,757 384 458 2,351 1,298 980 4,622 1,745 220 415 $ 11,922 $ 11,631 $ 11 4 7 50 12 164 43 $ 291 As at October 31, 2016, the cost of 474 (2015 – 610) available-for-sale securities exceeded their fair value by $285 million (2015 – $291 million). This unrealized loss is recorded in accumulated other comprehensive income as part of unrealized gains (losses) on available-for-sale securities. Of the 474 (2015 – 610) available-for-sale securities, 140 (2015 – 110) have been in an unrealized loss position continuously for more than a year, amounting to an unrealized loss of $206 million (2014 – $191 million). Investment securities are considered to be impaired only if objective evidence indicates one or more loss events have occurred and have affected the estimated future cash flows after considering available collateral. Collateral is not generally obtained directly from the issuers of debt securities. However, certain debt securities may be collateralized by specifically identified assets that would be obtainable in the event of default. Investment securities are evaluated for impairment at the end of each reporting date, or more frequently, if events or changes in circumstances indicate the existence of objective evidence of impairment. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 169 CONSOLIDATED FINANCIAL STATEMENTS (e) Net gain on sale of investment securities An analysis of net gain on sale of investment securities is as follows: For the year ended October 31 ($ millions) Net realized gains or losses Impairment losses(1) Net gain on sale of investment securities 2016 2015 2014 $ 570 36 $ 534 $ 646 7 $ 639 $ 755 14 $ 741 (1) Impairment losses (gains) are comprised of $36 from equity securities (2015 – $8; 2014 – $14) and nil from other debt securities (2015 – $(1); 2014 – nil). 12 Loans, Impaired Loans and Allowance for Credit Losses (a) Loans and acceptances outstanding by geography(1) As at October 31 ($ millions) Canada: Residential mortgages Personal and credit cards Business and government United States: Personal and credit cards Business and government Mexico: Residential mortgages Personal and credit cards Business and government Chile: Residential mortgages Personal and credit cards Business and government Peru: Residential mortgages Personal and credit cards Business and government Colombia: Residential mortgages Personal and credit cards Business and government Other International: Residential mortgages Personal and credit cards Business and government Total loans Acceptances(2) Total loans and acceptances(3) Allowance for credit losses Total loans and acceptances net of allowances for loan losses 2016 2015 $ 193,303 74,698 48,653 $ 190,123 70,263 44,808 316,654 305,194 1,844 36,613 38,457 6,346 3,079 11,384 20,809 6,300 4,632 8,466 19,398 2,586 4,573 10,661 17,820 1,497 3,850 3,948 9,295 12,856 6,826 42,675 62,357 484,790 11,978 496,768 1,558 28,593 30,151 6,043 3,076 9,473 18,592 5,068 3,681 7,710 16,459 2,367 4,317 10,287 16,971 1,286 2,956 4,441 8,683 12,611 5,626 48,538 66,775 462,825 10,296 473,121 (4,626) (4,197) $ 492,142 $ 468,924 (1) Geographic segmentation is based on the location of the property for residential mortgages; otherwise, the residence of the borrower. (2) 1% of borrowers reside outside Canada. (3) Loans and acceptances denominated in U.S. dollars were $103,503 (2015 – $95,581), in Mexican pesos $15,954 (2015 – $14,054), Chilean pesos $15,214 (2015 – $12,566), and in other foreign currencies $44,870 (2015 – $42,570). 170 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T (b) Loan maturities As at October 31, 2016 ($ millions) Residential mortgages Personal and credit cards Business and government Remaining term to maturity Rate sensitivity Within one year One to five years Five to ten years Over ten years No specific maturity Total Floating Fixed rate Non-rate sensitive Total $ 41,127 $ 160,713 $ 9,745 $ 9,520 $ 1,783 $ 222,888 $ 55,543 $ 165,189 $ 2,156 $ 222,888 99,502 162,400 99,502 162,400 40,163 111,384 48,391 5,616 31,191 79,960 14,107 70,051 58,439 48,183 4,820 6,278 900 2,833 993 495 Total $ 125,285 $ 271,864 $ 20,843 $ 11,008 $ 55,790 $ 484,790 $ 207,090 $ 271,811 $ 5,889 $ 484,790 Allowance for credit losses – – – – (4,626) (4,626) – – (4,626) (4,626) Total loans net of allowance for credit losses $ 125,285 $ 271,864 $ 20,843 $ 11,008 $ 51,164 $ 480,164 $ 207,090 $ 271,811 $ 1,263 $ 480,164 As at October 31, 2015 Remaining term to maturity Rate sensitivity C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S ($ millions) Residential mortgages Personal and credit cards Business and government Total loans Allowance for credit losses Total loans net of allowance Within one year One to five years Five to ten years Over ten years No specific maturity Total Floating Fixed rate Non-rate sensitive Total $ 43,659 $ 151,685 $ 9,438 $ 10,928 $ 1,788 $ 217,498 $ 61,553 $ 153,896 $ 2,049 $ 217,498 91,477 153,850 91,477 153,850 39,137 100,492 44,177 4,889 11,872 70,079 29,709 72,195 51,465 50,803 4,595 6,186 1,124 501 875 2,555 $ 125,610 $ 253,589 $ 20,219 $ 12,553 $ 50,854 $ 462,825 $ 201,182 $ 256,164 $ 5,479 $ 462,825 (4,197) (4,197) (4,197) (4,197) – – – – – – for credit losses $ 125,610 $ 253,589 $ 20,219 $ 12,553 $ 46,657 $ 458,628 $ 201,182 $ 256,164 $ 1,282 $ 458,628 (c) Impaired loans(1)(2) As at October 31 ($ millions) Residential mortgages Personal and credit cards Business and government Total By geography: Canada United States Mexico Peru Chile Colombia Other International Total Gross impaired loans(1) $ 1,608 1,622 2,164 $ 5,394 2016 Allowance for credit losses $ 458(3) 1,596(3) 894(4) $ 2,948 Net $ 1,150 26 1,270 $ 2,446 $ 435 163 86 263 262 142 1,095 $ 2,446 Gross impaired loans(1) $ 1,668 1,332 1,658 $ 4,658 2015 Allowance for credit losses $ 529(3) 1,327(3) 717(4) $ 2,573 Net $ 1,139 5 941 $ 2,085 $ 450 5 85 181 230 121 1,013 $ 2,085 Interest income recognized on impaired loans during the year ended October 31, 2016 was $18 (2015 – $13). (1) (2) Excludes loans acquired under FDIC guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. For loans where the guarantee has expired, the total amount of loans considered impaired is $94 (2015 – $150). (3) Allowance for credit losses for residential mortgages and personal and credit card loans is assessed on a collective basis. (4) Allowance for credit losses for business and government loans is individually assessed. For the years ended October 31, 2016 and 2015, the Bank would have recorded additional interest income of $367 million and $337 million, respectively, on impaired loans, if these impaired loans were classified as performing loans. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 171 CONSOLIDATED FINANCIAL STATEMENTS (d) Allowance for credit losses ($ millions) Individual Collective Total before loans acquired under FDIC guarantee Loans acquired under FDIC guarantee(2) ($ millions) Individual Collective Total before loans acquired under FDIC guarantee Loans acquired under FDIC guarantee(2) As at October 31, 2016 Balance at beginning of year $ 717 3,260 3,977 220 Write-offs(1) Recoveries $ (428) (2,151) (2,579) (9) $ 40 542 582 18 $ Provision for credit losses 585 1,827 2,412 – Other, including foreign currency adjustment $ (20) 20 – 5 5 $ 4,197 $ (2,588) $ 600 $ 2,412 $ As at October 31, 2015 Balance at beginning of year $ 614 2,856 3,470 171 Write-offs(1) Recoveries $ (320) (1,908) (2,228) (2) $ 52 377 429 56 Provision for credit losses $ 255 1,721 1,976 (34) Other, including foreign currency adjustment(3) $ 116 214 330 29 Balance at end of year $ 894 3,498 4,392 234 $ 4,626 Balance at end of year $ 717 3,260 3,977 220 $ 3,641 $ (2,230) $ 485 $ 1,942 $ 359 $ 4,197 Represented by: Allowance against impaired loans Allowance against performing loans and loans past due but not impaired(4) Total before loans acquired under FDIC guarantee Loans acquired under FDIC guarantee(2) 2016 2015 $ 2,948 1,444 4,392 234 $ 2,573 1,404 3,977 220 $ 4,626 $ 4,197 (1) For the wholesale portfolios, impaired loans restructured during the year amounted to $111 (2015 – $81). Write-offs of impaired loans restructured during the year were nil (2015 – nil). Non-impaired loans restructured during the year amounted to $55 (2015 – $93). (2) This represents the gross amount of allowance for credit losses as the receivable from FDIC is separately recorded in other assets. (3) Includes rebalancing of reserves between off-balance sheet and on-balance sheet credit exposures; and retrospective adjustments primarily relating to foreign currency translation of prior years. (4) The allowance for performing loans is attributable to business and government loans $662 (2015 –$644) with the remainder allocated to personal and credit card loans $662 (2015 – $614) and residential mortgages $120 (2015 – $146). (e) Loans acquired under FDIC guarantee As at October 31, 2016 ($ millions) R-G Premier Bank Unpaid principal balance Fair value adjustments Net carrying value Allowance for credit losses As at October 31, 2015 ($ millions) R-G Premier Bank Unpaid principal balance Fair value adjustments Net carrying value Allowance for credit losses Non-single family home loans Single family home loans $ 353 135 488 (157) $ 1,939 (211) 1,728 (77) Total $ 2,292 (76) 2,216 (234) $ 331 $ 1,651 $ 1,982 Non-single family home loans Single family home loans $ 417 136 553 (160) $ 2,136 (291) 1,845 (60) Total $ 2,553 (155) 2,398 (220) $ 393 $ 1,785 $ 2,178 Loans purchased as part of the acquisition of R-G Premier Bank of Puerto Rico are subject to loss share agreements with the FDIC. Under this agreement, the FDIC guarantees 80% of loan losses. The provision for credit losses in the Consolidated Statement of Income related to these loans is reflected net of the amount expected to be reimbursed by the FDIC. Allowance for credit losses in the Consolidated Statement of Financial Position is reflected on a gross basis. The FDIC guarantee on non-single family loans expired in 2015. The guarantee for single family home loans will expire in April 2020. As at October 31, 2016, the carrying value of loans acquired under the FDIC guarantee was $2.0 billion (2015 – $2.2 billion) and the carrying value of loans for which claims for losses under the guarantee expired during the year was $331 million. A net receivable of $116 million (2015 – $218 million) from the FDIC is included in Other assets in the Consolidated Statement of Financial Position. 172 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Loans past due but not impaired(1) (f) A loan is considered past due when a counterparty has not made a payment by the contractual due date. The following table presents the carrying value of loans that are contractually past due but not classified as impaired because they are either less than 90 days past due or fully secured and collection efforts are reasonably expected to result in repayment, or restoring it to a current status in accordance with the Bank’s policy. As at October 31 ($ millions) Residential mortgages Personal and credit cards Business and government Total 2016(2)(3) 2015(2)(3) 31 – 60 days $ 1,194 784 186 $ 2,164 61 – 90 days $ 472 447 44 $ 963 91 days and greater $ 123 94 189 $ 406 Total $ 1,789 1,325 419 $ 3,533 31 – 60 days $ 1,256 677 172 $ 2,105 61 – 90 days $ 453 360 73 $ 886 91 days and greater $ 127 56 338 $ 521 Total $ 1,836 1,093 583 $ 3,512 Loans past due 30 days or less are not presented in this analysis as they are not administratively considered past due. (1) (2) Excludes loans acquired under the FDIC guarantee related to the acquisition of R-G Premier Bank of Puerto Rico. (3) These loans would be considered in the determination of an appropriate level of collective allowances despite not being individually classified as impaired. C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 13 Derecognition of Financial Assets Securitization of residential mortgage loans The Bank securitizes fully insured residential mortgage loans, Bank originated and others, through the creation of mortgage backed securities (MBS) under the National Housing Act (NHA) MBS program, sponsored by Canada Mortgage Housing Corporation (CMHC). MBS created under the program are sold to Canada Housing Trust (the Trust), a government sponsored entity, under the Canada Mortgage Bond (CMB) program and/or third-party investors. The Trust issues securities to third-party investors. The sale of mortgages under the above programs does not meet the derecognition requirements, as the Bank retains the pre-payment and interest rate risk associated with the mortgages, which represents substantially all the risk and rewards associated with the transferred assets. The transferred mortgages continue to be recognized on the Consolidated Statement of Financial Position as residential mortgage loans. Cash proceeds from the transfer are treated as secured borrowings and included in Deposits – Business and government on the Consolidated Statement of Financial Position. The following table provides the carrying amount of transferred assets that do not qualify for derecognition and the associated liabilities: As at October 31 ($ millions) Assets Carrying value of residential mortgage loans Other related assets(2) Liabilities Carrying value of associated liabilities 2016(1) 2015(1) $ 17,570 3,102 $ 18,313 3,296 19,836 20,816 (1) The fair value of the transferred assets is $20,776 (2015 – $21,728) and the fair value of the associated liabilities is $20,493 (2015 – $21,416), for a net position of $283 (2015 – $312). (2) These include cash held in trust and trust permitted investment assets acquired as part of principal reinvestment account that the Bank is required to maintain in order to participate in the programs. Securitization of personal lines of credit, credit cards and auto loans The Bank securitizes a portion of its unsecured personal lines of credit, credit card and auto loan receivables through consolidated structured entities. These receivables continue to be recognized on the Consolidated Statement of Financial Position as personal and credit cards loans. For further details, refer to Note 14. Securities sold under repurchase agreements and securities lent The Bank enters into transactions, such as repurchase agreements and securities lending agreements, where the Bank transfers assets under agreements to repurchase them on a future date and retains all the substantial risks and rewards associated with the assets. The transferred assets remain on the Consolidated Statement of Financial Position. The following table provides the carrying amount of the transferred assets and the associated liabilities: As at October 31 ($ millions) Carrying value of assets associated with: Repurchase agreements(2) Securities lending agreements Total Carrying value of associated liabilities(3) 2016(1) 2015(1) $ 87,402 38,668 126,070 $ 67,052 41,190 108,242 $ 97,033 $ 77,015 (1) The fair value of transferred assets is $126,070 (2015 – $108,242) and the fair value of the associated liabilities is $97,033 (2015 – $77,015), for a net position of $29,037 (2015 – $31,227). (2) Does not include over-collateralization of assets pledged. (3) Liabilities for securities lending arrangements only include amounts related to cash collateral received. In most cases, securities are received as collateral. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 173 CONSOLIDATED FINANCIAL STATEMENTS 14 Structured Entities (a) Consolidated structured entities U.S. multi-seller conduit The Bank-sponsored U.S. multi-seller conduit purchases high-quality financial assets from independent third parties (the sellers) funded by the issuance of highly rated asset-backed commercial paper. The sellers continue to service the financial assets and provide credit enhancements through overcollateralization protection and cash reserves. Each asset purchased by the conduit has a deal-specific liquidity facility provided by the Bank in the form of a liquidity asset purchase agreement (LAPA). The primary purpose of the backstop liquidity facility is to provide an alternative source of financing in the event the conduit is unable to access the asset-backed commercial paper market. The administration agent can require the Bank in its capacity as liquidity provider to perform under its asset-specific LAPA agreements, in which case the Bank is obliged to purchase an interest in the related assets owned by the conduit. The Bank is not obligated to perform under the LAPA agreements in the event the conduit itself is insolvent. The Bank’s liquidity agreements with the conduit call for the Bank to fund full par value of the assets, including defaulted assets, if any, of the conduit. This facility is available to absorb the losses on defaulted assets, if any, in excess of losses absorbed by deal-specific seller credit enhancements. Further, the Bank holds the subordinated note issued by the conduit. The Bank’s exposure from the U.S. conduit through the LAPA, including the obligation to purchase defaulted assets and investment in the conduit’s subordinated note, gives the Bank the obligation to absorb losses that could potentially be significant to the conduit, which in conjunction with power to direct the conduit’s activities, result in the Bank consolidating the U.S. multi-seller conduit. The conduit’s assets are primarily included in business and government loans on the Bank’s Consolidated Statement of Financial Position. There are contractual restrictions on the ability of the Bank’s consolidated U.S. multi-seller conduit to transfer funds to the Bank. The Bank is restricted from accessing the conduit’s assets under the relevant arrangements. The Bank has no rights to the assets owned by the conduit. In the normal course of business, the assets of the conduit can only be used to settle the obligations of the conduit. Bank funding vehicles The Bank uses funding vehicles to facilitate cost-efficient financing of its own operations, including the issuance of covered bonds and notes. These vehicles include Scotia Covered Bond Trust, Scotiabank Covered Bond Guarantor Limited Partnership, Hollis Receivables Term Trust II, Trillium Credit Card Trust II and Securitized Term Auto Receivables Trust 2016-1. Activities of these structured entities are generally limited to holding an interest in a pool of assets or receivables generated by the Bank. These structured entities are consolidated due to the Bank’s decision-making power and ability to use the power to affect the Bank’s returns. Covered bond programs Scotia Covered Bond Trust Under the Bank’s global covered bond program, the Bank issues debt to investors that is guaranteed by Scotia Covered Bond Trust (the “Trust”). Under the program, the Trust purchases CMHC insured residential mortgages from the Bank, which it acquires with funding provided by the Bank. As at October 31, 2016, $6.0 billion (2015 – $8.5 billion) covered bonds were outstanding and included in Deposits – Business and government on the Consolidated Statement of Financial Position. The Bank’s outstanding covered bonds issued under this program are denominated in U.S. dollars. As at October 31, 2016, assets pledged in relation to these covered bonds were insured residential mortgages denominated in Canadian dollars of $4.8 billion (2015 – $6.8 billion). Scotiabank Covered Bond Guarantor Limited Partnership The Bank has a registered covered bond program through which it issues debt that is guaranteed by Scotiabank Covered Bond Guarantor Limited Partnership (the “LP”). Under this program, the LP purchases uninsured residential mortgages from the Bank, which it acquires with funding provided by the Bank. As at October 31, 2016, $23.9 billion (2015 – $13.7 billion) covered bonds were outstanding and included in Deposits – Business and government on the Consolidated Statement of Financial Position. The Bank’s outstanding covered bonds are denominated in U.S. dollars, Australian dollars, British pounds and Euros. As at October 31, 2016, assets pledged in relation to these covered bonds were uninsured residential mortgages denominated in Canadian dollars of $25.7 billion (2015 – $14.5 billion). Personal line of credit securitization trust The Bank securitizes a portion of its unsecured personal line of credit receivables (receivables) through Hollis Receivables Term Trust II (Hollis), a Bank-sponsored structured entity. Hollis issues notes to third-party investors and the Bank, proceeds of which are used to purchase co-ownership interests in receivables originated by the Bank. Recourse of the note holders is limited to the purchased interests. The Bank is responsible for servicing the transferred receivables as well as performing administrative functions for Hollis. The subordinated notes issued by Hollis are held by the Bank. As at October 31, 2016, $1.5 billion notes (2015 – $2.0 billion) were outstanding and included in Deposits – Business and government on the Consolidated Statement of Financial Position. As at October 31, 2016, assets pledged in relation to these notes were $1.8 billion (2015 – $2.5 billion). Credit card receivables securitization trust The Bank securitizes a portion of its credit card receivables (receivables) through Trillium Credit Card Trust II (Trillium), a Bank-sponsored structured entity. Trillium issues notes to third-party investors and the Bank, and the proceeds of such issuance are used to purchase co-ownership interests in receivables originated by the Bank. Recourse of the note holders is limited to the purchased interest. 174 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T The Bank is responsible for servicing the transferred receivables as well as performing administrative functions for Trillium. The subordinated notes issued by Trillium are held by the Bank. As at October 31, 2016, $1.2 billion Class A notes, denominated in U.S. dollars, were outstanding and included in Deposits – Business and government on the Consolidated Statement of Financial Position. As at October 31, 2016 assets pledged in relation to these notes were credit card receivables, denominated in Canadian dollars, of $1.3 billion. Auto loan receivables securitization trust The Bank securitizes a portion of its Canadian auto loan receivables (receivables) through Securitized Term Auto Receivables Trust 2016-1 (START), a Bank-sponsored structured entity. START issues multiple series of Class A notes to third-party investors and subordinated notes to the Bank, and the proceeds of such issuances are used to purchase a discrete pool of retail indirect auto loan receivables from the Bank on a fully serviced basis. Recourse of the note holders is limited to the receivables. The Bank is responsible for servicing the transferred receivables as well as performing administrative functions for START. The subordinated notes issued by START are held by the Bank. As at October 31, 2016, $0.7 billion Class A notes were outstanding and included in Deposits – Business and government on the Consolidated Statement of Financial Position. START’s outstanding Class A notes are denominated in U.S. dollars. As at October 31, 2016, assets pledged in relation to these notes were auto loan receivables denominated in Canadian dollars of $0.7 billion. Other Assets of other consolidated structured entities are comprised of securities, deposits with banks and other assets to meet the Bank’s and customer needs. C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (b) Unconsolidated structured entities The following table provides information about other structured entities in which the Bank has a significant interest but does not control and therefore does not consolidate. A significant interest is generally considered to exist where the Bank is exposed to 10% or more of the unconsolidated structured entities maximum exposure to loss. ($ millions) As at October 31, 2016 Canadian multi-seller conduits that the Bank administers Structured finance entities Capital funding vehicles Other Total Total assets (on structured entity’s financial statements) $ 4,401 $ 7,653 $ 1,520 $ 68 $ 13,642 Assets recognized on the Bank’s financial statements Trading assets Investment securities Loans(1) Liabilities recognized on the Bank’s financial statements Deposits – Business and government Derivative financial instruments Bank’s maximum exposure to loss ($ millions) Total assets (on structured entity’s financial statements) Assets recognized on the Bank’s financial statements Trading assets Investment securities Loans(1) Liabilities recognized on the Bank’s financial statements Deposits – Business and government 2 – – 2 – 2 2 467 1,147 712 2,326 – – – – 15 47 62 1,400 – 1,400 – 20 – 20 – – – 469 1,182 759 2,410 1,400 2 1,402 4,401 $ 2,326 $ 62 $ 20 $ 6,809 As at October 31, 2015 Canadian multi-seller conduits that the Bank administers Structured finance entities Capital funding vehicles Other Total 2,491 $ 7,813 $ 1,520 $ 950 $ 12,774 $ $ 3 – – 3 – – 470 1,144 716 2,330 – 15 47 62 – – 1,488 1,488 57 86 35 178 – – 530 1,245 798 2,573 1,488 1,488 Bank’s maximum exposure to loss $ 2,491 $ 2,330 $ 62 $ 178 $ 5,061 (1) Loan balances are presented net of allowance for credit losses. The Bank’s maximum exposure to loss represents the notional amounts of guarantees, liquidity facilities, and other credit support relationships with the structured entities, the credit risk amount for certain derivative contracts with the entities and the amount invested where the Bank holds an ownership interest in the structured entities. Of the aggregate amount of maximum exposure to loss as at October 31, 2016, the Bank has recorded $2.4 billion (2015 – $2.6 billion), primarily its interest in the structured entities, on its Consolidated Statement of Financial Position. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 175 CONSOLIDATED FINANCIAL STATEMENTS Canadian multi-seller conduits that the Bank administers The Bank sponsors two Canadian multi-seller conduits. The conduits purchase assets from independent third parties (the sellers) funded by the issuance of asset-backed commercial paper. The sellers continue to service the assets and provide credit enhancements through overcollateralization protection and cash reserves. The Bank has no rights to these assets as they are available to support the obligations of the respective programs, but manages for a fee the commercial paper selling programs. To ensure timely repayment of the commercial paper, each asset pool financed by the multi-seller conduits has a deal-specific liquidity asset purchase agreement (LAPA) with the Bank. Pursuant to the terms of the LAPA, the Bank as the liquidity provider is obligated to purchase non-defaulted assets, transferred by the conduit at the conduit’s original cost as reflected in the table above. In most cases, the liquidity agreements do not require the Bank to purchase defaulted assets. Additionally, the Bank has not provided any program- wide credit enhancement to these conduits. The Bank provides additional liquidity facilities to these multi-seller conduits to a maximum amount of $1.4 billion (2015 – $1.4 billion) based on future asset purchases by these conduits. Although the Bank has power over the relevant activities of the conduits, it has limited exposure to variability in returns, which results in the Bank not consolidating the two Canadian conduits. Structured finance entities The Bank has interests in structured entities used to assist corporate clients in accessing cost-efficient financing through their securitization structures. The Bank may act as an administrator, an investor or a combination of both in these types of structures. Capital funding vehicles These entities are designed to pass the Bank’s credit risk to the holders of the securities. Therefore the Bank does not have exposure or rights to variable returns from these entities. Other Other includes investments in managed funds, collateralized debt obligation entities, and other structured entities. The Bank’s maximum exposure to loss is limited to its net investment in these funds. (c) Other unconsolidated Bank-sponsored entities The Bank sponsors unconsolidated structured entities in which it has insignificant or no interest at the reporting date. The Bank is a sponsor when it is significantly involved in the design and formation at inception of the structured entities, and the Bank’s name is used by the structured entities to create an awareness of the instruments being backed by the Bank’s reputation and obligation. The Bank also considers other factors, such as its continuing involvement and obligations to determine if, in substance, the Bank is a sponsor. The Bank considers mutual funds and managed companies as sponsored entities. The following table provides information on revenue from unconsolidated Bank-sponsored entities. As at October 31 ($ millions) Revenue (1) Includes mutual funds, other funds and trusts. 2016 Scotia Managed Companies Funds(1) 2015 Scotia Managed Companies Total Total Funds(1) $ 1,960 $ 8 $ 1,968 $ 1,964 $ 13 $ 1,977 The Bank earned revenue of $1,968 million (2015 – $1,977 million) from its involvement with the unconsolidated Bank-sponsored structured entities for the year ended October 31, 2016, which was comprised of interest income of $2 million (2015 – $3 million), non-interest income – banking of $134 million (2015 – $133 million) and non-interest income – wealth management of $1,832 million (2015 – $1,841 million), including mutual fund, brokerage and investment management and trust fees. 176 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 15 Property and Equipment ($ millions) Cost Balance as at October 31, 2014 Additions Disposals Foreign currency adjustments and other Balance as at October 31, 2015 Acquisitions Additions Disposals Foreign currency adjustments and other Balance as at October 31, 2016 Accumulated depreciation Balance as at October 31, 2014 Depreciation Disposals Foreign currency adjustments and other Balance as at October 31, 2015 Depreciation Disposals Foreign currency adjustments and other Balance as at October 31, 2016 Net book value Balance as at October 31, 2015 Balance as at October 31, 2016 C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Land Buildings Equipment Leasehold improvements Total $ 266 19 (11) 60 $ 1,687 135 (243) 70 $ 3,378 262 (118) 17 $ 1,224 100 (57) 38 $ 6,555 516 (429) 185 $ 334 $ 1,649 $ 3,539 $ 1,305 $ 6,827 39 17 (42) (19) 117 239 (244) (19) 60 223 (102) (9) 26 98 (61) (11) 242 577 (449) (58) $ 329 $ 1,742 $ 3,711 $ 1,357 $ 7,139 $ $ $ – – – – – – – – – $ $ 715 47 (17) 9 754 99 (69) (18) $ 2,815 178 (46) 31 $ 2,978 170 (121) (12) $ $ 753 78 (27) 5 809 56 (18) (9) $ 4,283 303 (90) 45 $ 4,541 325 (208) (39) $ 766 $ 3,015 $ 838 $ 4,619 $ 334 $ 329 $ $ 895 976 $ $ 561 696 $ $ 496 519 $ 2,286(1) $ 2,520(1) (1) Includes $20 (2015 – $27) of investment property. 16 Investments in Associates The Bank had significant investments in the following associates: As at October 31 ($ millions) Thanachart Bank Public Company Limited Canadian Tire’s Financial Services business (CTFS)(2) Bank of Xi’an Co. Ltd. Maduro & Curiel’s Bank N.V.(3) Banco del Caribe(4) Country of incorporation Nature of business Ownership percentage Date of financial statements(1) Carrying value 2016 2015 Carrying value Thailand Banking 49.0% September 30, 2016 $ 2,612 $ 2,415 Canada China Curacao Venezuela Financial Services Banking Banking Banking 20.0% 19.9% 48.1% 26.6% September 30, 2016 September 30, 2016 September 30, 2016 September 30, 2016 532 654 280 26 538 610 264 30 (1) Represents the date of the most recent published financial statements. Where available, financial statements prepared by the associates’ management or other published information is used to estimate the change in the Bank’s interest since the most recent published financial statements. (2) On October 1, 2014, the Bank acquired a 20% equity interest in Canadian Tire’s Financial Services business (CTFS). Under the agreement Canadian Tire has an option to sell to the Bank up to an additional 29% equity interest within the next 10 years at the then fair value, that can be settled, at the Bank’s discretion, by issuance of common shares or cash. After 10 years, for a period of six months, the Bank has the option to sell its equity interest back to Canadian Tire at the then fair value. As at October 1, 2014 CTFS had total assets of $5,351 and total liabilities of $4,387. (3) The local regulator requires financial institutions to set aside reserves for general banking risks. These reserves are not required under IFRS, and represent undistributed retained earnings related to a foreign associated corporation, which are subject to local regulatory restrictions. As of October 31, 2016 these reserves amounted to $63 (2015 – $61). (4) As at October 31, 2016, the Bank’s total net investment in Banco del Caribe, along with monetary assets, comprising of cash and dividend receivable was translated at the DICOM exchange rate of 1 USD to 660 VEF replacing the SIMADI exchange rate (2015 – 1 USD to 198 VEF). 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 177 CONSOLIDATED FINANCIAL STATEMENTS Summarized financial information of the Bank’s significant associates are as follows. ($ millions) Thanachart Bank Public Company Limited Canadian Tire’s Financial Services business (CTFS) Bank of Xi’an Co. Ltd. Maduro & Curiel’s Bank N.V. Banco del Caribe ($ millions) Thanachart Bank Public Company Limited Canadian Tire’s Financial Services business (CTFS) Bank of Xi’an Co. Ltd. Maduro & Curiel’s Bank N.V. Banco del Caribe (1) Based on the most recent available financial statements. 17 Goodwill and Other Intangible Assets For the twelve months ended and as at September 30, 2016(1) Revenue $ 1,622 999 915 347 90 Net income $ 449 305 427 101 (46) Total assets Total liabilities $ 37,372 5,490 38,083 5,456 703 $ 32,637 4,469 35,022 4,855 601 For the twelve months ended and as at September 30, 2015(1) Revenue $ 1,601 1,003 942 327 111 Net income 389 310 378 92 (9) Total assets Total liabilities 35,483 5,829 29,525 4,954 1,131 31,399 4,782 26,688 4,391 1,016 Goodwill The changes in the carrying amounts of goodwill by cash-generating unit (CGU) are as follows: ($ millions) Canadian Banking Global Wealth & Insurance Balance as at October 31, 2014 Transfers November 1, 2014 Acquisitions Foreign currency adjustments and other $ 1,633 1,728 – – Balance as at October 31, 2015 3,361 Acquisitions Foreign currency adjustments and other 49 (7) Balance as at October 31, 2016 $ 3,403 $ 2,292 (2,292) – – – – – – Global Capital Markets 100 (100) – – – – – – $ Global Corporate & Investment Banking 123 (123) – – – – – – $ Global Banking and Markets – 223 – 35 258 – 7 Caribbean and Central America Asia Pacific 720 151 – 134 1,005 241 9 – – – – – – – Latin America 2,041 413 116 (179) 2,391 – 70 Total 6,909 – 116 (10) 7,015 290 79 $ 265 $ 2,461 $ 1,255 $ – $ 7,384 Effective November 1, 2014, the Canadian and International businesses previously reported in Global Wealth & Insurance are included in Canadian Banking and International Banking’s results, respectively. In addition, there was a reallocation of the results of the Global Capital Markets CGU and Global Corporate & Investment Banking CGU into Global Banking and Markets CGU. As well, certain business activity previously reported in the Asia Pacific CGU is now included in Global Banking and Markets CGU. Consequently, the aggregate number of CGUs for the purposes of goodwill impairment assessment as of November 1, 2014 is reduced to 5 (October 31, 2014 – 7 CGUs). Goodwill was assessed for impairment following the reallocation and no impairment was determined to exist. Impairment testing of goodwill Goodwill acquired in business combinations is allocated to each of the Bank’s group of CGUs that are expected to benefit from the synergies of the particular acquisition. Goodwill is assessed for impairment annually or more frequently if events or circumstances occur that may result in the recoverable amount of the CGU falling below its carrying value. The bank determines the carrying value of the CGU using a regulatory capital approach based on credit, market, and operational risks, and leverage, consistent with the Bank’s capital attribution for business line performance measurement. The recoverable amount is the higher of fair value less costs of disposal and value in use. The recoverable amount for the CGU has been determined using the fair value less costs of disposal method. In arriving at such value for the CGU, the Bank has used price earnings (P/E) multiples applied to normalized net income for the last four quarters as of the test date, a control premium is added based on a five year weighted average acquisition premium paid for comparable companies, and costs of disposal are deducted from the fair value of the CGU. The resulting recoverable amount determined is then compared to its respective carrying amount to identify any impairment. P/E multiples ranging from 10 to 13 times (2015 – 10 to 12.5 times) have been used. The fair value less costs of disposal of the CGU is sensitive to changes in net income, P/E multiples and control premiums. Management believes that reasonable negative changes in any one key assumption used to determine the recoverable amount of the CGU would not result in an impairment. Goodwill was assessed for annual impairment as at July 31, 2016 and July 31, 2015 and no impairment was determined to exist. 178 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Intangible assets Intangible assets consist of assets with indefinite and finite useful lives. Indefinite life intangible assets consist substantially of fund management contracts. The fund management contracts are for the management of open-ended funds. Finite life intangible assets include assets such as computer software, customer relationships and core deposit intangibles. ($ millions) Cost Balance as at October 31, 2014 Acquisitions Additions Foreign currency adjustments and other Balance as at October 31, 2015 Acquisitions Additions Foreign currency adjustments and other Balance as at October 31, 2016 Accumulated amortization Balance as at October 31, 2014 Amortization Expense Foreign currency adjustments and other Balance as at October 31, 2015 Amortization Expense Foreign currency adjustments and other Balance as at October 31, 2016 Net book value As at October 31, 2015 As at October 31, 2016 Finite life Indefinite life Computer software Other intangibles Fund management contracts(1) Other intangibles Total $ 1,771 $ 1,231 $ 2,325 $ 67 $ 5,394 5 474 (57) $ 2,193 – 584 (40) $ 2,737 296 – (17) $ 1,510 61 31 29 $ 1,631 $ 629 $ 790 $ 191 (42) 778 255 (24) $ 90 4 884 104 7 $ 1,009 $ 995 – – – $ 2,325 – – – $ 2,325 $ $ $ – – – – – – – – – 1 $ 68 – – – $ 68 $ $ $ – – – – – – – $ 1,415(2) $ 1,728(2) $ $ 626 636 $ 2,325 $ 2,325 $ 68 $ 68 301 474 (73) $ 6,096 61 615 (11) $ 6,761 $ 1,419 281 (38) $ 1,662 359 (17) $ 2,004 $ 4,434 $ 4,757 Fund management contracts are attributable to HollisWealth Inc. (formerly DundeeWealth Inc.). (1) (2) Computer software comprises of purchased software of $377 (2015 – $256), internally generated software of $948 (2015 – $619), and in process software not subject to amortization of $403 (2015 – $540). Impairment testing of intangible assets Indefinite life intangible assets are not amortized and are assessed for impairment annually or more frequently if events or changes in circumstances indicate that the asset may be impaired. Impairment is assessed by comparing the carrying value of the indefinite life intangible asset to its recoverable amount. The recoverable amount of the fund management contracts is based on a value in use approach using the multi-period excess earnings method. This approach uses cash flow projections from management-approved financial budgets which include key assumptions related to market appreciation, net sales of funds, and operating margins taking into consideration past experience and market expectations. The forecast cash flows cover a 5-year period, with a terminal growth rate of 4.5% (2015 – 4.5%) applied thereafter. These cash flows have been discounted at a rate of 10% (2015 – 10%). Management believes that reasonable negative changes in any one key assumption used to determine the recoverable amount would not result in an impairment. Indefinite life intangible assets were assessed for annual impairment as at July 31, 2016 and July 31, 2015 and no impairment was determined to exist. 18 Other Assets As at October 31 ($ millions) Accrued interest Accounts receivable and prepaids Current tax assets Margin deposit derivatives Pension assets (Note 27) Receivable from brokers, dealers and clients Receivable from the Federal Deposit Insurance Corporation (Note 12) Other Total $ 2016 1,986 1,939 422 4,604 184 796 116 2,823 $ 2015 1,742 1,983 649 4,085 183 504 218 2,939 $ 12,870 $ 12,303 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 179 CONSOLIDATED FINANCIAL STATEMENTS 19 Deposits As at October 31 ($ millions) Personal Business and government Financial institutions Total Recorded in: Canada United States United Kingdom Mexico Peru Chile Colombia Other International Total(5) 2016 2015 Payable on demand(1) Interest- bearing $ 10,296 69,348 3,583 $ 83,227 $ 69,542 6,236 – – 2,479 62 106 4,802 $ 83,227 Non-interest bearing $ 6,118 22,346 2,464 Payable after Payable on a notice(2) fixed date(3) Total $ 111,956 26,363 2,958 $ 70,932 254,246 31,267 $ 199,302 372,303 40,272 $ 30,928 $ 141,277(4) $ 356,445 $ 611,877 $ 16,938 330 – 4,055 592 1,659 557 6,797 $ 113,739 1,075 307 4,753 4,474 74 2,833 14,022 $ 234,665 47,356 14,949 7,456 8,002 9,006 3,776 31,235 $ 434,884 54,997 15,256 16,264 15,547 10,801 7,272 56,856 $ $ $ 190,044 375,144 35,731 600,919 409,415 79,015 14,547 15,794 14,727 7,940 6,825 52,656 $ 30,928 $ 141,277 $ 356,445 $ 611,877 $ 600,919 (1) Deposits payable on demand include all deposits for which we do not have the right to notice of withdrawal, generally chequing accounts. (2) Deposits payable after notice include all deposits for which we require notice of withdrawal, generally savings accounts. (3) All deposits that mature on a specified date, generally term deposits, guaranteed investments certificates and similar instruments. (4) (5) Deposits denominated in U.S. dollars amount to $217,850 (2015 – $227,320) deposits denominated in Mexican pesos amount to $14,464 (2015 – $14,034) and deposits Includes $135 (2015 – $120) of non-interest bearing deposits. denominated in other foreign currencies amount to $76,777 (2015 – $66,860). The following table presents the maturity schedule for term deposits in Canada greater than $100,000(1). ($ millions) As at October 31, 2016 As at October 31, 2015 Within three months $ $ 40,211 24,170 Three to six months Six to twelve months $ $ 24,077 18,890 $ $ 23,690 27,219 $ $ One to five years 99,905 90,927 Over five years 12,451 17,231 $ $ $ $ 200,334 178,437 (1) The majority of foreign term deposits are in excess of $100,000. 20 Subordinated Debentures These debentures are direct, unsecured obligations of the Bank and are subordinate to the claims of the Bank’s depositors and other creditors. The Bank, where appropriate, enters into interest rate and cross-currency swaps to hedge the related risks. As at October 31 ($ millions) Maturity date January 2021 August 2022 Interest rate (%) 6.65 2.898 October 2024 3.036 June 2025 8.90 December 2025(3) 3.37 December 2025(3) 4.50 March 2027(3) 2.58 November 2037 April 2038 August 2085 3.015 3.37 Floating Terms(1) Redeemed on January 22, 2016. Redeemable on or after August 3, 2017. After August 3, 2017, interest will be payable at an annual rate equal to the 90-day bankers’ acceptance rate plus 1.255%. Redeemable on or after October 18, 2017. After October 18, 2019, interest will be payable at an annual rate equal to the 90-day bankers’ acceptance rate plus 1.14%. Redeemable at any time. Redeemable on or after December 8, 2020. After December 8, 2020, interest will be payable at an annual rate equal to the 90 day bankers’ acceptance rate plus 2.19%. US$1,250 million. Interest will be payable semi-annually in arrears on June 16 and December 16 of each year. Redeemable on or after March 30, 2022. After March 30, 2022, interest will be payable at an annual rate equal to the 90-day bankers’ acceptance rate plus 1.19%. JPY ¥10 billion. Redeemable on November 20, 2017. JPY ¥10 billion. Redeemable on April 9, 2018. US$99 million bearing interest at a floating rate of the offered rate for six-month Eurodollar deposits plus 0.125%. Redeemable on any interest payment date. 2016 Carrying value(2) 2015 Carrying value(2) $ – $ 1,000 1,500 1,798 262 759 1,677 1,271 118 116 1,501 1,806 263 – – 1,247 100 100 132 $ 7,633 165 $ 6,182 (1) In accordance with the provisions of the Capital Adequacy Guideline of the Superintendent, all redemptions are subject to regulatory approval and subject to the terms in the relevant prospectus. (2) The carrying value of subordinated debentures may differ from par value due to adjustments related to hedge accounting. (3) These debentures contain non-viability contingent capital (NVCC) provisions. Under such NVCC provisions, the debentures are convertible into a variable number of common shares if OSFI announces that the Bank has ceased, or is about to cease, to be viable, or if a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection, or equivalent support, from the federal government or any provincial government or political subdivision or agent thereof without which the Bank would have been determined by OSFI to be non-viable. If such a conversion were to occur, the debentures would be converted into common shares pursuant to an automatic conversion formula defined as 150% of the par value plus accrued and unpaid interest divided by the conversion price. The conversion price is based on the greater of: (i) a floor price of $5.00 or, where applicable, the US dollar equivalent of $5.00 (subject to adjustments in certain events as set out in the respective prospectus supplements, and (ii) the current market price of the Bank’s common shares at the time of the trigger event (10-day weighted average). 180 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 21 Other Liabilities As at October 31 ($ millions) Accrued interest Accounts payable and accrued expenses Current tax liabilities Deferred tax liabilities (Note 26) Gold and silver certificates and bullion Margin and collateral accounts Payables to brokers, dealers and clients Provisions (Note 22) Pension liabilities (Note 27) Other liabilities of subsidiaries and structured entities Other Total 22 Provisions ($ millions) As at November 1, 2014 Provisions made during the year Provisions utilized / released during the year Balance as at October 31, 2015 Provisions made during the year Provisions utilized / released during the year Balance as at October 31, 2016 2016 2015 $ 2,033 5,427 587 611 8,430 6,708 528 536 1,613 10,950 5,293 $ 1,888 5,225 584 599 7,812 8,848 226 315 722 10,835 4,584 $ 42,716 $ 41,638 C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Off-balance sheet credit risks Restructuring Other Total $ 184 – (72) $ 112 26 – $ 138 $ 136 – (87) $ 49 378 (150) $ 277 $ 198 66 (110) $ 154 85 (118) $ 121 $ 518 66 (269) $ 315 489 (268) $ 536 Off-balance sheet credit risks The provision for off-balance sheet credit risks relates primarily to credit risks such as undrawn lending commitments, letters of credit and letters of guarantee. These are collectively assessed at each reporting period in a manner consistent with the collective allowance for performing on-balance sheet credit risks. Restructuring charge During fiscal 2016, the Bank recorded a restructuring provision of $378 million ($278 million after tax) as part of the Bank’s efforts to enhance customer experience, reduce costs in a sustainable manner, to achieve greater operational efficiencies, and to simplify the organization. The restructuring charge primarily related to employee severance and was recorded within non-interest expenses. As at October 31, 2016, $265 million of the restructuring provision remains and is expected to be utilized in line with the approved plans, during fiscal 2017 and early part of fiscal 2018. This amount represents the Bank’s best estimate of the amount required to settle the obligation. Uncertainty exists with respect to when the obligation will be settled and the amounts ultimately paid, as this will largely depend upon individual facts and circumstances. In the fourth quarter of 2014, a restructuring charge of $148 million was recorded in non-interest expenses, primarily relating to employee severance costs. As at October 31, 2016, the restructuring provision has been substantially utilized. Litigation and Other Other primarily includes provisions related to litigation. In the ordinary course of business, the Bank and its subsidiaries are routinely defendants in, or parties to a number of pending and threatened legal actions and regulatory proceedings, including actions brought on behalf of various classes of claimants. In view of the inherent difficulty of predicting the outcome of such matters, the Bank cannot state what the eventual outcome of such matters will be. However, based on current knowledge, management does not believe that liabilities, if any, arising from pending litigation or regulatory proceedings will have a material adverse effect on the Consolidated Statement of Financial Position or results of operations of the Bank. Legal provisions are established when it becomes probable that the Bank will incur an expense related to a legal action and the amount can be reliably estimated. Such provisions are recorded at the best estimate of the amount required to settle any obligation related to these legal actions as at the balance sheet date, taking into account the risks and uncertainties surrounding the obligation. Management and internal and external experts are involved in estimating any amounts that may be required. The actual costs of resolving these claims may vary significantly from the amount of the legal provisions. The Bank’s estimate involves significant judgement, given the varying stages of the proceedings, the fact that the Bank’s liability, if any, has yet to be determined and the fact that the underlying matters will change from time to time. As such, there is a possibility that the ultimate resolution of those legal actions may be material to the Bank’s consolidated results of operations for any particular reporting period. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 181 CONSOLIDATED FINANCIAL STATEMENTS 23 Common and Preferred Shares (a) Common shares Authorized: An unlimited number of common shares without nominal or par value. Issued and fully paid: As at October 31 ($ millions) 2016 2015 Number of shares Amount Number of shares Amount Outstanding at beginning of year Issued under Shareholder Dividend and Share Purchase Plan(1) Issued in relation to share-based payments, net (Note 25) Issued in relation to the acquisition of a subsidiary or associated corporation Repurchased for cancellation under the Normal Course Issuer Bid Outstanding at end of year 1,202,937,205 2,234,037 4,228,124 29,138 (1,534,900) 1,207,893,604(2) $ 15,141 153 236 2 (19) $ 15,513 1,216,582,245 27,220 1,827,730 – (15,499,990) 1,202,937,205(2) $ 15,231 2 102 – (194) $ 15,141 (1) Effective June 30, 2016, the Bank commenced issuing shares from Treasury for the Dividend and Share Purchase options of the Plan. As at October 31, 2016, there were 7,786,784 (2) common shares held in reserve for issuance under the Plan. In the normal course of business, the Bank’s regulated Dealer subsidiary purchases and sells the Bank’s common shares to facilitate trading/institutional client activity. During fiscal 2016, the number of such shares bought and sold was 13,912,150 (2015 – 12,466,541). Dividend The dividends paid on common shares in fiscal 2016 and 2015 were $3,468 million ($2.88 per share) and $3,289 million ($2.72 per share), respectively. The Board of Directors approved a quarterly dividend of 74 cents per common share at its meeting on November 28, 2016. This quarterly dividend applies to shareholders of record as of January 3, 2017, and is payable January 27, 2017. Normal Course Issuer Bid During the year ended October 31, 2016, under normal course issuer bids, the Bank repurchased and cancelled approximately 1.5 million common shares (2015 –15.5 million) at an average price of $52.34 per share (2015 – $61.64) for a total amount of approximately $80 million (2015 – $955 million). On May 31, 2016, the Bank announced that OSFI and the Toronto Stock Exchange (TSX) approved a normal course issuer bid pursuant to which it may repurchase for cancellation up to 12 million of the Bank’s common shares, which represented approximately 1% of the Bank’s common shares issued and outstanding as of May 26, 2016. Purchases under the new bid commenced on June 2, 2016, and will end on the earlier of June 1, 2017, or the date on which the Bank completes its purchases. On a quarterly basis, the Bank will consult with OSFI prior to making purchases. Under this bid, the Bank has not repurchased any common shares. On May 29, 2015, the Bank announced that OSFI and the TSX approved its normal course issuer bid pursuant to which it may repurchase for cancellation up to 24 million of the Bank’s common shares, which represented approximately 2% of the Bank’s common shares issued and outstanding as of May 25, 2015. The bid ended on June 1, 2016. Under this bid, the Bank repurchased and cancelled approximately 9.5 million common shares at an average price of $58.94 per share. (b) Preferred shares Authorized: An unlimited number of preferred shares without nominal or par value. Issued and fully paid: As at October 31 ($ millions) Preferred shares:(a) Series 14(b) Series 15(c) Series 16(d) Series 17(e) Series 18(f)(g) Series 19(f)(g) Series 20(f)(h) Series 21(f)(h) Series 22(f)(i) Series 23(f)(i) Series 30(f)(j) Series 31(f)(j) Series 32(f)(k) Series 33(f)(k) Series 34(f)(l)(o) Series 36(f)(m)(o) Series 38(f)(n)(o) 2016 2015 Number of shares Amount – – 13,800,000 9,200,000 7,497,663 6,302,337 8,039,268 5,960,732 9,376,944 2,623,056 6,142,738 4,457,262 11,161,422 5,184,345 14,000,000 20,000,000 20,000,000 $ – – 345 230 187 158 201 149 234 66 154 111 279 130 350 500 500 Dividends declared per share 0.562500 0.843750 1.312500 1.400000 0.837500 0.628938 0.902500 0.541438 0.957500 0.586438 0.455000 0.366438 0.638235 0.334959 1.184800 0.852350 – Number of shares Amount 13,800,000 13,800,000 13,800,000 9,200,000 7,497,663 6,302,337 8,039,268 5,960,732 9,376,944 2,623,056 6,142,738 4,457,262 16,345,767 – – – – $ 345 345 345 230 187 158 201 149 234 66 154 111 409 – – – – Dividends declared per share 1.125000 1.125000 1.312500 1.400000 0.837500 0.697813 0.902500 0.610313 0.957500 0.655313 0.708750 0.197313 0.925000 – – – – Total preferred shares 143,745,767 $ 3,594 117,345,767 $ 2,934 182 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Terms of preferred shares Preferred shares(a): Series 14(b) Series 15(c) Series 16(d) Series 17(e) Series 18(f)(g) Series 19(f)(g) Series 20(f)(h) Series 21(f)(h) Series 22(f)(i) Series 23(f)(i) Series 30(f)(j) Series 31(f)(j) Series 32(f)(k) Series 33(f)(k) Series 34(f)(l)(o) Series 36(f)(m)(o) Series 38(f)(n)(o) C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Issue date Issue price Initial dividend Initial dividend payment date January 24, 2007 April 5, 2007 April 17, 2007 October 12, 2007 25.00 25.00 0.283560 0.348290 April 26, 2007 July 27, 2007 25.00 0.391950 January 29, 2008 January 31, 2008 25.00 0.337530 April 28, 2008 Rate reset spread – – – – March 25, 2008 March 27, 2008 April 26, 2013 25.00 0.431500 July 29, 2008 2.05% 25.00 0.189250 July 29, 2013 June 10, 2008 October 26, 2013 25.00 25.00 0.167800 0.167875 July 29, 2008 January 29, 2014 September 9, 2008 January 26, 2014 25.00 25.00 0.482900 0.173875 January 28, 2009 April 28, 2014 April 12, 2010 April 26, 2015 25.00 25.00 0.282200 0.095500 July 28, 2010 July 29, 2015 February 1, 2011 February 28, 2011 February 2, 2016 25.00 0.215410 April 27, 2011 25.00 0.105690 April 27, 2016 December 17, 2015 March 14, 2016 September 16, 2016 25.00 25.00 25.00 0.497300 0.508600 0.441800 April 27, 2016 July 27, 2016 January 27, 2017 Redemption date Redemption price April 27, 2016 July 27, 2016 January 27, 2016 to January 26, 2017 April 27, 2016 to April 25, 2017 April 26, 2018 2.05% April 26, 2013 to April 26, 2018 1.70% October 26, 2018 1.70% October 26, 2013 to October 26, 2018 1.88% January 26, 2019 1.88% January 26, 2014 to January 26, 2019 April 26, 2020 April 26, 2015 to April 26, 2020 February 2, 2021 1.00% 1.00% 1.34% 1.34% February 2, 2016 to February 2, 2021 April 26, 2021 July 26, 2021 January 27, 2022 4.51% 4.72% 4.19% 25.00 25.00 25.25 25.25 25.00 25.50 25.00 25.50 25.00 25.50 25.00 25.50 25.00 25.50 25.00 25.00 25.00 (a) Non-cumulative preferential cash dividends on Series 16, 17, 18, 19, 20, 21, 22, 23, 30, 31, 32, 33, 34, 36 and 38 are payable quarterly, as and when declared by the Board. Dividends on the Non-cumulative 5-Year Rate Reset Preferred Shares (Series 18, 20, 22, 30 and 32) and the Non- cumulative 5-Year Rate Reset Preferred Shares Non Viability Contingent Capital (NVCC) (Series 34, 36, and 38) are payable at the applicable rate for the initial five-year fixed rate period ending one day prior to the redemption date. Subsequent to the initial five-year fixed rate period, and resetting every five years thereafter, the dividend on all Rate Reset Preferred Shares will be determined by the sum of the 5-year Government of Canada Yield plus the indicated rate reset spread, multiplied by $25.00. If outstanding, non-cumulative preferential cash dividends on the Series 19, 21, 23, 31, 33, 35, 37 and 39 are payable quarterly, as and when declared by the Board. Dividends on the Non-cumulative 5-Year Rate Reset Preferred Shares (Series 19, 21, 23, 31 and 33) and the Non-cumulative 5-Year Rate Reset Preferred Shares NVCC (Series 35, 37 and 39) are payable, in an amount per share equal to the sum of the T-Bill Rate plus the rate reset spread of the converted preferred shares, multiplied by $25.00. For each of the years presented, the Bank paid all of the non-cumulative preferred share dividends. (b) On April 27, 2016, the Bank redeemed all outstanding Series 14 Non-cumulative Preferred Shares at $25.00 per share together with declared and unpaid dividends. (c) On July 27, 2016, the Bank redeemed all outstanding Series 15 Non-cumulative Preferred shares at $25.00 per share together with declared and unpaid dividends. (d) With regulatory approval, the Series 16 Non-cumulative Preferred Shares may be redeemed by the Bank during the period commencing January 27, 2016 and ending January 26, 2017 at $25.25 per share, together with declared and unpaid dividends to the date then fixed for redemption and at $25.00 per share commencing January 27, 2017. (e) With regulatory approval, the Series 17 Non-cumulative Preferred Shares may be redeemed by the Bank during the period commencing April 27, 2016 and ending April 25, 2017 at $25.25 per share, together with declared and unpaid dividends to the date then fixed for redemption and at $25.00 per share commencing April 26, 2017. (f) Holders of Fixed Rate Reset Preferred Shares will have the option to convert shares into an equal number of the relevant series of Floating Rate Preferred Shares on the applicable Rate Reset Series conversion date and every five years thereafter. Holders of Floating Rate Reset Preferred Shares have reciprocal conversion options into the relevant series of Fixed Rate Reset Preferred Shares. With respect to Series 18 and 19, 20 and 21, 22 and 23, 30 and 31, 32 and 33, 34 and 35, 36 and 37, and 38 and 39, if the Bank determines that, after giving effect to any Election Notices received, there would be less than 1,000,000 Fixed Rate or Floating Rate Preferred Shares of such Series issued and outstanding on an applicable conversion date, then all of the issued and outstanding preferred shares of such Series will automatically be converted into an equal number of the preferred shares of the other relevant Series. (g) Holders of Series 18 Non-cumulative 5-Year Rate Reset Preferred Shares will have the option to convert shares into an equal number of Series 19 non-cumulative floating rate preferred shares on April 26, 2018 and on April 26 every five years thereafter. With regulatory approval, the Series 18 preferred shares may be redeemed by the Bank on April 26, 2018 and every five years thereafter, respectively, at $25.00 per share, together 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 183 CONSOLIDATED FINANCIAL STATEMENTS with declared and unpaid dividends. With regulatory approval, the Series 19 Non-cumulative Preferred Shares may be redeemed by the Bank at (i) $25.00 together with all declared and unpaid dividends to the date fixed for redemption in the case of redemptions on April 26, 2018 and on April 26 every five years thereafter, or (ii) $25.50 together with all declared and unpaid dividends to the date fixed for redemption on any other date on or after April 26, 2013. (h) Holders of Series 20 Non-cumulative 5-Year Rate Reset Preferred Shares will have the option to convert shares into an equal number of Series 21 non-cumulative floating rate preferred shares on October 26, 2018, and on October 26 every five years thereafter. With regulatory approval, the Series 20 preferred shares may be redeemed by the Bank on October 26, 2018, and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. With regulatory approval, the Series 21 Non-cumulative Preferred Shares may be redeemed by the Bank at (i) $25.00 together with all declared and unpaid dividends to the date fixed for redemption in the case of redemptions on October 26, 2018 and on October 26 every five years thereafter, or (ii) $25.50 together with all declared and unpaid dividends to the date fixed for redemption on any other date on or after October 26, 2013. (i) Holders of Series 22 Non-cumulative 5-Year Rate Reset Preferred Shares will have the option to convert shares into an equal number of Series 23 non-cumulative floating rate preferred shares on January 26, 2019, and on January 26 every five years thereafter. With regulatory approval, the Series 22 preferred shares may be redeemed by the Bank on January 26, 2019, and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. With regulatory approval, the Series 23 Non-cumulative Preferred Shares may be redeemed by the Bank at (i) $25.00 together with all declared and unpaid dividends to the date fixed for redemption in the case of redemptions on January 26, 2019 and on January 26 every five years thereafter, or (ii) $25.50 together with all declared and unpaid dividends to the date fixed for redemption on any other date after January 26, 2014. (j) Holders of Series 30 Non-cumulative 5-Year Rate Reset Preferred Shares will have the option to convert shares into an equal number of Series 31 non-cumulative floating rate preferred shares on April 26, 2020, and on April 26 every five years thereafter. With regulatory approval, the Series 30 preferred shares may be redeemed by the Bank on April 26, 2020, and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. With regulatory approval, the Series 31 Non-cumulative Preferred Shares may be redeemed by the Bank at (i) $25.00 together with all declared and unpaid dividends to the date fixed for redemption in the case of redemptions on April 26, 2020 and on April 26 every five years thereafter, or (ii) $25.50 together with all declared and unpaid dividends to the date fixed for redemption on any other date after April 26, 2015. (k) Holders of Series 32 Non-cumulative 5-Year Rate Reset Preferred Shares will have the option to convert shares into an equal number of Series 33 non-cumulative floating rate preferred shares on February 2, 2021 and on February 2 every five years thereafter. With regulatory approval, the Series 32 preferred shares may be redeemed by the Bank on February 2, 2021, and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. With regulatory approval, the Series 33 Non-cumulative Preferred Shares may be redeemed by the Bank at (i) $25.00 together with all declared and unpaid dividends to the date fixed for redemption in the case of redemptions on February 2, 2021 and on February 2 every five years thereafter, or (ii) $25.50 together with all declared and unpaid dividends to the date fixed redemption on any other date after February 2, 2016. (l) Holders of Series 34 Non-cumulative 5-Year Rate Reset Preferred Shares (NVCC) will have the option to convert shares into an equal number of Series 35 non-cumulative floating rate preferred shares on April 26, 2021, and on April 26 every five years thereafter. With regulatory approval, Series 34 preferred shares may be redeemed by the Bank on April 26, 2021, and for Series 35 preferred shares (NVCC), if applicable, on April 26, 2026 and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. (m) Holders of Series 36 Non-cumulative 5-Year Rate Reset Preferred Shares (NVCC) will have the option to convert shares into an equal number of Series 37 non-cumulative floating rate preferred shares (NVCC) on July 26, 2021, and on July 26 every five years thereafter. With regulatory approval, Series 36 preferred shares may be redeemed by the Bank on July 26, 2021, and for Series 37 preferred shares, if applicable, on July 26, 2026 and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. (n) Holders of Series 38 Non-cumulative 5-Year Rate Reset Preferred Shares (NVCC) will have the option to convert shares into an equal number of Series 39 non-cumulative floating rate preferred shares (NVCC) on January 27, 2022, and on January 27 every five years thereafter. With regulatory approval, Series 38 preferred shares may be redeemed by the Bank on January 27, 2022, and for Series 39 preferred shares, if applicable, on January 27, 2027 and every five years thereafter, respectively, at $25.00 per share, together with declared and unpaid dividends. The initial dividend, if declared will be payable on January 27, 2017 and will be $0.4418 per share of Preferred Shares Series 38. (o) These preferred shares contain NVCC provisions necessary for the shares to qualify as Tier 1 regulatory capital under Basel III. NVCC provisions require the conversion of capital instruments into a variable number of common shares if OSFI announces that the Bank has ceased, or is about to cease, to be viable, or if a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection, or equivalent support, from the federal government or any provincial government or political subdivision or agent thereof without which the Bank would have been determined by OSFI to be non-viable. If such a conversion were to occur, NVCC preferred shares Series 34, Series 35, Series 36, Series 37, Series 38 and Series 39, if outstanding, would be converted into common shares pursuant to an automatic conversion formula defined as 100% times the share value of $25.00 plus declared and unpaid dividends divided by the conversion price. NVCC subordinated debentures due March 30, 2027, December 8, 2025, and December 16, 2025, would be converted into common shares pursuant to an automatic conversion formula defined as 150% of the par value plus accrued and unpaid interest divided by the conversion price. The conversion price is based on the greater of: (i) a floor price of $5.00 or, where applicable, the U.S. dollar equivalent of $5.00 (subject in each case to adjustments in certain events as set out in their respective prospectus supplements), and (ii) the current market price of the Bank’s common shares at the time of the trigger event (10-day weighted average). Based on the floor price, excluding the impact of accrued and unpaid interest (if any) and declared but unpaid dividends (if any), the maximum number of common shares issuable on conversion of the subordinated debentures and preferred shares would be 1,373 million common shares. 184 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T (c) Restrictions on dividend payments Under the Bank Act, the Bank is prohibited from declaring any dividends on its common or preferred shares when the Bank is, or would be placed by such a declaration, in contravention of the capital adequacy, liquidity or any other regulatory directives issued under the Bank Act. In addition, common share dividends cannot be paid unless all dividends to which preferred shareholders are then entitled have been paid or sufficient funds have been set aside to do so. In the event that applicable cash distributions on any of the Scotiabank Trust Securities are not paid on a regular distribution date, the Bank has undertaken not to declare dividends of any kind on its preferred or common shares. Similarly, should the Bank fail to declare regular dividends on any of its directly issued and outstanding preferred or common shares, cash distributions will also not be made on any of the Scotiabank Trust Securities. Currently, these limitations do not restrict the payment of dividends on preferred or common shares. 24 Capital Management The primary regulator over the Bank’s consolidated capital adequacy is the Office of the Superintendent of Financial Institutions, Canada (OSFI). The capital adequacy regulations in Canada are largely consistent with international standards set by the Basel Committee on Banking Supervision (BCBS). OSFI requires Canadian deposit-taking institutions to fully implement the 2019 Basel III reforms, without the transitional phase-in provisions for capital deductions (referred to as ‘all-in’), and achieve minimums of 7%, 8.5% and 10.5% for CET1, Tier 1 and Total Capital, respectively. OSFI has also designated the Bank as a domestic systemically important bank (D-SIB), increasing its minimum capital ratio requirements by 1% across all tiers of capital effective January 1, 2016, in line with the requirements for global systemically important banks. In addition to risk-based capital requirements, the Basel III reforms introduced a simpler, non risk-based Leverage ratio requirement to act as a supplementary measure to its risk-based capital requirements. In October 2014, OSFI released its Leverage Requirements Guideline which outlines the application of the Basel III Leverage ratio in Canada and the replacement of the former Assets-to-Capital Multiple (ACM), effective the first quarter of 2015. Institutions are expected to maintain a material operating buffer above the 3% minimum. The Bank’s regulatory capital ratios were as follows: C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S As at October 31 ($ millions) Capital Common Equity Tier 1 Capital Net Tier 1 Capital Total regulatory capital Risk-weighted assets/exposures used in calculation of capital ratios CET1 risk-weighted assets(1) Tier 1 risk-weighted assets(1) Total risk-weighted assets(1) Leverage exposures Capital ratios Common Equity Tier 1 Capital ratio Tier 1 capital ratio Total capital ratio Leverage ratio 2016 2015 All-in Transitional All-in Transitional $ $ $ 39,989 45,066 53,330 $ $ $ 45,816 47,668 55,824 $ $ $ 36,965 41,366 48,230 $ $ $ 44,811 44,811 51,501 $ 364,048 $ 364,504 $ 364,894 $ 1,010,987 $ 368,215 $ 368,215 $ 368,215 $ 1,013,346 $ 357,995 $ 358,780 $ 359,453 $ 980,212 $ 364,824 $ 364,824 $ 364,824 $ 983,318 11.0% 12.4% 14.6% 4.5% 12.4% 12.9% 15.2% 4.7% 10.3% 11.5% 13.4% 4.2% 12.3% 12.3% 14.1% 4.6% (1) In accordance with OSFI’s requirements, scalars for CVA risk-weighted assets of 0.64, 0.71 and 0.77 (0.64, 0.71 and 0.77 in 2015) were used to compute the CET1 capital ratio, Tier 1 capital ratio and Total capital ratio, respectively. The Bank substantially exceeded the OSFI capital targets as at October 31, 2016. OSFI has also prescribed an authorized leverage ratio and the Bank was above the regulatory minimum as at October 31, 2016. 25 Share-Based Payments (a) Stock option plans The Bank grants stock options and stand-alone stock appreciation rights (SARs) as part of the Employee Stock Option Plan. Options to purchase common shares and/or to receive an equivalent cash payment, as applicable, may be granted to selected employees at an exercise price of the higher of the closing price of the Bank’s common shares on the Toronto Stock Exchange (TSX) on the trading day prior to the grant date or the volume weighted average trading price for the five trading days immediately preceding the grant date. Stock Options granted since December 2014 vest 50% at the end of the third year and 50% at the end of the fourth year. This change is prospective and does not impact prior period grants. Stock Options are exercisable no later than 10 years after the grant date. In the event that the expiry date falls within an insider trading blackout period, the expiry date will be extended for 10 business days after the end of the blackout period. As approved by the shareholders, a total of 129 million common shares have been reserved for issuance under the Bank’s Employee Stock Option Plan of which 99.4 million common shares have been issued as a result of the exercise of options and 19.6 million common shares are committed under outstanding options, leaving 10.0 million common shares available for issuance as options. Outstanding options expire on dates ranging from December 13, 2016 to December 3, 2025. The cost of these options is recognized on a graded vesting basis except where the employee is eligible to retire prior to a tranche’s vesting date, in which case the cost is recognized between the grant date and the date the employee is eligible to retire. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 185 CONSOLIDATED FINANCIAL STATEMENTS The stock option plans include: Š Tandem stock appreciation rights Employee stock options granted between December 13, 2006 to November 1, 2009 have Tandem SARs, which provide the employee the choice to either exercise the stock option for shares, or to exercise the Tandem SARs and thereby receive the intrinsic value of the stock option in cash. As at October 31, 2016, 57,800 Tandem SARs were outstanding (2015 – 175,876). The share-based payment liability recognized for vested Tandem SARs as at October 31, 2016 was $2 million (2015 – $3 million). The corresponding intrinsic value of this liability as at October 31, 2016 was $2 million (2015 – $3 million). In 2016, an expense of $0.4 million (2015 – $0.3 million benefit) was recorded in salaries and employee benefits in the Consolidated Statement of Income. This expense is net of gains arising from derivatives used to manage the volatility of share-based payments of $0.6 million (2015 – $1.1 million losses). Š Stock options Employee stock options granted beginning December 2009, are equity-classified stock options which call for settlement in shares and do not have Tandem SARs features. The amount recorded in equity – other reserves for vested stock options as at October 31, 2016 was $161 million (2015 – $182 million). In 2016, an expense of $7 million (2015 – $13 million) was recorded in salaries and employee benefits in the Consolidated Statement of Income. As at October 31, 2016, future unrecognized compensation cost for non-vested stock options was $4 million (2015 – $5 million) which is to be recognized over a weighted-average period of 1.80 years (2015 – 1.90 years). Š Stock appreciation rights Stand-alone SARs are granted instead of stock options to selected employees in countries where local laws may restrict the Bank from issuing shares. When a SAR is exercised, the Bank pays the appreciation amount in cash equal to the rise in the market price of the Bank’s common shares since the grant date. During fiscal 2016, 77,298 SARs were granted (2015 – 88,768) and as at October 31, 2016, 1,541,368 SARs were outstanding (2015 – 1,791,458), of which 1,478,854 SARs were vested (2015 – 1,726,644). The share-based payment liability recognized for vested SARs as at October 31, 2016 was $25 million (2015 – $17 million). The corresponding intrinsic value of this liability as at October 31, 2016 was $25 million (2015 – $17 million). In 2016, a benefit of $2 million (2015 – benefit of $3 million) was recorded in salaries and employee benefits in the Consolidated Statement of Income. This benefit is net of gains arising from derivatives used to manage the volatility of share-based payment of $18 million (2015 – $6 million losses). Determination of fair values The share-based payment liability and corresponding expense for SARs and options with Tandem SAR features were quantified using the Black- Scholes option pricing model with the following assumptions and resulting fair value per award: As at October 31 Assumptions Risk-free interest rate % Expected dividend yield Expected price volatility Expected life of option Fair value Weighted-average fair value 2016 2015 0.56% - 0.81% 3.92% 16.28% - 30.40% 0.00 - 4.48 years 0.57% – 0.82% 4.33% 16.34% – 28.12% 0.05 – 4.43 years $ 17.69 $ 10.23 The share-based payment expense for stock options, i.e., without Tandem SAR features, was quantified using the Black-Scholes option pricing model on the date of grant. The fiscal 2016 and 2015 stock option grants were fair valued using the following weighted-average assumptions and resulting fair value per award: Assumptions Risk-free interest rate % Expected dividend yield Expected price volatility Expected life of option Fair value Weighted-average fair value 2016 Grant 2015 Grant 1.20% 4.49% 20.10% 6.65 years 1.60% 3.86% 21.90% 6.69 years $ 5.27 $ 7.63 The risk-free rate is based on Canadian treasury bond rates interpolated for the maturity equal to the expected life until exercise of the options. Expected dividend yield is based on historical dividend payout. Expected price volatility is determined based on the historical volatility for compensation. For accounting purposes, an average of the market consensus implied volatility for traded options on our common shares and the historical volatility is used. 186 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Details of the Bank’s Employee Stock Option Plan are as follows(1): As at October 31 Outstanding at beginning of year Granted Exercised as options Exercised as Tandem SARs Forfeited Expired Outstanding at end of year(2) Exercisable at end of year(3) Available for grant As at October 31, 2016 Range of exercise prices $33.89 to $47.75 $49.93 to $52.57 $55.21 to $60.67 $63.98 to $68.32 2016 2015 Number of stock options (000’s) Weighted average exercise price Number of stock options (000’s) Weighted average exercise price 22,957 1,263 (4,224) (28) (92) (24) 19,852 14,617 10,198 $ 53.19 60.67 48.81 48.41 62.49 61.47 $ 54.55 $ 51.57 23,355 1,514 (1,811) (2) (99) – 22,957 16,192 11,317 $ 51.68 68.32 46.10 47.92 58.06 – $ 53.19 $ 50.09 Options Outstanding Options Exercisable Number of stock options (000’s) Weighted average remaining contractual life (years) Weighted average exercise price Number of stock options (000’s) Weighted average exercise price 3,770 3,897 7,639 4,546 19,852 2.67 3.88 5.76 7.24 5.15 $ 41.70 $ 50.66 $ 56.44 $ 65.39 $ 54.55 3,770 3,897 5,435 1,515 14,617 $ 41.70 $ 50.66 $ 55.61 $ 63.98 $ 51.57 (1) Excludes SARs. (2) (3) Includes outstanding options of 57,800 Tandem SARs (2015 – 175,876) and 257,170 options originally issued under HollisWealth plans (2015 – 301,950). Includes exercisable options of 57,800 Tandem SARs (2015 – 175,876) and 257,170 options originally issued under HollisWealth plans (2015 – 301,950). (b) Employee share ownership plans Eligible employees can contribute up to a specified percentage of salary towards the purchase of common shares of the Bank. In general, the Bank matches 50% of eligible contributions, up to a maximum dollar amount, which is expensed in salaries and employee benefits. In Canada, the maximum dollar amounts were increased effective January 1, 2016. During 2016, the Bank’s contributions totalled $49 million (2015 – $31 million). Contributions, which are used to purchase common shares in the open market, do not result in a subsequent expense to the Bank from share price appreciation. As at October 31, 2016, an aggregate of 19 million common shares were held under the employee share ownership plans (2015 – 19 million). The shares in the employee share ownership plans are considered outstanding for computing the Bank’s basic and diluted earnings per share. (c) Other share-based payment plans Other share-based payment plans use notional units that are valued based on the Bank’s common share price on the TSX. These units accumulate dividend equivalents in the form of additional units based on the dividends paid on the Bank’s common shares. These plans are settled in cash and, as a result, are liability-classified. Fluctuations in the Bank’s share price change the value of the units, which affects the Bank’s share-based payment expense. As described below, the value of a portion of the Performance Share Unit notional units also varies based on Bank performance. Upon exercise or redemption, payments are made to the employees with a corresponding reduction in the accrued liability. In 2016, an aggregate expense of $237 million (2015 – $209 million) was recorded in salaries and employee benefits in the Consolidated Statement of Income for these plans. This expense includes gains from derivatives used to manage the volatility of share-based payment of $121 million (2015 – $72 million losses). As at October 31, 2016, the share-based payment liability recognized for vested awards under these plans was $849 million (2015 – $754 million). Details of these other share-based payment plans are as follows: Deferred Stock Unit Plan (DSU) Under the DSU Plan, senior executives may elect to receive all or a portion of their cash bonus under the Annual Incentive Plan (which is expensed for the year awarded in salaries and employee benefits in the Consolidated Statement of Income) in the form of deferred stock units which vest immediately. In addition the DSU plan allows for eligible executives of the Bank to participate in grants that are not allocated from the Annual Incentive Plan election. These grants are subject to specific vesting schedules. Units are redeemable in cash only when an executive ceases to be a Bank employee, and must be redeemed by December 31 of the year following that event. As at October 31, 2016, there were 703,168 units (2015 – 1,325,679) awarded and outstanding of which 703,168 units were vested (2015 – 1,325,679). Directors’ Deferred Stock Unit Plan (DDSU) Under the DDSU Plan, non-officer directors of the Bank may elect to receive all or a portion of their fee for that fiscal year (which is expensed by the Bank in other expenses in the Consolidated Statement of Income) in the form of deferred stock units which vest immediately. Units are redeemable in cash, only following resignation or retirement, and must be redeemed by December 31 of the year following that event. As at October 31, 2016, there were 348,197 units outstanding (2015 – 337,413). Restricted Share Unit Plan (RSU) Under the RSU Plan, selected employees receive an award of restricted share units which, for the majority of grants, vest at the end of three years. There are certain grants that provide for a graduated vesting schedule. Upon vesting all RSU units are paid in cash to the employee. The share-based 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 187 CONSOLIDATED FINANCIAL STATEMENTS payment expense is recognized evenly over the vesting period except where the employee is eligible to retire prior to the vesting date in which case, the expense is recognized between the grant date and the date the employee is eligible to retire. As at October 31, 2016, there were 2,214,543 units (2015 – 2,147,971) awarded and outstanding of which 1,537,076 were vested (2015 –1,566,333). Performance Share Unit Plan (PSU) Eligible executives receive an award of performance share units, for the majority of grants vest at the end of three years. One grant provides for a graduated vesting schedule which includes a specific performance factor calculation. A portion of the PSU awards are subject to performance criteria measured over a three-year period whereby a multiplier factor is applied which impacts the incremental number of outstanding shares due to employees. The three-year performance measures include return on equity compared to target and total shareholder return relative to a comparator group selected prior to the granting of the award. The Bank uses a probability-weighted-average of potential outcomes to estimate the multiplier impact. The share-based payment expense is recognized over the vesting period except where the employee is eligible to retire prior to the vesting date; in which case, the expense is recognized between the grant date and the date the employee is eligible to retire. This expense varies based on changes in the Bank’s share price and the Bank’s performance compared to the performance measures. Upon vesting, the units are paid in cash to the employee. As at October 31, 2016, there were 8,588,753 units (2015 – 9,025,306) outstanding subject to performance criteria, of which 7,035,242 units were vested (2015 – 7,686,580). Deferred Performance Plan Under the Deferred Performance Plan, a portion of the bonus received by Global Banking and Markets employees (which is accrued and expensed in the year to which it relates) is allocated to qualifying employees in the form of units. These units are subsequently paid in cash to the employees over each of the following three years. Changes in the value of the units, which arise from fluctuations in the market price of the Bank’s common shares, are expensed in the same manner as the Bank’s other liability-classified share-based payment plans in the salaries and employee benefits expense in the Consolidated Statement of Income. As at October 31, 2016, there were 1,802,540 units outstanding (2015 – 1,940,375). 26 Corporate Income Taxes Corporate income taxes recorded in the Bank’s consolidated financial statements for the years ended October 31 are as follows: (a) Components of income tax provision For the year ended October 31 ($ millions) Provision for income taxes in the Consolidated Statement of Income: Current income taxes: Domestic: Federal Provincial Adjustments related to prior periods Foreign Adjustments related to prior periods Deferred income taxes: Domestic: Federal Provincial Foreign Total provision for income taxes in the Consolidated Statement of Income Provision for income taxes in the Consolidated Statement of Changes in Equity: Current income taxes Deferred income taxes Reported in: Other Comprehensive Income Retained earnings Common shares Other reserves Total provision for income taxes in the Consolidated Statement of Changes in Equity Total provision for income taxes Provision for income taxes in the Consolidated Statement of Income includes: Deferred tax expense (benefit) relating to origination/reversal of temporary differences Deferred tax expense (benefit) of tax rate changes Deferred tax expense (benefit) of previously unrecognized tax losses, tax credits and temporary differences 188 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T 2016 2015 2014 $ 467 386 4 935 (19) $ 528 459 23 897 2 $ 565 423 (70) 865 (3) 1,773 1,909 1,780 141 70 46 (16) (20) (20) 141 66 15 257 $ 2,030 (56) $ 1,853 222 $ 2,002 $ (158) (168) (326) $ (496) (8) (504) $ (248) (174) (422) (322) (10) 1 5 (326) $ 1,704 $ $ 372 (4) (111) 257 (464) (43) 1 2 (504) $ 1,349 $ $ 118 (2) (172) (56) (432) 4 1 5 (422) $ 1,580 $ $ 163 – 59 222 (b) Reconciliation to statutory rate Income taxes in the Consolidated Statement of Income vary from the amounts that would be computed by applying the composite federal and provincial statutory income tax rate for the following reasons: For the year ended October 31 ($ millions) Income taxes at statutory rate Increase (decrease) in income taxes resulting from: Lower average tax rate applicable to subsidiaries and foreign branches Tax-exempt income from securities Deferred income tax effect of substantively enacted tax rate changes Other, net Total income taxes and effective tax rate 2016 2015 2014 Percent of pre-tax income Amount Percent of pre-tax income Percent of pre-tax income Amount Amount $ 2,485 26.4% $ 2,386 26.3% $ 2,439 26.2% (234) (220) (2.5) (2.3) (233) (281) (2.6) (3.1) (177) (212) (4) 3 $ 2,030 – – (2) (17) 21.6% $ 1,853 – – (0.2) (48) 20.4% $ 2,002 (1.9) (2.3) – (0.5) 21.5% C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S The change in the statutory tax rate between 2016 and 2015 was primarily due to an increase in certain provincial tax rates. (c) Deferred taxes Significant components of the Bank’s deferred tax assets and liabilities are as follows: October 31 ($ millions) Deferred tax assets: Loss carryforwards Allowance for credit losses Deferred compensation Deferred income Property and equipment Pension and other post-retirement benefits Securities Other Total deferred tax assets Deferred tax liabilities: Deferred income Property and equipment Pension and other post-retirement benefits Securities Intangible assets Other Total deferred tax liabilities Net deferred tax assets (liabilities)(1) Statement of Income Statement of Financial Position For the year ended As at 2016 2015 2016 2015 $ 57 3 (14) 18 99 18 139 57 $ 377 $ 5 7 25 19 (129) 193 $ 120 $ 257 $ $ $ 80 (93) 50 46 (72) 54 8 (10) 63 39 1 22 (26) 38 45 $ 484 852 224 289 101 937 162 511 $ 539 812 215 301 186 676 138 408 $ 3,560 $ 3,275 $ 122 75 146 221 1,043 543 $ 114 65 153 68 914 526 $ 119 $ (56) $ 2,150 $ 1,410 $ 1,840 $ 1,435 (1) For Consolidated Statement of Financial Position presentation, deferred tax assets and liabilities are assessed by legal entity. As a result, the net deferred tax assets of $1,410 (2015 – $1,435) are represented by deferred tax assets of $2,021 (2015 – $2,034), and deferred tax liabilities of $611 (2015 – $599) on the Consolidated Statement of Financial Position. The major changes to net deferred taxes were as follows: For the year ended October 31 ($ millions) Balance at beginning of year Deferred tax benefit (expense) for the year recorded in income Deferred tax benefit (expense) for the year recorded in equity Acquired in business combinations Other Balance at end of year 2016 2015 $ 1,435 (257) 168 71 (7) $ 1,410 $ 1,309 56 8 27 35 $ 1,435 The tax related to temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognized in the Consolidated Statement of Financial Position amounts to $55 million (2015 – $166 million). The amount related to unrecognized tax losses is $14 million, which will expire as follows: $13 million in 2018 and beyond and $1 million have no fixed expiry date. Included in the net deferred tax asset are tax benefits of $73 million (2015 – $41 million) that have been recognized in certain Canadian and foreign subsidiaries that have incurred losses in either the current or the preceding year. In determining if it is appropriate to recognize these tax benefits, the Bank relied on projections of future taxable profits. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 189 CONSOLIDATED FINANCIAL STATEMENTS Deferred tax liabilities are not required to be recognized for taxable temporary differences arising on investments in subsidiaries, associates and interests in joint ventures if the Bank controls the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. At the end of the year taxable temporary differences of $52.5 billion (2015 – $46.0 billion) related to the Bank’s investment in subsidiaries were not recognized as deferred tax liabilities in line with these requirements. Reassessment of dividend deductions In November 2016 the Bank received a federal reassessment of $179 million for tax and interest as a result of the Canada Revenue Agency denying the tax deductibility of certain Canadian dividends received during the 2011 taxation year. The circumstances of the dividends subject to the reassessment are similar to those prospectively addressed by recently enacted rules which had been introduced in the 2015 Canadian federal budget. The Bank is confident that its tax filing position was appropriate and in accordance with the relevant provisions of the Income Tax Act (Canada), and intends to vigorously defend its position. 27 Employee Benefits The Bank sponsors a number of employee benefit plans, including pensions (defined benefit and defined contribution) and other benefit plans (post- retirement benefits and other long-term employee benefits) for most of its employees globally. The information presented below relates to the Bank’s principal plans; other plans operated by certain subsidiaries of the Bank are not considered material and are not included in these disclosures. Global pension plans The principal pension plans include plans in Canada, the US, Mexico, the UK, Ireland, Jamaica, Trinidad & Tobago and other countries in the Caribbean in which the Bank operates. The Bank has a strong and well defined governance structure to manage these global obligations. The investment policy for each principal plan is reviewed periodically and all plans are in good standing with respect to legislation and local regulations. Actuarial valuations for funding purposes for the Bank’s funded pension plans are conducted as required by applicable legislation. The purpose of the actuarial valuation is to determine the funded status of the plans on a going-concern and statutory basis and to determine the required contributions. The plans are funded in accordance with applicable pension legislation and the Bank’s funding policies such that future benefit promises based on plan provisions are well secured. The assumptions used for the funding valuations are set by independent plan actuaries on the basis of the requirements of the local actuarial standards of practice and statute. Scotiabank Pension Plan (Canada) The most significant pension plan is the Scotiabank Pension Plan (SPP) in Canada, a defined benefit pension plan, which was recently amended to include an optional defined contribution (DC) component for employees in Canada hired on or after January 1, 2016. As the administrator of the SPP, the Bank has established a well-defined governance structure and policies to ensure compliance with legislative and regulatory requirements under OSFI and the Canada Revenue Agency. The Bank appoints a number of committees to oversee and make decisions related to the administration of the SPP. Certain committees are also responsible for the investment of the assets of the SPP Fund and for monitoring the investment managers and performance. Š The Human Resources Committee (HRC) of the Board approves the charter of the Pension Administration and Investment Committee (PAIC), reviews reports, and approves the investment policy. The HRC also reviews and recommends any amendments to the SPP to the Board of Directors. Š PAIC is responsible for recommending the investment policy to the HRC, for appointing and monitoring investment managers, and for reviewing auditor and actuary reports. PAIC also monitors the administration of member pension benefits. Š The Scotiabank Master Trust Committee (MTC) invests assets in accordance with the investment policy and all applicable legislation. The MTC assigns specific mandates to investment management firms. PAIC and the MTC both have independent member representation on the committees. Š The Capital Accumulation Plans (CAP) Committee is responsible for the administration and investment of the DC component of the SPP including the selection and monitoring of investment options available to DC participants. Actuarial valuations for funding purposes for the SPP are conducted on an annual basis. The most recent funding valuation was conducted as of November 1, 2015. Contributions are being made to the SPP in accordance with this valuation and are shown in the table in b) below. The assumptions used for the funding valuation are set by independent plan actuaries on the basis of the requirements of the Canadian Institute of Actuaries and applicable regulation. Other benefit plans The principal other benefit plans include plans in Canada, the US, Mexico, Uruguay, the UK, Jamaica, Panama, Trinidad & Tobago and other countries in the Caribbean in which the Bank operates. The most significant other benefit plans provided by the Bank are in Canada. Key assumptions The financial information reported below in respect of pension and other benefit plans are based on a number of assumptions. The most significant assumption is the discount rate used to determine the defined benefit obligation, which is set by reference to the yields on high quality corporate bonds with matching durations. Prior to 2016, the discount rate used to determine the annual benefit expense was the same as the rate used to determine the defined benefit obligation. Beginning in 2016, separate discount rates were used to determine the annual benefit expense in Canada and the US. These rates were determined with reference to the yields on high quality corporate bonds with durations that match the various components of the annual defined benefit expense. The discount rate used to determine the annual benefit expense for all other plans continues to be same as the rate used to determine the defined benefit obligation. Other assumptions set by management are determined in reference to market conditions, plan-level experience, best practices and future expectations. The key weighted-average assumptions used by the Bank for the measurement of the benefit obligation and benefit expense for all of the Bank’s principal plans are summarized in the table in f) below. 190 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Risk management The Bank’s defined benefit pension plans and other benefit plans expose the Bank to a number of risks. Some of the more significant risks include interest rate risk, investment risk, longevity risk and health care cost increases, among others. These risks could result in higher defined benefit expense and a higher defined benefit obligation to the extent that: Š there is a decline in discount rates; and/or Š plan assets returns are less than expected; and/or Š plan members live longer than expected; and/or Š health care costs are higher than assumed. In addition to the governance structure and policies in place, the Bank manages risks by regularly monitoring market developments and asset investment performance. The Bank also monitors regulatory and legislative changes along with demographic trends and revisits the investment strategy and/or plan design as warranted. (a) Relative size of plan obligations and assets For the year ended October 31, 2016 Percentage of total benefit obligations Percentage of total plan assets Percentage of total benefit expense(1) For the year ended October 31, 2015 Percentage of total benefit obligations Percentage of total plan assets Percentage of total benefit expense(1) Pension plans Other benefit plans Canada SPP Other International Canada International 73% 11% 76% 6% 76% 17% 16% 18% 7% 63% 19% 46% 37% 81% 54% Pension plans Other benefit plans Canada SPP Other International Canada International 72% 11% 6% 76% 78% 16% 17% 18% 6% 62% 20% 63% 38% 80% 37% (1) Excludes non-routine benefit expense items such as past service costs, curtailment charges and settlement charges. (b) Cash contributions and payments The table below shows the cash contributions and payments made by the Bank to its principal plans in 2016, and the two prior years. Contributions to the principal plans for the year ended October 31 ($ millions) 2016 2015 2014 Defined benefit pension plans (cash contributions to fund the plans, including paying beneficiaries under the unfunded pension arrangements) SPP All other plans Other benefit plans (cash contributions mainly in the form of benefit payments to beneficiaries) Defined contribution pension plans (cash contributions) Total contributions(1) $ 187 77 45 31 $ 340 $ 236 60 42 29 $ 367 $ 268 75 46 21 $ 410 (1) Based on preliminary estimates, the Bank expects to make contributions of $174 to the SPP, $216 to all other defined benefit pension plans, $54 to other benefit plans and $32 to all other defined contribution plans for the year ending October 31, 2017. (c) Funded and unfunded plans The excess (deficit) of the fair value of assets over the benefit obligation at the end of the year includes the following amounts for plans that are wholly unfunded and plans that are wholly or partly funded. As at October 31 ($ millions) 2016 2015 2014 2016 2015 2014 Benefit obligation Benefit obligation of plans that are wholly unfunded Benefit obligation of plans that are wholly or partly funded $ 408 8,731 $ 373 7,740 $ 376 7,571 $ 1,310 372 $ 1,231 408 $ 1,201 418 Pension plans Other benefit plans Funded status Benefit obligation of plans that are wholly or partly funded Fair value of assets Excess (deficit) of fair value of assets over benefit obligation of wholly or partly funded plans Benefit obligation of plans that are wholly unfunded Excess (deficit) of fair value of assets over total benefit obligation Effect of asset limitation and minimum funding requirement $ 8,731 7,770 $ 7,740 7,615 $ 7,571 7,323 $ 372 284 $ 408 307 $ 418 341 $ (961) 408 $ $(1,369) (60) $ $ $ (125) 373 (498) (41) $ $ $ (248) 376 (624) (76) $ (88) $ 1,310 $(1,398) – $ (101) $ 1,231 $ (1,332) – $ (77) $ 1,201 $ (1,278) – Net asset (liability) at end of year $(1,429) $ (539) $ (700) $(1,398) $ (1,332) $ (1,278) 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 191 CONSOLIDATED FINANCIAL STATEMENTS (d) Financial information The following tables present financial information related to the Bank’s principal plans. For the year ended October 31 ($ millions) Change in benefit obligation Benefit obligation at beginning of year Current service cost Interest cost on benefit obligation Employee contributions Benefits paid Actuarial loss (gain) Past service cost Business combination Settlements Foreign exchange Benefit obligation at end of year Pension plans Other benefit plans 2016 2015 2014 2016 2015 2014 $ 8,113 284 314 24 (593) 1,119 (16) – – (106) $ 9,139 $ 7,947 304 350 23 (498) 152 (241) – (48) 124 $ 8,113 $ 6,940 262 342 21 (393) 731 (19) – – 63 $ 7,947 $ 1,639 39 77 – (71) 95 (77) 9 – (29) $ 1,682 $ 1,619 43 84 – (73) (52) 3 – (2) 17 $ 1,639 $ 1,510 41 84 – (66) 35 7 – (23) 31 $ 1,619 275 264 24 (593) (12) – – (113) $ 7,770 $ (1,369) (60) $ (1,429) $ 184 (1,613) $ (1,429) $ $ $ $ $ 284 9 13 (16) – – 290 31 (275) 1,119 18 862 $ 1,183 Change in fair value of assets Fair value of assets at beginning of year Interest income on fair value of assets Return on plan assets in excess of interest income on fair value of assets Employer contributions Employee contributions Benefits paid Administrative expenses Business combination Settlements Foreign exchange Fair value of assets at end of year Funded status Excess (deficit) of fair value of assets over benefit obligation at end Effect of asset limitation and minimum funding requirement(1) Net asset (liability) at end of year Recorded in: Other assets in the Bank’s Consolidated Statement of Financial Other liabilities in the Bank’s Consolidated Statement of Financial of year Position Position Net asset (liability) at end of year Annual benefit expense Current service cost Net interest expense (income) Administrative expenses Past service costs Amount of settlement (gain) loss recognized Remeasurement of other long-term benefits Benefit expense (income) recorded in the Consolidated Statement of Income Defined contribution benefit expense Remeasurements (Return) on plan assets in excess of interest income on fair value of assets Actuarial loss (gain) on benefit obligation Change in the asset limitation Remeasurements recorded in OCI Total benefit cost Additional details on actual return on assets and actuarial (gains) Actual return on assets (net of administrative expenses) Actuarial (gains) and losses from changes in demographic and losses assumptions Actuarial (gains) and losses from changes in financial assumptions Actuarial (gains) and losses from changes in experience Additional details on fair value of pension plan assets invested In Scotiabank securities (stock, bonds) In property occupied by Scotiabank Change in asset ceiling/onerous liability Asset ceiling /onerous liability at end of prior year Interest expense Remeasurements Foreign exchange Asset ceiling /onerous liability at end of year $ 7,615 310 $ 7,323 343 $ 6,647 343 $ 55 296 23 (498) (12) – (39) 124 $ 7,615 310 343 21 (393) (9) – – 61 $ 7,323 $ 307 22 5 45 – (71) – 2 – (26) 284 $ $ 341 23 (12) 42 – (73) – – – (14) 307 $ $ 332 25 11 46 – (66) – – (18) 11 341 $ $ $ $ $ $ $ $ $ $ (498) (41) (539) 183 (722) (539) 304 15 10 (241) (9) – 79 29 (55) 152 (49) 48 156 $ $ $ $ $ $ $ $ $ $ 262 6 9 (19) – – 258 21 (310) 731 (8) 413 692 (624) (76) (700) $ (1,398) – $ (1,398) $ (1,332) – $ (1,332) $ (1,278) – $ (1,278) 117 $ – $ – $ – (817) (700) (1,398) $ (1,398) (1,332) $ (1,332) (1,278) $ (1,278) $ $ $ $ $ $ $ $ $ 39 55 – (77) – (20) (3) – (3) 113 – 110 107 27 (5) 133 (33) – – – – – – – $ $ $ $ $ $ $ $ $ 43 60 – 4 (2) 4 109 – 13 (58) – (45) 64 11 (22) (28) (2) – – – – – – – $ $ $ $ $ $ $ $ $ 41 59 – 7 (5) 5 107 – (8) 27 – 19 126 36 (26) 102 (41) – – – – – – – $ 573 $ 386 $ 644 $ $ 9 1,116 (6) 410 5 41 5 18 (4) 60 $ $ 91 22 39 404 5 77 8 (49) 5 41 $ $ 54 645 32 556 4 77 7 (8) – 76 (1) The recognized asset is limited by the present value of economic benefits available from a reduction in future contributions to a plan and from the ability to pay plan expenses from the fund. 192 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T (e) Maturity profile of the defined benefit obligation The weighted average duration of the total benefit obligation at October 31, 2016 is 15.3 years (2015 – 15.3 years, 2014 – 14.7 years). For the year ended October 31 Disaggregation of the benefit obligation (%) Canada Active members Inactive and retired members Total Mexico Active members Inactive and retired members Total United States Active members Inactive and retired members Total Pension plans Other benefit plans 2016 2015 2014 2016 2015 2014 60% 58% 58% 33% 35% 36% 40% 42% 42% 67% 65% 64% 100% 100% 100% 100% 100% 100% 29% 30% 35% 57% 58% 59% 71% 70% 65% 43% 42% 41% 100% 100% 100% 100% 100% 100% 33% 39% 40% 38% 37% 36% 67% 61% 60% 62% 63% 64% 100% 100% 100% 100% 100% 100% C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (f) Key assumptions (%) The key weighted-average assumptions used by the Bank for the measurement of the benefit obligation and benefit expense for all of the Bank’s principal plans are summarized as follows: For the year ended October 31 Benefit obligation at end of year Discount rate – all plans Discount rate – Canadian plans only Rate of increase in future compensation(1) Benefit expense (income) for the year Discount rate – All plans Discount rate for defined benefit obligations Discount rate for net interest cost Discount rate for service cost Discount rate for interest on service cost Discount rate – Canadian plans only Discount rate for defined benefit obligations Discount rate for net interest cost Discount rate for service cost Discount rate for interest on service cost Rate of increase in future compensation(1) Health care cost trend rates at end of year Initial rate Ultimate rate Year ultimate rate reached Assumed life expectancy in Canada (years) Life expectancy at 65 for current pensioners – male Life expectancy at 65 for current pensioners – female Life expectancy at 65, for future pensioners currently aged 45 – male Life expectancy at 65, for future pensioners currently aged 45 – female Assumed life expectancy in Mexico (years) Life expectancy at 65 for current pensioners – male Life expectancy at 65 for current pensioners – female Life expectancy at 65, for future pensioners currently aged 45 – male Life expectancy at 65, for future pensioners currently aged 45 – female Assumed life expectancy in United States (years) Life expectancy at 65 for current pensioners – male Life expectancy at 65 for current pensioners – female Life expectancy at 65, for future pensioners currently aged 45 – male Life expectancy at 65, for future pensioners currently aged 45 – female Pension plans Other benefit plans 2016 2015 2014 2016 2015 2014 3.86% 4.64% 4.46% 4.74% 5.33% 5.24% 3.60% 4.40% 4.20% 3.42% 4.27% 4.12% 2.72% 2.75% 2.77% 4.09% 4.41% 4.51% 4.64% 4.46% 5.04% 5.33% 5.24% 5.56% 4.03% 4.46% 5.04% 4.91% 5.24% 5.56% 4.83% 4.46% 5.04% 5.62% 5.24% 5.56% 4.31% 4.46% 5.04% 5.56% 5.24% 5.56% 4.40% 4.20% 4.80% 4.27% 4.12% 4.80% 3.70% 4.20% 4.80% 3.67% 4.12% 4.80% 4.60% 4.20% 4.80% 4.54% 4.12% 4.80% 4.00% 4.20% 4.80% 4.44% 4.12% 4.80% 2.75% 2.77% 2.84% 4.41% 4.51% 4.49% n/a n/a n/a 23.2 24.3 24.2 25.3 21.3 23.8 21.7 24.0 23.0 24.7 23.7 25.6 n/a n/a n/a 23.1 24.3 24.1 25.2 21.3 23.8 21.7 24.0 22.3 23.5 23.0 25.4 n/a n/a n/a 23.0 24.2 24.0 25.1 21.3 23.8 21.7 24.0 20.5 22.6 19.9 22.0 6.12% 6.29% 6.37% 4.93% 4.97% 5.02% 2030 2030 2029 23.2 24.3 24.2 25.3 21.3 23.8 21.7 24.0 23.0 24.7 23.7 25.6 23.1 24.3 24.1 25.2 21.3 23.8 21.7 24.0 22.3 23.5 23.0 25.4 23.0 24.2 24.0 25.1 21.3 23.8 21.7 24.0 20.5 22.6 19.9 22.0 (1) The weighted-average rates of increase in future compensation shown for other benefit plans do not include Canadian flexible post-retirement benefits plans established in fiscal 2005, as they are not impacted by future compensation increases. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 193 CONSOLIDATED FINANCIAL STATEMENTS (g) Sensitivity analysis The sensitivity analysis presented below represents the impact of a change in a single assumption with other assumptions left unchanged. For purposes of the sensitivity analysis, the present value of the defined benefit obligation has been calculated using the projected unit credit method at the end of the reporting period, which is the same as that applied in calculating the defined benefit obligation recognized in the statement of financial position. For the year ended October 31, 2016 ($ millions) Impact of the following changes: 1% decrease in discount rate 0.25% increase in rate of increase in future compensation 1% increase in health care cost trend rate 1% decrease in health care cost trend rate 1 year increase in Canadian life expectancy 1 year increase in Mexican life expectancy 1 year increase in the United States life expectancy Pension plans Other benefit plans Benefit obligation Benefit expense Benefit obligation Benefit expense $ 1,697 102 n/a n/a 170 3 9 $ 100 7 n/a n/a 7 – – $ 284 1 166 (132) 27 4 5 $ 16 – 17 (13) 1 – – (h) Assets The Bank’s principal pension plans’ assets are generally invested with the long-term objective of maximizing overall expected returns, at an acceptable level of risk relative to the benefit obligation. A key factor in managing long-term investment risk is asset mix. Investing the pension assets in different asset classes and geographic regions helps to mitigate risk and to minimize the impact of declines in any single asset class, particular region or type of investment. Investment management firms – including related-party managers – are typically hired and assigned specific mandates within each asset class. Pension plan asset mix guidelines are set for the long term, and are documented in each plan’s investment policy. Asset mix policy typically also reflects the nature of the plan’s benefit obligations. Legislation places certain restrictions on asset mix – for example, there are usually limits on concentration in any one investment. Other concentration and quality limits are also set forth in the investment policies. The use of derivatives is generally prohibited without specific authorization; currently, the main use of derivatives is for currency hedging. Asset mix guidelines are reviewed at least once each year, and adjusted, where appropriate, based on market conditions and opportunities. However, large asset class shifts are rare, and typically reflect a change in the pension plan’s situation (e.g. a plan termination). Actual asset mix is reviewed regularly, and rebalancing back to target asset mix is considered – as needed – generally on a semi-annual basis. The Bank’s other benefit plans are generally not funded; the assets reflected for these other benefit plans are related to programs in Canada and Mexico. The tables below shows the weighted-average actual and target asset allocations for the Bank’s principal plans at October 31, by asset category. Pension plans Other benefit plans Actual 2016 Actual 2015 Actual 2014 Actual 2016 Actual 2015 Actual 2014 2% 2% 4% 2% 2% 2% 44% 16% 60% 4% 27% 31% 44% 19% 63% 5% 25% 30% 42% 22% 64% 6% 23% 29% 45% –% 45% 29% 24% 53% 45% –% 45% 28% 25% 53% 46% –% 46% 28% 24% 52% 1% 6% 7% –% –% –% 100% 100% 100% 100% 100% 100% –% 3% 3% –% 5% 5% –% –% –% –% –% –% Pension plans Other benefit plans –% 60% 33% 7% 100% 2% 45% 53% –% 100% Asset category % Cash and cash equivalents Equity investments Quoted in an active market Non quoted Fixed income investments Quoted in an active market Non quoted Other Quoted in an active market Non quoted Total Target asset allocation at October 31, 2016 Asset category % Cash and cash equivalents Equity investments Fixed income investments Other Total 194 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 28 Operating Segments Scotiabank is a diversified financial services institution that provides a wide range of financial products and services to retail, commercial and corporate customers around the world. The Bank’s businesses are grouped into three business lines: Canadian Banking, International Banking and Global Banking and Markets. Other smaller business segments are included in the Other segment. The results of these business segments are based upon the internal financial reporting systems of the Bank. The accounting policies used in these segments are generally consistent with those followed in the preparation of the consolidated financial statements as disclosed in Note 3 of the consolidated financial statements. Notable accounting measurement differences are: Š tax normalization adjustments related to the gross-up of income from associated corporations. This adjustment normalizes the effective tax rate in the divisions to better present the contribution of the associated companies to the divisional results. Š the grossing up of tax-exempt net interest income and non-interest income to an equivalent before-tax basis for those affected segments. These differences in measurement enable comparison of net interest income and non-interest income arising from taxable and tax-exempt sources. Scotiabank’s results, and average assets and liabilities, allocated by these operating segments, are as follows: For the year ended October 31, 2016 Taxable equivalent basis ($ millions) Net interest income(2) Non-interest income(3) Total revenues Provision for credit losses Depreciation and amortization Non-interest expenses Income tax expense Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Average assets ($ billions) Average liabilities ($ billions) Canadian Banking International Banking Global Banking and Markets Other(1) Total $ 7,024 5,164 12,188 832 340 5,984 1,296 $6,359 3,482 9,841 1,281 265 5,258 707 $1,293 3,139 4,432 249 68 1,972 572 $(384) 273 (111) 50 11 642 (545) $14,292 12,058 26,350 2,412 684 13,856 2,030 $ 3,736 $2,330 $1,571 $(269) $ 7,368 – 3,736 309 232 251 2,079 143 109 – 1,571 351 270 – (269) 111 247 251 7,117 914 858 (1) (2) (3) Includes all other smaller operating segments and corporate adjustments, such as the elimination of the tax-exempt income gross-up reported in net interest income and non- interest income and provision for income taxes for the year ended October 31, 2016 amounting to $299 to arrive at the amounts reported in the Consolidated Statement of Income, differences in the actual amount of costs incurred and charged to the operating segments. Interest income is reported net of interest expense as management relies primarily on net interest income as a performance measure. Includes net income from investments in associated corporations for Canadian Banking – $78; International Banking – $473 and Other – $(137). For the year ended October 31, 2015 Taxable equivalent basis ($ millions) Net interest income(2) Non-interest income(3) Total revenues Provision for credit losses Depreciation and amortization Non-interest expenses Income tax expense Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Average assets ($ billions) Average liabilities ($ billions) $ Canadian Banking 6,415 4,832 11,247 687 272 5,742 1,202 International Banking Global Banking and Markets Other(1) Total $ 5,706 3,137 $ 1,071 2,953 $ (100) 35 $ 13,092 10,957 8,843 1,128 242 4,853 568 4,024 67 57 1,789 558 (65) 60 13 73 (475) 24,049 1,942 584 12,457 1,853 $ 3,344 $ 2,052 $ 1,553 $ 264 $ 7,213 – 3,344 300 218 199 1,853 128 94 – 1,553 342 240 – 264 91 257 199 7,014 861 809 (1) (2) (3) Includes all other smaller operating segments and corporate adjustments, such as the elimination of the tax-exempt income gross-up reported in net interest income and non- interest income and provision for income taxes for the year ended October 31, 2015 amounting to $390, to arrive at the amounts reported in the Consolidated Statement of Income, differences in the actual amount of costs incurred and charged to the operating segments. Interest income is reported net of interest expense as management relies primarily on net interest income as a performance measure. Includes net income from investments in associated corporations for Canadian Banking – $66; International Banking – $476 and Other – $(137). 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 195 CONSOLIDATED FINANCIAL STATEMENTS For the year ended October 31, 2014 Taxable equivalent basis ($ millions) Net interest income(2) Non-interest income(3) Total revenues Provision for credit losses Depreciation and amortization Non-interest expenses Income tax expense Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Average assets ($ billions) Average liabilities ($ billions) $ Canadian Banking 5,996 5,263 11,259 663 235 5,564 1,113 International Banking $ 5,155 2,945 Global Banking and Markets $ 1,064 3,167 8,100 1,024 224 4,466 544 4,231 16 56 1,824 665 Other(1) Total $ 90 (76) 14 – 11 221 (320) $ 12,305 11,299 23,604 1,703 526 12,075 2,002 $ 3,684 $ 1,842 $ 1,670 $ 102 $ 7,298 1 3,683 292 208 226 1,616 115 85 – 1,670 311 217 – 102 78 238 227 7,071 796 748 (1) (2) (3) Includes all other smaller operating segments and corporate adjustments, such as the elimination of the tax-exempt income gross-up reported in net interest income and non- interest income and provision for income taxes for the year ended October 31, 2014 amounting to $354, to arrive at the amounts reported in the Consolidated Statement of Income, differences in the actual amount of costs incurred and charged to the operating segments. Interest income is reported net of interest expense as management relies primarily on net interest income as a performance measure. Includes net income from investments in associated corporations for Canadian Banking – $157; International Banking – $411 and Other – $(140). Geographical segmentation(1) The following table summarizes the Bank’s financial results by geographic region. Revenues and expenses which have not been allocated back to specific operating business lines are reflected in corporate adjustments. For the year ended October 31, 2016 ($ millions) Net interest income Non-interest income(1) Total revenues(2) Provision for credit losses Non-interest expenses Income tax expense $ Canada 7,022 6,893 13,915 876 7,339 1,235 $ United States 479 871 1,350 112 633 155 $ Mexico 1,224 554 1,778 225 1,121 69 $ Peru 1,231 600 1,831 315 740 201 $ Chile 763 325 1,088 113 605 45 Colombia $ 674 419 1,093 320 550 89 Other International $ 2,950 2,409 5,359 401 3,036 497 $ 4,465 $ 450 $ 363 $ 575 $ 325 $ 134 $ 1,425 Corporate adjustments Net income Net income attributable to non- controlling interests in subsidiaries Net income attributable to equity holders of the Bank Total average assets ($ billions) Corporate adjustments Total average assets, including corporate adjustments $ 529 $ 126 $ 27 $ 23 $ 20 $ 10 $ 165 Total 14,343 12,071 26,414 2,362 14,024 2,291 7,737 (369) 7,368 251 7,117 900 14 914 $ $ $ $ $ $ Includes net income from investments in associated corporations for Canada – $78; Peru – $5 and Other International – $468. (1) (2) Revenues are attributed to countries based on where services are performed or assets are recorded. For the year ended October 31, 2015 ($ millions) Net interest income Non-interest income(1) Total revenues(2) Provision for credit losses Non-interest expenses Income tax expense Corporate adjustments Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Total average assets ($ billions) Corporate adjustments Total average assets, including corporate adjustments Canada United States Mexico Peru Chile Colombia $ 6,458 6,272 $ 472 882 $1,246 561 $1,077 601 12,730 728 6,936 1,038 1,354 6 507 267 1,807 260 1,160 27 1,678 266 744 195 $554 231 785 108 431 24 $ 677 372 1,049 246 541 84 Other International $2,631 2,163 4,794 268 2,745 401 $ 4,028 $ 574 $ 360 $ 473 $222 $ 178 $1,380 $ 502 $ 125 $ 26 $ 21 $ 17 $ 10 $ 148 Total $13,115 11,082 24,197 1,882 13,064 2,036 $ 7,215 (2) $ 7,213 199 $ 7,014 $ $ 849 12 861 Includes net income from investments in associated corporations for Canada – $66; Peru – $4 and Other International – $472. (1) (2) Revenues are attributed to countries based on where services are performed or assets are recorded. 196 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T For the year ended October 31, 2014 ($ millions) Net interest income Non-interest income(1) Total revenues(2) Provision for credit losses Non-interest expenses Income tax expense Corporate adjustments Net income Net income attributable to non-controlling interests in subsidiaries Net income attributable to equity holders of the Bank Total average assets ($ billions) Corporate adjustments Total average assets, including corporate adjustments Canada United States Mexico Peru Chile Colombia $ 6,219 7,071 $ 440 810 $1,180 599 $ 935 534 $407 226 13,290 662 6,986 1,156 1,250 6 513 237 1,779 240 1,154 35 1,469 267 645 175 633 74 348 16 $ 726 391 1,117 145 556 141 Other International $2,443 2,049 4,492 309 2,495 340 $ 4,486 $ 494 $ 350 $ 382 $195 $ 275 $1,348 $ 470 $ 117 $ 24 $ 17 $ 15 $ 10 $ 130 C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Total $12,350 11,680 24,030 1,703 12,697 2,100 $ 7,530 (232) $ 7,298 227 $ 7,071 $ $ 783 13 796 Includes net income from investments in associated corporations for Canada – $156; Peru – $6 and Other International – $405. (1) (2) Revenues are attributed to countries based on where services are performed or assets are recorded. 29 Related Party Transactions Compensation of key management personnel of the Bank Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Bank, directly or indirectly, and comprise the directors of the Bank, the President and Chief Executive Officer, certain direct reports of the President and Chief Executive Officer and Group Heads. For the year ended October 31 ($ millions) Salaries and cash incentives(1) Equity-based payment(2) Pension and other benefits(1) Total (1) Expensed during the year. (2) Awarded during the year. 2016 2015 $ $ 20 24 3 47 $ $ 13 20 3 36 Directors can use some or all of their director fees earned to buy common shares of the Bank at market rates through the Directors’ Share Purchase Plan. Non-officer directors may elect to receive all or a portion of their fees in the form of deferred stock units which vest immediately. Refer to Note 25 for further details of these plans. Loans and deposits of key management personnel Loans are currently granted to key management personnel at market terms and conditions. As at October 31 ($ millions) Loans Deposits 2016 2015 $ $ 6 11 $ $ 5 5 The Bank’s committed credit exposure to companies controlled by directors totaled $99.5 million as at October 31, 2016 (2015 – $182.9 million), while actual utilized amounts were $3.9 million (2015 – $6.7 million). Transactions with associates and joint ventures In the ordinary course of business, the Bank provides normal banking services and enters into transactions with its associated and other related corporations on terms similar to those offered to non-related parties. If these transactions are eliminated on consolidation, they are not disclosed as related party transactions. Transactions between the Bank and its associated companies and joint ventures also qualify as related party transactions and were recorded as follows: As at and for the year ended October 31 ($ millions) Net income / (loss) Loans Deposits Guarantees and commitments $ 2016 (45) 788 338 99 $ 2015 (27) 747 187 84 $ 2014 11 553 223 75 Scotiabank principal pension plan The Bank manages assets of $1.9 billion (2015 – $2.0 billion) which is a portion of the Scotiabank principal pension plan assets and earned $4 million (2015 – $4.0 million) in fees. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 197 CONSOLIDATED FINANCIAL STATEMENTS 30 Principal Subsidiaries and Non-Controlling Interests in Subsidiaries (a) Principal subsidiaries(1) The following table presents the major operating subsidiaries the Bank owns, directly or indirectly. All of these subsidiaries are included in the Bank’s consolidated financial statements. As at October 31 ($ millions) Canadian 1832 Asset Management L.P. BNS Investments Inc. Montreal Trust Company of Canada Hollis Canadian Bank HollisWealth Inc. National Trustco Inc. The Bank of Nova Scotia Trust Company National Trust Company RoyNat Inc. Scotia Capital Inc. Scotia Dealer Advantage Inc. Scotia Life Insurance Company Scotia Mortgage Corporation Scotia Securities Inc. Tangerine Bank International Banco Colpatria Multibanca Colpatria S.A. (51%) The Bank of Nova Scotia Berhad The Bank of Nova Scotia International Limited BNS Asia Limited The Bank of Nova Scotia Trust Company (Bahamas) Limited Grupo BNS de Costa Rica, S.A. Scotiabank & Trust (Cayman) Ltd. Scotiabank (Bahamas) Limited Scotiabank (British Virgin Islands) Limited Scotiabank (Hong Kong) Limited Scotiabank (Ireland) Designated Activity Company Scotiabank (Turks and Caicos) Ltd. Grupo Financiero Scotiabank Inverlat, S.A. de C.V. (97.4%) Nova Scotia Inversiones Limitada Scotiabank Chile, S.A. (99.6%) Scotia Holdings (US) Inc.(2) Scotiabanc Inc. Scotia Capital (USA) Inc.(2)(3) Scotia International Limited Scotiabank Anguilla Limited Scotiabank Brasil S.A. Banco Multiplo Scotiabank Caribbean Holdings Ltd. Scotia Group Jamaica Limited (71.8%) The Bank of Nova Scotia Jamaica Limited Scotia Investments Jamaica Limited (77.0%) Scotiabank (Belize) Ltd. Scotiabank Trinidad and Tobago Limited (50.9%) Scotiabank de Puerto Rico Scotiabank El Salvador, S.A. (99.6%) Scotiabank Europe plc Scotiabank Peru S.A.A. (98.05%) Principal office Toronto, Ontario Toronto, Ontario Montreal, Quebec Toronto, Ontario Toronto, Ontario Toronto, Ontario Toronto, Ontario Stratford, Ontario Calgary, Alberta Toronto, Ontario Burnaby, British Columbia Toronto, Ontario Toronto, Ontario Toronto, Ontario Toronto, Ontario Bogota, Colombia Kuala Lumpur, Malaysia Nassau, Bahamas Singapore Nassau, Bahamas San Jose, Costa Rica Grand Cayman, Cayman Islands Nassau, Bahamas Road Town, Tortola, B.V.I. Hong Kong, China Dublin, Ireland Providenciales, Turks and Caicos Islands Mexico, D.F., Mexico Santiago, Chile Santiago, Chile Houston, Texas Houston, Texas New York, New York Nassau, Bahamas The Valley, Anguilla Sao Paulo, Brazil Bridgetown, Barbados Kingston, Jamaica Kingston, Jamaica Kingston, Jamaica Belize City, Belize Port of Spain, Trinidad and Tobago San Juan, Puerto Rico San Salvador, El Salvador London, United Kingdom Lima, Peru Carrying value of shares 2016 2015 $ 1,762 13,733 $ 1,241 12,746 411 3,499 650 175 1,194 509 166 941 80 3,489 392 3,632 608 58 1,598 445 206 797 53 3,443 1,302 311 17,815 1,259 288 16,310 3,141 3,200 2,986 2,585 387 899 225 1,658 145 1,311 1,371 646 2,546 4,046 1,316 597 2,472 3,418 (1) The Bank (or immediate parent of an entity) owns 100% of the outstanding voting shares of each subsidiary unless otherwise noted. (2) The carrying value of this subsidiary is included with that of its parent, BNS Investments Inc. (3) The carrying value of this subsidiary is included with that of its parent, Scotia Holdings (US) Inc. 198 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Subsidiaries may have a different reporting date from that of the Bank of October 31. Dates may differ for a variety of reasons including local reporting requirements or tax laws. In accordance with our accounting policies, for the purpose of inclusion in the consolidated financial statements of the Bank, adjustments are made where significant for subsidiaries with different reporting dates. (b) Non-controlling interests in subsidiaries The Bank’s significant non-controlling interests in subsidiaries are comprised of the following entities: October 31 ($ millions) Banco Colpatria Multibanca Colpatria S.A.(1) Scotia Group Jamaica Limited Scotiabank Trinidad and Tobago Limited Cencosud Administradora de Tarjetas S.A. Other As at For the year ended 2016 2015 2016 2015 Non-controlling interest % Non-controlling interests in subsidiaries Non-controlling interests in subsidiaries Net income attributable to non-controlling interests in subsidiaries Dividends paid to non-controlling interest Net income attributable to non-controlling interests in subsidiaries Dividends paid to non-controlling interest 49.0% 28.2% 49.1% 49.0% 0.1% - 49.0%(2) $ 471 311 359 139 290 $ 417 307 353 111 272 $ 85 36 62 38 30 $ 25 17 54 10 10 $ 75 37 54 – 33 $ 27 17 33 – 9 $ 86 Total $ 1,570 $ 1,460 $ 251 $ 116 $ 199 (1) Non-controlling interest holders for Banco Colpatria Multibanca Colpatria S.A. have a right to sell their holding to the Bank after the end of 7th anniversary (January 17, 2019) and at subsequent pre-agreed intervals, into the future, at fair market value that can be settled at the Bank’s discretion, by issuance of common shares or cash. (2) Range of non-controlling interest % for other subsidiaries. Summarized financial information of the Bank’s subsidiaries with significant non-controlling interests are as follows: ($ millions) Banco Colpatria Multibanca Colpatria S.A. Scotia Group Jamaica Limited Scotiabank Trinidad and Tobago Limited Cencosud Administradora de Tarjetas S.A. ($ millions) Banco Colpatria Multibanca Colpatria S.A. Scotia Group Jamaica Limited Scotiabank Trinidad and Tobago Limited Cencosud Administradora de Tarjetas S.A. 31 Non-Interest Income As at and for the year ended October 31, 2016 Total comprehensive income $ 152 71 118 85 Total assets $ 11,081 5,001 4,780 2,114 Total liabilities $ 10,345 3,860 3,889 1,755 As at and for the year ended October 31, 2015 Total comprehensive income $ (165) 263 214 (1) Total assets $ 10,969 4,877 4,670 1,772 Total liabilities $ 10,207 3,667 3,731 1,265 Revenue $ 973 407 318 350 Revenue $ 942 383 283 125 The following table presents details of banking revenues and wealth management revenues in non-interest income. For the year ended October 31 ($ millions) Banking Card revenues Deposit and payment services Credit fees Other Banking fee related expenses Total banking revenues Wealth management Mutual funds Brokerage fees Investment management and trust Total wealth management revenues 2016 2015 2014 $ 1,359 1,279 1,154 436 4,228 559 $ 1,089 1,235 1,053 406 3,783 423 $ 933 1,183 1,014 379 3,509 339 $ 3,669 $ 3,360 $ 3,170 $ 1,624 1,010 648 $ 3,282 $ 1,619 1,006 644 $ 3,269 $ 1,468 942 613 $ 3,023 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 199 CONSOLIDATED FINANCIAL STATEMENTS 32 Trading Revenues The following table presents details of trading revenues. For the year ended October 31 ($ millions) Interest rate and credit Equities Commodities Foreign exchange Other Total 33 Earnings Per Share For the year ended October 31 ($ millions) Basic earnings per common share Net income attributable to common shareholders Weighted average number of common shares outstanding (millions) Basic earnings per common share(1) (in dollars) Diluted earnings per common share Net income attributable to common shareholders Adjustments to net income due to share-based payment options and others(2) Net income attributable to common shareholders (diluted) Weighted average number of common shares outstanding (millions) Adjustments to average shares due to share-based payment options and others(2) (millions) Weighted average number of diluted common shares outstanding (millions) Diluted earnings per common share(1) (in dollars) $ 2016 613 101 376 262 51 $ 2015 400 177 345 201 62 $ 2014 415 92 359 208 40 $ 1,403 $ 1,185 $ 1,114 2016 2015 2014 $ 6,987 1,204 $ 6,897 1,210 $ 6,916 1,214 $ 5.80 $ 5.70 $ 5.69 $ 6,987 83 $ 6,897 86 $ 6,916 8 $ 7,070 $ 6,983 $ 6,924 1,204 22 1,226 5.77 $ 1,210 22 1,232 5.67 $ 1,214 8 1,222 5.66 $ (1) Earnings per share calculations are based on full dollar and share amounts. (2) Certain tandem stock appreciation rights or options that the Bank may settle at its own discretion by issuing common shares were not included in the calculation of diluted earnings per share as they were anti-dilutive. 34 Guarantees, Commitments and Pledged Assets (a) Guarantees The Bank enters into various types of guarantees and indemnifications in the normal course of business. Guarantees represent an undertaking to another party to make a payment to that party when certain specified events occur. The various guarantees and indemnifications that the Bank provides with respect to its customers and other third parties are presented below: As at October 31 ($ millions) Standby letters of credit and letters of guarantee Liquidity facilities Derivative instruments Indemnifications 2016 2015 Maximum potential amount of future Maximum potential amount of future payments(1) payments(1) $ 34,520 5,814 4,129 597 $ 30,944 3,874 5,206 568 (1) The maximum potential amount of future payments represents those guarantees that can be quantified and excludes other guarantees that cannot be quantified. As many of these guarantees will not be drawn upon and the maximum potential amount of future payments listed above does not consider the possibility of recovery under recourse or collateral provisions, the above amounts are not indicative of future cash requirements, credit risk, or the Bank’s expected losses from these arrangements. Standby letters of credit and letters of guarantee (i) Standby letters of credit and letters of guarantee are irrevocable undertakings by the Bank on behalf of a customer, to make payments to a third party in the event that the customer is unable to meet its obligations to the third party. Generally, the term of these guarantees does not exceed four years. The types and amounts of collateral security held by the Bank for these guarantees is generally the same as for loans. As at October 31, 2016, $19 million (2015 – $4 million) was included in other liabilities in the Consolidated Statement of Financial Position with respect to these guarantees. Liquidity facilities (ii) The Bank’s backstop liquidity facilities are committed liquidity and provided to asset-backed commercial paper conduits, administered by the Bank. These facilities generally provide an alternative source of financing in the event market disruption prevents the conduit from issuing commercial paper or, in some cases, when certain specified conditions or performance measures are not met. These facilities generally have a term of up to three years. 200 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (iii) Derivative instruments The Bank enters into written credit derivative contracts under which a counterparty is compensated for losses on a specified referenced asset, typically a loan or bond, if certain events occur. The Bank also enters into written option contracts under which a counterparty is granted the right, but not the obligation, to sell a specified quantity of a financial instrument at a pre-determined price on or before a set date. These written option contracts are normally referenced to interest rates, foreign exchange rates, commodity prices or equity prices. Typically, a corporate or government entity is the counterparty to the written credit derivative and option contracts that meet the characteristics of guarantees described above. The maximum potential amount of future payments disclosed in the table above relates to written credit derivatives, puts and floors. However, these amounts exclude certain derivatives contracts, such as written caps, as the nature of these contracts prevents quantification of the maximum potential amount of future payments. As at October 31, 2016, $333 million (2015 – $891 million) was included in derivative instrument liabilities in the Consolidated Statement of Financial Position with respect to these derivative instruments. Indemnifications (iv) In the ordinary course of business, the Bank enters into many contracts which contain indemnification provisions, such as purchase contracts, service agreements, trademark licensing agreements, director / officer contracts, escrow arrangements, sales of assets or businesses, outsourcing agreements, leasing arrangements, clearing system arrangements, securities lending agency agreements and structured transactions. The Bank cannot estimate the maximum potential future amount that may be payable. The Bank has not made any significant payments under such indemnifications. Historically, the Bank has not made any significant payments under these indemnities. As at October 31, 2016, $3 million (2015 – $3 million) was included in other liabilities in the Consolidated Statement of Financial Position with respect to indemnifications. (b) Other indirect commitments In the normal course of business, various other indirect commitments are outstanding which are not reflected on the Consolidated Statement of Financial Position. These may include: Š Commercial letters of credit which require the Bank to honour drafts presented by a third-party when specific activities are completed; Š Commitments to extend credit which represent undertakings to make credit available in the form of loans or other financings for specific amounts and maturities, subject to specific conditions; Š Securities lending transactions under which the Bank, acting as principal or agent, agrees to lend securities to a borrower. The borrower must fully collateralize the security loan at all times. The market value of the collateral is monitored relative to the amounts due under the agreements, and where necessary, additional collateral is obtained; and Š Security purchase commitments which require the Bank to fund future investments. These financial instruments are subject to normal credit standards, financial controls and monitoring procedures. The table below provides a detailed breakdown of the Bank’s other indirect commitments expressed in terms of the contractual amounts of the related commitment or contract which are not reflected on the Consolidated Statement of Financial Position. As at October 31 ($ millions) Commercial letters of credit Commitments to extend credit(1) Original term to maturity of one year or less Original term to maturity of more than one year Securities lending Securities purchase and other commitments Total (1) Includes liquidity facilities. (c) Lease commitments 2016 $ 777 $ 2015 921 69,865 104,380 38,668 538 64,522 101,874 41,190 682 $ 214,228 $ 209,189 Operating lease commitments The Bank leases various offices, branches and other premises under non-cancellable operating lease arrangements. The leases have various terms, escalation and renewal rights. There are no contingent rents payable. The Bank also leases equipment under non-cancellable lease arrangements. Where the Bank is the lessee, the future minimum lease payment under non-cancellable operating leases are as follows: As at October 31 ($ millions) Within one year After one year but not more than five years More than five years Total $ 2016 344 922 536 $ 2015 328 880 546 $ 1,802 $ 1,754 Building rent expense, included in premises and technology expense in the Consolidated Statement of Income, was $428 million (2015 – $433 million). 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 201 CONSOLIDATED FINANCIAL STATEMENTS (d) Assets pledged and repurchase agreements In the ordinary course of business, securities and other assets are pledged against liabilities. As well, securities are sold under repurchase agreements. The carrying value of pledged assets and details of related activities are shown below. As at October 31 ($ millions) Assets pledged to: Bank of Canada(1) Foreign governments and central banks(1) Clearing systems, payment systems and depositories(1) Assets pledged in relation to exchange-traded derivative transactions Assets pledged in relation to over-the-counter derivative transactions Assets pledged as collateral related to securities borrowing and lending Assets pledged in relation to covered bond program (Note 14) Assets pledged in relation to other securitization programs (Note 14) Assets pledged under CMHC programs (Note 13) Other Total assets pledged Obligations related to securities sold under repurchase agreements Total(2) 2016 2015 $ 25 3,080 1,400 2,128 10,505 107,901 30,491 3,919 20,672 1,031 $ 25 2,933 1,557 1,512 12,447 88,839 21,293 2,467 21,609 569 $ 181,152 87,402 $ 153,251 67,052 $ 268,554 $ 220,303 (1) (2) Includes assets pledged in order to participate in clearing and payment systems and depositories, or pledged to have access to the facilities of central banks in foreign jurisdictions. Includes assets that have been received from counterparties through normal course of business in securities financing and derivative transactions. (e) Other executory contracts The Bank and its subsidiaries have entered into certain long-term executory contracts, relating to outsourced services. The significant outsourcing arrangements have variable pricing based on utilization and are cancellable with notice. 35 Financial Instruments – Risk Management The Bank’s principal business activities result in a balance sheet that consists primarily of financial instruments. In addition, the Bank uses derivative financial instruments for both trading and hedging purposes. The principal financial risks that arise from transacting financial instruments include credit risk, liquidity risk and market risk. The Bank’s framework to monitor, evaluate and manage these risks is consistent with that in place as at October 31, 2015: (cid:129) extensive risk management policies define the Bank’s risk appetite, set the limits and controls within which the Bank and its subsidiaries can operate, and reflect the requirements of regulatory authorities. These policies are approved by the Bank’s Board of Directors, either directly or through the Risk Committee of the Board, (the Board); (cid:129) guidelines are developed to clarify risk limits and conditions under which the Bank’s risk policies are implemented; (cid:129) processes are implemented to identify, evaluate, document, report and control risk. Standards define the breadth and quality of information required to make a decision; and compliance with risk policies, limits and guidelines is measured, monitored and reported to ensure consistency against defined goals. (cid:129) Further details on the fair value of financial instruments and how these amounts were determined are provided in Note 6. Note 9 provides details on the terms and conditions of the Bank’s derivative financial instruments including notional amounts, remaining term to maturity, credit risk, and fair values of derivatives used in trading and hedging activities. (a) Credit risk Credit risk is the risk of loss resulting from the failure of a borrower or counterparty to honour its financial or contractual obligations to the Bank. The Bank’s credit risk appetite and credit risk policy are developed by its Global Risk Management (GRM) department and are reviewed and approved by the Board on an annual and biennial basis, respectively. The credit risk appetite defines target markets and risk tolerances that are developed at an all- Bank level, and then further refined at the business line level. The objectives of the credit risk appetite are to ensure that, for the Bank, including the individual business lines: (cid:129) (cid:129) (cid:129) target markets and product offerings are well defined; the risk parameters for new underwritings and for the portfolios as a whole are clearly specified; and transactions, including origination, syndication, loan sales and hedging, are managed in a manner to ensure the goals for the overall portfolio are met. The credit risk policy sets out, among other things, the credit risk rating systems and associated parameter estimates, the delegation of authority for granting credit, the provisions for credit losses and the collective allowance on performing loans. It forms an integral part of enterprise-wide policies and procedures that encompass governance, risk management and control structure. The Bank’s credit risk rating systems are designed to support the determination of key credit risk parameter estimates which measure credit and transaction risk. For non-retail exposures, parameters are associated with each credit facility through the assignment of borrower and transaction ratings. Borrower risk is evaluated using methodologies that are specific to particular industry sectors and/or business lines. The risk associated with facilities of a given borrower is assessed by considering the facilities’ structural and collateral-related elements. For retail portfolios, product specific models assign accounts into homogeneous segments using internal and external borrower/facility-level credit experience. This process provides for a meaningful differentiation of risk, and allows for appropriate and consistent estimation of loss characteristics at the model and segment level. Further details on credit risk relating to derivatives are provided in Note 9(c). 202 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T (i) Credit risk exposures Credit risk exposures disclosed below are presented based on the Basel framework utilized by the Bank i.e. exposures subject to credit risk capital. The Bank uses the Advanced Internal Ratings Based approach (AIRB) for all material Canadian, U.S., European portfolios, and effective 2011 for a significant portion of all international corporate and commercial portfolios. The remaining portfolios, including other individual portfolios, are treated under the standardized approach. Under the AIRB approach, the Bank uses internal risk parameter estimates, based on historical experience, for probability of default (PD), loss given default (LGD) and exposure at default (EAD), as defined below: (cid:129) (cid:129) (cid:129) EAD: Generally represents the expected gross exposure – outstanding amount for on-balance sheet exposure and loan equivalent amount for off-balance sheet exposure. PD: Measures the likelihood that a borrower will default within a 1-year time horizon, expressed as a percentage. LGD: Measures the severity of loss on a facility in the event of a borrower’s default, expressed as a percentage of exposure at default. Under the standardized approach, credit risk is estimated using the risk weights as prescribed by the Basel framework either based on credit assessments by external rating agencies or based on the counterparty type for non-retail exposures and product type for retail exposures. Standardized risk weights also takes into account other factors such as specific provisions for defaulted exposures, eligible collateral, and loan-to-value for real estate secured retail exposures. C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S As at October 31 ($ millions) Category By counterparty type Non-retail AIRB portfolio Corporate Bank Sovereign Standardized portfolio Corporate Bank Sovereign Total non-retail Retail(4) AIRB portfolio Real estate secured Qualifying revolving Other retail Standardized portfolio Real estate secured Other retail Total retail Total By geography(5) Canada United States Mexico Peru Chile Columbia Other International Europe Caribbean Latin America (other) All other Total 2016 Exposure at default(1) 2015 Drawn(2) Undrawn commitments Other exposures(3) Total Total $ 130,387 23,978 181,227 335,592 47,042 2,044 8,402 57,488 $ 393,080 $ 106,771 16,717 28,246 151,734 30,865 33,936 64,801 $ 216,535 $ 609,615 $ 357,268 79,932 23,965 23,931 21,354 10,239 23,164 37,900 7,891 23,971 $ $ $ 67,990 1,944 1,042 70,976 5,721 38 10 5,769 76,745 14,587 21,108 799 36,494 $ 69,777 23,740 5,429 98,946 2,919 196 – 3,115 $ 102,061 $ – – – – – – – $ 36,494 $ 113,239 – – – $ – $ 102,061 $ 69,447 27,951 1,183 1,413 782 186 5,936 1,704 522 4,115 $ 42,208 35,925 1,725 2,984 1,374 518 12,425 1,564 495 2,843 $ 268,154 49,662 187,698 505,514 55,682 2,278 8,412 66,372 $ 571,886 $ 121,358 37,825 29,045 188,228 30,865 33,936 64,801 $ 253,029 $ 824,915 $ 468,923 143,808 26,873 28,328 23,510 10,943 41,525 41,168 8,908 30,929 $ 232,963 54,922 194,445 482,330 54,870 3,081 5,508 63,459 $ 545,789 $ 132,259 34,615 27,559 194,433 27,934 26,466 54,400 $ 248,833 $ 794,622 $ 435,953 153,285 23,808 27,007 19,777 9,899 40,048 39,831 8,962 36,052 $ 609,615 $ 113,239 $ 102,061 $ 824,915 $ 794,622 (1) Exposure at default is presented after credit risk mitigation. Exposures exclude available-for-sale equity securities and other assets. (2) Non-retail drawn includes loans, acceptances, deposits with financial institutions and available-for-sale debt securities. Retail drawn includes residential mortgages, credit cards, lines of credit, and other personal loans. (3) Non-retail other exposures include off-balance sheet lending instruments such as letters of credit, letters of guarantees, securitizations including first loss protection of $20 (2015 – $48), derivatives and repo-style transactions (reverse repurchase agreements, repurchase agreements, securities lending and securities borrowing), net of related collateral. Not applicable for retail exposures. (4) During the year 2015, the Bank implemented new retail probability of default (PD), exposure at default (EAD) and loss given default (LGD) models for mortgages and term loans. (5) Geographic segmentation is based upon the location of the ultimate risk of the credit exposure. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 203 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statement of Financial Position asset categories cross-referenced to credit risk exposures The table below provides mapping of on-balance sheet asset categories that are included in the various Basel III exposure categories as presented in the credit risk exposure summary table of these consolidated financial statements. In addition, it also provides other exposures which are subject to market risk and/or other assets which are not subject to market and credit risk with a reconciliation to the balance sheet. The credit risk exposures on certain assets such as cash, precious metals, investment securities (equities) and other assets are not included on the credit risk exposure summary table. Also excluded from the credit risk exposures are certain trading assets and all assets of the Bank’s insurance subsidiaries. Credit Risk Exposures Other Exposures Drawn(1) Other Exposures Market Risk Exposures As at October 31, 2016 ($ millions) Non-retail Retail Securitization Cash and deposits with financial Repo-style Transactions OTC Derivatives Equity Also subject to Credit Risk All Other(1) Total institutions Precious metals Trading assets Securities Loans Other Financial assets designated at fair value through profit or loss Securities purchased under resale agreements and securities borrowed Derivative financial instruments Investment securities Loans: Residential mortgages(2) Personal and credit cards Business & government Allowances for credit losses(3) Customers’ liability under acceptances Property and equipment Investment in associates Goodwill and other intangibles assets Other (including Deferred tax assets) $ 44,001 $ – – 11,485 – 16 – – 68,134 104,890 – 152,720 (781) 11,978 – – – 637 – – – – – – – – – 117,839 95,825 2,489 – – – – – 383 $ $ – – – – – – $ – – – – – – $ – – – – – – – – – – – – – 11,485 – 87,287 7,936 1,853 – 205 $ – $ – – 8,442 $ 2,343 $ 46,344 8,442 – – – 832 – 2,418 7,161 – – – – – – 92,129 – – – 41,657 – – – 2,042 – 36,401 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 1,911 159 1,259 30 (3,845) – 2,520 4,299 12,141 13,871 87,287 19,421 1,853 221 92,129 41,657 72,919 222,888 99,502 162,400 (4,626) 11,978 2,520 4,299 12,141 14,891 Total $ 393,080 $ 216,536 $ 10,411 $ 92,129 $ 41,657 $ 2,042 $ 47,886 $ 105,723 $ 34,688 $ 896,266 Includes the Bank’s insurance subsidiaries’ assets and all other assets which are not subject to credit and market risks. Includes $100.9 billion in mortgages guaranteed by Canada Mortgage Housing Corporation including 90% of privately insured mortgages. (1) (2) (3) Amounts for AIRB exposures are reported gross of allowances and amounts for standardized exposures are reported net of allowances. Credit Risk Exposures Other Exposures Drawn(1) Other Exposures Market Risk Exposures As at October 31, 2015 ($ millions) Non-retail Retail Securitization Cash and deposits with financial Repo-style Transactions OTC Derivatives Equity Also subject to Credit Risk All Other(1) Total institutions Precious metals Trading assets Securities Loans Other Financial assets designated at fair value through profit or loss Securities purchased under resale agreements and securities borrowed Derivative financial instruments Investment securities Loans: Residential mortgages(2) Personal and credit cards Business & government Allowances for credit losses(3) Customers’ liability under acceptances Property and equipment Investment in associates Goodwill and other intangibles assets Other (including Deferred tax assets) $ 71,631 $ – – 11,213 – 295 – – 39,187 88,945 – 147,210 (1,045) 10,296 – – – 41 – – – – – – – – – 128,398 89,220 – – – – – – 168 $ – $ – – – – – – – – – 2,240 6,599 – – – – – – $ – – – – – – – – – – – – 87,312 – – – 41,003 – $ – – – – – 25 – – 2,960 – – – – – – – – – – – – – – – – – – – – – – – – – – – $ – – $ – 10,550 $ 2,296 $ – 73,927 10,550 – 11,213 – – – 35,862 – – – – – – – – – – 78,380 7,128 2,419 – – – – – – – – – – – – – – – – – – – 1,069 155 17 41 (3,152) – 2,286 4,033 11,449 14,128 78,380 18,341 2,419 320 87,312 41,003 43,216 217,498 91,477 153,850 (4,197) 10,296 2,286 4,033 11,449 14,337 Total $ 367,773 $ 217,786 $ 8,839 $ 87,312 $ 41,003 $ 2,985 $ 47,075 $ 98,477 $ 32,322 $ 856,497 Includes the Bank’s insurance subsidiaries’ assets and all other assets which are not subject to credit and market risks. Includes $86.8 billion in mortgages guaranteed by Canada Mortgage Housing Corporation including 90% of privately insured mortgages. (1) (2) (3) Amounts for AIRB exposures are reported gross of allowances and amounts for standardized exposures are reported net of allowances. 204 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (ii) Credit quality of non-retail exposures Credit decisions are made based upon an assessment of the credit risk of the individual borrower or counterparty. Key factors considered in the assessment include: the borrower’s management; the borrower’s current and projected financial results and credit statistics; the industry in which the borrower operates; economic trends; and geopolitical risk. Banking units and Global Risk Management also review the credit quality of the credit portfolio across the organization on a regular basis to assess whether economic trends or specific events may affect the performance of the portfolio. The Bank’s non-retail portfolio is well diversified by industry. As at October 31, 2016, and October 31, 2015, a significant portion of the authorized corporate and commercial lending portfolio was internally assessed at a grade that would generally equate to an investment grade rating by external rating agencies. There has not been a significant change in concentrations of credit risk since October 31, 2015. Internal grades (IG) are used to differentiate the risk of default of a borrower. The following table cross references the Bank’s internal borrower grades with equivalent ratings categories utilized by external rating agencies: Cross referencing of internal ratings to external ratings(1) Equivalent External Rating S&P AAA to AA+ AA to A+ A to A- BBB+ BBB BBB- BB+ BB BB- B+ B to B- CCC+ CCC CCC- to CC – Default Moody’s Aaa to Aa1 Aa2 to A1 A2 to A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 to B3 Caa1 Caa2 Caa3 to Ca – DBRS Internal Grade AAA to AA (high) AA to A (high) A to A (low) BBB (high) BBB BBB (low) BB (high) BB BB (low) B (high) B to B (low) – – – – Investment grade Non-Investment grade Watch list Default Internal Grade Code 99 – 98 95 90 87 85 83 80 77 75 73 70 65 60 40 30 27 – 21 PD Range(2) 0.0000% – 0.0510% 0.0510% – 0.1321% 0.0618% – 0.1517% 0.0969% – 0.2429% 0.1381% – 0.3383% 0.1969% – 0.4714% 0.3059% – 0.5239% 0.4751% – 0.5822% 0.5822% – 0.7380% 0.7380% – 1.4180% 1.4180% – 2.7248% 2.7248% – 9.9903% 9.9903% – 19.0626% 19.0626% – 35.9847% 35.9847% – 59.9872% 100% (1) Applies to non-retail portfolio. (2) PD ranges overlap across IG codes as the Bank utilizes two risk rating systems for its AIRB portfolios, and each risk rating system has its own separate IG to PD mapping. Non-retail AIRB portfolio The credit quality of the non-retail AIRB portfolio, expressed in terms of risk categories of borrower internal grades is shown in the table below: As at October 31 ($ millions) Category of internal grades Investment grade Non-Investment grade Watch list Default 2016 Exposure at Default(1) Undrawn commitments Other exposures(2) $ 1,920 7,005 14,127 10,109 10,446 9,870 8,314 3,900 2,355 1,143 422 208 285 487 1 384 $ $ 15,719 23,209 21,597 8,806 10,707 8,282 3,689 1,907 2,554 1,143 239 73 311 214 1 475 Total 77,441 54,007 56,845 42,398 40,271 38,044 36,135 23,941 15,941 7,307 4,692 1,297 1,221 2,465 100 2,520 $ 2015 Total 89,664 47,214 52,276 43,056 33,445 38,646 33,036 20,340 19,589 8,737 4,804 991 1,101 1,454 3 1,093 IG Code 99 – 98 95 90 87 85 83 80 77 75 73 70 65 60 40 30 27 – 21 $ Drawn 59,802 23,793 21,121 23,483 19,118 19,892 24,132 18,134 11,032 5,021 4,031 1,016 625 1,764 98 1,661 Total, excluding residential mortgages Government guaranteed residential mortgages(3) Total $ 234,723 100,869 $ 335,592 $ 70,976 – $ 70,976 $ 98,926 – $ 98,926 $ 404,625 100,869 $ 505,494 $ 395,449 86,832 $ 482,281 (1) After credit risk mitigation. (2) Includes off-balance sheet lending instruments such as letters of credit, letters of guarantee, securitizations, excluding first loss protection of $20 (2015 – $48), derivatives and repo- style transactions (reverse repurchase agreements, repurchase agreements and securities lending and borrowing), net of related collateral. (3) These exposures are classified as sovereign exposures and are included in the non-retail category. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 205 CONSOLIDATED FINANCIAL STATEMENTS Non-retail standardized portfolio Non-retail standardized portfolio as at October 31, 2016 comprised of drawn, undrawn and other exposures to corporate, bank and sovereign counterparties amounted to $66 billion (October 31, 2015 – $63 billion). Exposures to most Corporate/Commercial counterparties mainly in the Caribbean and Latin American region are to non-investment grade counterparties based on the Bank’s internal grading systems. (iii) Credit quality of retail exposures The Bank’s retail portfolios consist of a number of relatively small loans to a large number of borrowers. The portfolios are distributed across Canada and a wide range of countries. As such, the portfolios inherently have a high degree of diversification. In addition, as of October 31, 2016, 57% of the Canadian banking residential mortgage portfolio is insured and the average loan-to-value ratio of the uninsured portion of the portfolio is 50%. Retail AIRB portfolio The data in the table below provides a distribution of the retail AIRB exposure within each PD range by asset class: As at October 31 ($ millions) Category of (PD) grades Exceptionally Low Very Low Low Medium Low Medium High Extremely High Default Total (1) After credit risk mitigation. 2016 Exposure at default(1) Real estate secured PD range Mortgages 0.0000% – 0.0499% $ 35,903 29,193 0.0500% – 0.1999% 16,371 0.2000% – 0.9999% $ 1.0000% – 2.9999% 3.0000% – 9.9999% 10.0000% – 19.9999% 20.0000% – 99.9999% 100% 4,635 638 299 284 215 HELOC – 15,846 11,532 4,760 1,035 311 279 57 $ Qualifying revolving 8,036 7,854 10,130 7,160 2,281 1,365 803 196 $ Other retail 417 6,616 14,228 4,296 2,311 22 946 209 $ Total 44,356 59,509 52,261 20,851 6,265 1,997 2,312 677 $ 2015 Total 49,414 59,484 53,094 21,545 5,551 2,213 2,521 611 $ 87,538 $ 33,820 $ 37,825 $ 29,045 $ 188,228 $ 194,433 Retail standardized portfolio The retail standardized portfolio of $65 billion as at October 31, 2016 (2015 – $54 billion) was comprised of residential mortgages, personal loans, credit cards and lines of credit to individuals, mainly in the Caribbean and Latin American region. Of the total retail standardized exposures, $31 billion (2015 – $28 billion) was represented by mortgages and loans secured by residential real estate, mostly with a loan-to-value ratio of below 80%. (iv) Collateral Collateral held In the normal course of business, to reduce its exposure to counterparty credit risk, the Bank receives collateral on derivative, securities lending, and other transactions related to the capital markets. The following are examples of the terms and conditions customary to collateral for these types of transactions: The risks and rewards of the pledged assets reside with the pledgor. (cid:129) (cid:129) Additional collateral is required when the market value of the transaction exceeds thresholds agreed upon with the pledgor. (cid:129) The Bank is normally permitted to sell or repledge the collateral it receives, although this right is specific to each agreement under which the collateral is pledged. (cid:129) Upon satisfaction of the obligation, the Bank must return the pledged assets, unless the Bank has the right to sell or repledge the collateral it receives, in which case the Bank must return comparable collateral to the pledgor. As at October 31, 2016, the approximate market value of collateral accepted that may be sold or repledged by the Bank was $99 billion (2015 – $117 billion). This collateral is held primarily in connection with reverse repurchase agreements, securities lending and derivative transactions. Collateral pledged In the normal course of business, securities and other assets are pledged to secure an obligation, participate in clearing or settlement systems, or operate in a foreign jurisdiction. Note 34(d) details the nature and extent of the Bank’s asset pledging activities. Asset pledging transactions are conducted under terms that are common and customary to standard derivative, securities financing, and other borrowing activities. Standard risk management controls are applied with respect to asset pledging. Assets acquired in exchange for loans The carrying value of non-financial assets acquired in exchange for loans as at October 31, 2016 was $404 million (2015 – $310 million) mainly comprised of real estate and was classified as either held-for-sale or held-for-use as appropriate. 206 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (b) Liquidity risk Liquidity risk is the risk that the Bank is unable to meet its financial obligations in a timely manner at reasonable prices. The Bank’s liquidity risk is subject to extensive risk management controls and is managed within the framework of policies and limits approved by the Board. The Board receives reports on risk exposures and performance against approved limits. The Asset-Liability Committee (ALCO) provides senior management oversight of liquidity risk. The key elements of the Bank’s liquidity risk management framework include: (cid:129) liquidity risk measurement and management limits, including limits on maximum net cash outflow by currency over specified short-term horizons; (cid:129) prudent diversification of its wholesale funding activities by using a number of different funding programs to access the global financial markets and manage its maturity profile, as appropriate; large holdings of liquid assets to support its operations, which can generally be sold or pledged to meet the Bank’s obligations; liquidity stress testing, including Bank-specific, global-systemic, and combination systemic/specific scenarios; and liquidity contingency planning. (cid:129) (cid:129) (cid:129) The Bank’s foreign operations have liquidity management frameworks that are similar to the Bank’s framework. Local deposits are managed from a liquidity risk perspective based on the local management frameworks and regulatory requirements. (i) Commitments to extend credit In the normal course of business, the Bank enters into commitments to extend credit in the form of loans or other financings for specific amounts and maturities, subject to specific conditions. These commitments, which are not reflected on the Consolidated Statement of Financial Position, are subject to normal credit standards, financial controls and monitoring procedures. (ii) Derivative instruments The Bank is subject to liquidity risk relating to its use of derivatives to meet customer needs, generate revenues from trading activities, manage market and credit risks arising from its lending, funding and investment activities, and lower its cost of capital. The maturity profile of the notional amounts of the Bank’s derivative instruments is summarized in Note 9(b). (c) Market risk Market risk arises from changes in market prices and rates (including interest rates, credit spreads, equity prices, foreign exchange rates and commodity prices), the correlations between them, and their levels of volatility. Market risk is subject to extensive risk management controls, and is managed within the framework of market risk policies and limits approved by the Board. The ALCO and Market Risk Management and Policy Committee oversee the application of the framework set by the Board, and monitor the Bank’s market risk exposures and the activities that give rise to these exposures. The Bank uses a variety of metrics and models to measure and control market risk exposures. The measurements used are selected based on an assessment of the nature of risks in a particular activity. The principal measurement techniques are Value at Risk (VaR), stress testing, sensitivity analysis and simulation modeling, and gap analysis. The Board reviews results from these metrics quarterly. Models are independently validated internally prior to implementation and are subject to formal periodic review. VaR is a statistical measure that estimates the potential loss in value of the Bank’s trading positions due to adverse market movements over a defined time horizon with a specified confidence level. The quality of the Bank’s VaR is validated by regular back testing analysis, in which the VaR is compared to theoretical and actual profit or loss results. To complement VaR, the Bank also uses stress testing to examine the impact that abnormally large swings in market factors and periods of prolonged inactivity might have on trading portfolios. The stress testing program is designed to identify key risks and ensure that the Bank’s capital can absorb potential losses from abnormal events. The Bank subjects its trading portfolios to a series of stress tests on a daily, weekly and monthly basis. In trading portfolios, sensitivity analysis is used to measure the effect of changes in risk factors, including prices and volatility, on financial products and portfolios. In non-trading portfolios, sensitivity analysis assesses the effect of changes in interest rates on current earnings and on the economic value of shareholders’ equity. Simulation modeling under various scenarios is particularly important for managing risk in the deposit, lending and investment products the Bank offers to its retail customers. Gap analysis is used to assess the interest rate sensitivity of the Bank’s retail, wholesale banking and international operations. Under gap analysis, interest rate-sensitive assets, liabilities and derivative instruments are assigned to defined time periods, on the earlier of contractual repricing or maturity dates on the basis of expected repricing dates. (i) Non-trading interest rate risk Interest rate risk, inclusive of credit spread risk, is the risk of loss due to the following: changes in the level, slope and curvature of the yield curve; the volatility of interest rates; mortgage prepayment rates; changes in the market price of credit; and the creditworthiness of a particular issuer. The Bank actively manages its interest rate exposures with the objective of enhancing net interest income within established risk tolerances. Interest rate risk arising from the Bank’s funding and investment activities is managed in accordance with Board-approved policies and global limits, which are designed to control the risk to net interest income and economic value of shareholders’ equity. The income limit measures the effect of a specified shift in interest rates on the Bank’s annual net income over the next twelve months, while the economic value limit measures the impact of a specified change in interest rates on the present value of the Bank’s net assets. Interest rate exposures in individual currencies are also controlled by gap limits. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 207 CONSOLIDATED FINANCIAL STATEMENTS Interest rate sensitivity gap The following table summarizes carrying amounts of assets, liabilities and equity, and derivative instrument notional amounts in order to arrive at the Bank’s interest rate gap based on the earlier of contractual repricing or maturity dates. To arrive at the Bank’s view of its effective interest rate gap, adjustments are made to factor in expected mortgage and loan repayments based on historical patterns and reclassify the Bank’s trading instruments to the immediately rate sensitive and within 3 months categories. Consumer behaviour assumptions are used to reclassify certain non-maturity assets and liabilities. Immediately rate sensitive Within 3 months Three to 12 months One to 5 years Over 5 years Non-rate sensitive Total As at October 31, 2016 ($ millions) Cash and deposits with financial institutions Precious metals Trading assets Financial instruments designated at fair value through profit or loss Securities purchased under resale agreements and securities borrowed Investment securities Loans Other assets Total assets Deposits Financial instruments designated at fair value through profit or loss Obligations related to securities sold short Obligations related to securities sold under repurchase agreements and securities lent Subordinated debentures Other liabilities Equity $ 21,400 – – $ 17,928 – 26,385 – – 13,593 – 24,180 – 59,173 41,300 15,667 222,268 – $ 323,548 85,878 $ 310,666 $ $ – 42 67,895 – 849 – 35 280 25,334 – 2,471 958 Total liabilities and equity $ 154,664 $ 339,744 On-balance sheet gap Off-balance sheet gap Interest rate sensitivity gap based on contractual repricing Adjustment to expected repricing Total interest rate sensitivity gap $ (95,491) – $ (95,491) 143,969 $ 48,478 $ $ $ (16,196) (29,682) (45,878) (10,504) (56,382) As at October 31, 2015 ($ millions) $ $ $ $ $ $ $ 183 – 8,037 205 8,287 9,275 52,946 – 78,933 $ 345 – 16,209 $ – – 15,432 $ 6,488 8,442 42,498 $ 46,344 8,442 108,561 16 – – 221 – 41,482 162,402 – – 4,908 17,108 – 28,949 1,587(1) 1,260(2) 87,486 92,129 72,919 480,164 87,486 $ 220,454 $ 37,448 $ 176,710 $ 896,266 68,693 $ 106,025 $ 8,549 $ 32,066 $ 611,877 4 1,147 273 – 1,459 1,309 7,256 9,038 5,387 23,312 2,901 1,632 1,108 230 1 2,792 2,692 1,905 – 3,209 3,686 500 952 – 86,275 54,228 97,083 7,633 97,081 57,821 75,877 $ 121,818 $ 25,255 $ 178,908 $ 896,266 3,056 (1,748) $ 98,636 23,409 $ 12,193 7,589 1,308 (14,262) $ 122,045 (54,507) $ 19,782 (29,223) (12,954) $ 67,538 $ (9,441) $ $ $ (2,198) 432 (1,766) (35,473) (37,239) $ $ $ – – – – – – Total interest rate sensitivity gap $ 61,735 $ (37,345) $ (29,091) $ 30,707 $ 7,012 $ (33,018) $ (1) Represents common shares, preferred shares, and equity accounted investments. Includes net impaired loans, less the collective allowance on performing loans. (2) Interest rate sensitivity Based on the Bank’s interest rate positions, the following table shows the pro-forma after-tax impact on the Bank’s net income over the next twelve months and economic value of shareholders’ equity of an immediate and sustained 100 and 200 basis point increase and decrease in interest rates across major currencies as defined by the Bank. As at October 31 ($ millions) 2016 2015 100 bp increase 100 bp decrease(1) 200 bp increase 200 bp decrease(1) Net income Economic value of equity Canadian dollar Other currencies $ $ $ $ (76) 76 (152) 152 $ $ $ $ 44 (44) 88 (86) Total $ (32) $ 32 $ (64) $ 66 Canadian dollar $ $ $ $ (255) 52 (624) (428) Other currencies (530) $ $ 598 $ (1,006) $ 1,122 Total (785) $ $ 650 $ (1,630) 694 $ Net income $ 242 $ (240) $ 488 $ (483) Economic value of equity (488) $ $ 418 $ (1,035) 412 $ (1) The annual income sensitivities for CAD, USD, EUR, and GBP exposures are now measured using 100 and 200 basis point decline. Prior period items have been restated to reflect this change. 208 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (ii) Non-trading foreign currency risk Foreign currency risk is the risk of loss due to changes in spot and forward rates, and the volatility of currency exchange rates. Non-trading foreign currency risk, also referred to as structural foreign exchange risk, arises primarily from Bank’s net investments in self-sustaining foreign operations and is controlled by a Board-approved limit. This limit considers potential volatility to shareholders’ equity as well as the potential impact on capital ratios from foreign exchange fluctuations. On a quarterly basis, the Asset-Liability Committee (ALCO) reviews the Bank’s exposures to these net investments. The Bank may fully or partially hedge this exposure by funding the investments in the same currency, or by using other financial instruments, including derivatives. The Bank is subject to foreign currency risk on the earnings of its foreign operations. To manage this risk, foreign currency revenues and expenses, which are primarily denominated in U.S. dollars, are projected over a number of future fiscal quarters. The ALCO assesses economic data and forecasts to decide on the portion of the estimated future foreign currency revenues and expenses to hedge. Hedging instruments normally include foreign currency spot and forward contracts, as well as foreign currency options and swaps. As at October 31, 2016, a one percent increase (decrease) in the Canadian dollar against all currencies in which the Bank operates decreases (increases) the Bank’s before-tax annual earnings by approximately $60 million (2015 – $60 million) in the absence of hedging activity, primarily from exposure to U.S. dollars. A similar change in the Canadian dollar as at October 31, 2016 would increase (decrease) the unrealized foreign currency translation losses in the accumulated other comprehensive income of equity by approximately $366 million (2015 – $315 million), net of hedging. (iii) Non-trading equity risk Equity risk is the risk of loss due to adverse movements in equity prices. Equity price risk is often classified into two categories: general equity risk, which refers to the sensitivity of an instrument or portfolio’s value to changes in the overall level of equity prices, and specific equity risk, which refers to that portion of an individual equity instrument’s price volatility that is determined by entity-specific characteristics. The Bank is exposed to equity risk through its equity investment portfolios, which are controlled by Board-approved portfolio, VaR, and stress-test limits. Equity investments include common and preferred shares, as well as a diversified portfolio of third-party managed funds. The majority of the Bank’s equity investment portfolios are managed by Group Treasury under the strategic direction of the ALCO. Group Treasury delegates the management of a portion of equity and equity-related portfolios to other external fund managers to take advantage of these fund managers’ expertise in particular market niches and products. The fair value of available-for-sale equity securities is shown in Note 11. (iv) Trading portfolio risk management The Bank’s policies, processes and controls for trading activities are designed to achieve a balance between pursuing profitable trading opportunities and managing earnings volatility within a framework of sound and prudent practices. Trading activities are primarily customer focused. Market risk arising from the Bank’s trading activities is managed in accordance with Board-approved policies and limits, including aggregate VaR and stress testing limits. Trading portfolios are marked-to-market in accordance with the Bank’s valuation policies. Positions are marked-to-market daily and valuations are independently reviewed by back office, GRM or finance units on a regular basis. These units also provide profit or loss reporting, as well as VaR and limit compliance reporting to business unit management and executive management for evaluation and action as appropriate. VaR is calculated daily using a 99% confidence level, and a one-day holding period. This means that, once in every 100 days, the trading positions are expected to lose more than the VaR estimate. The Bank calculates general market risk VaR using historical simulation based on 300 days of market data. For debt specific risk VaR, the Bank uses historical resampling. The table below shows the Bank’s VaR by risk factor: ($ millions) As at October 31, 2016 Average High Low As at October 31, 2015 For the year ended October 31, 2016 Credit spread plus interest rate Credit spread Interest rate Equities Foreign exchange Commodities Debt specific Diversification effect All-Bank VaR All-Bank stressed VaR $ 10.6 8.0 8.5 2.0 2.1 2.0 4.2 (7.6) $ 13.2 $ 21.2 $ 10.6 8.3 6.4 2.7 1.3 2.4 6.3 (10.7) $ 12.6 $ 27.6 $ 16.4 13.6 10.0 6.4 2.9 3.9 12.6 N/A $ 20.3 $ 37.4 $ 7.5 4.5 3.0 0.8 0.6 1.3 3.7 N/A $ 8.7 $ 18.0 $ 10.6 8.1 4.3 4.1 0.8 2.0 7.4 (12.9) $ 11.9 $ 22.3 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 209 CONSOLIDATED FINANCIAL STATEMENTS Below are the market risk capital requirements as at October 31, 2016. ($ millions) All-Bank VaR All-Bank stressed VaR Incremental risk charge Comprehensive risk measure Standardized approach Total market risk capital $ 105 209 407 77 48 $ 846(1) (1) Equates to $10,571 of risk-weighted assets (2015 – $14,350). (d) Operational risk Operational risk is the risk of loss, whether direct or indirect, to which the Bank is exposed due to inadequate or failed internal processes or systems, human error, or external events. Operational risk includes legal and regulatory risk, business process and change risk, fiduciary or disclosure breaches, technology failure, financial crime and environmental risk. Operational risk, in some form, exists in each of the Bank’s business and support activities, and can result in financial loss, regulatory sanctions and damage to the Bank’s reputation. The Bank has developed policies, processes and assessment methodologies to ensure that operational risk is appropriately identified and managed with effective controls with a view to safeguarding client assets and preserving shareholder value. 36 Business Combinations and Divestitures Current year: Acquisitions JPMorgan Canadian Credit Card Business On November 16, 2015, the Bank acquired a MasterCard and private label credit card portfolio and the related Canadian credit card operations from JPMorgan Chase Bank, N.A. for cash consideration of $1.7 billion. The acquisition was accounted for as a business combination and resulted in the recognition of approximately $1.7 billion in assets, primarily credit card loans. The acquisition forms part of the Canadian Banking business operating segment. The Bank recorded fair value adjustments to the acquired loans, representing a credit mark of $121 million and an interest rate mark of $28 million, finite life intangible assets of $38 million relating to client relationships, and goodwill of $49 million. Citibank Panama and Costa Rica Retail Banking Operations On February 1, 2016, the Bank acquired 100% of the issued and outstanding common shares of Citigroup Panama and Citigroup Costa Rican entities (renamed Scotiabank Transformandose in both countries) for cash consideration of US$360 million. The acquisitions were accounted for as a business combination and resulted in the recognition of approximately $1.9 billion in assets (mainly consumer and credit card loans) and $1.6 billion in liabilities (mainly deposits). The acquisition forms part of the International Banking business operating segment. The Bank recorded preliminary fair value adjustments to the acquired loans, representing a credit mark of $190 million, finite life intangible assets of $23 million relating to client relationships, low cost deposits and insurance contracts, and goodwill of $241 million. The Bank continues to evaluate the fair values of all assets acquired and liabilities assumed. Divestiture Roynat Lease Finance On April 29, 2016, the Bank, through its wholly owned subsidiary, Roynat Inc., completed the sale of the business operations and assets of Roynat Lease Finance. Assets sold comprised mainly commercial lease receivables previously classified with Business and government loans. As a result of the transaction, the Bank recorded a gain on disposal of $116 million pre-tax ($100 million after tax), including deal and transaction costs, in non-interest income. Prior year: Cencosud Administradora de Tarjetas S.A., Chile On May 1, 2015, the Bank acquired a 51% controlling interest in Cencosud Administradora de Tarjetas S.A. and certain other smaller entities (collectively, CAT) from Cencosud S.A. (Cencosud), for a consideration of US $280 million. Simultaneously, the Bank entered into a 15 year exclusivity contract with Cencosud to manage the business. The acquisition was accounted for as a business combination resulting in consolidation of 100% of its assets and liabilities with the recording of non-controlling interest for the 49% held by another shareholder. Assets recognized mainly include credit card and consumer loans. The non-controlling interest was measured as the proportionate share of CAT’s identifiable net assets. A finite life intangible of $296 million relating to the exclusivity contract was recorded. Citibank Peru Operations On May 1, 2015, the Bank’s subsidiary in Peru acquired 100% of the retail and commercial banking operations of Citibank in Peru for cash consideration of $380 million. The acquisition was accounted for as a business combination and resulted in the recognition of mainly personal and credit card loans of $480 million and personal deposits of $210 million. 210 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Shareholder Information Annual meeting Shareholders are invited to attend the 185th Annual Meeting of Holders of Common Shares, to be held on April 4, 2017, at Scotiabank Centre, Scotia Plaza, 40 King Street West, 2nd Floor, Toronto, Ontario beginning at 9:00 a.m. local time. The record date for determining shareholders entitled to receive notice of and to vote at the meeting will be the close of business on February 7, 2017. Shareholdings and dividends Information regarding your shareholdings and dividends may be obtained by contacting the transfer agent. Direct deposit service Shareholders may have dividends deposited directly into accounts held at financial institutions which are members of the Canadian Payments Association. To arrange direct deposit service, please write to the transfer agent. Dividend and Share Purchase Plan Scotiabank’s dividend reinvestment and share purchase plan allows common and preferred shareholders to purchase additional common shares by reinvesting their cash dividend without incurring brokerage or administrative fees. As well, eligible shareholders may invest up to $20,000 each fiscal year to purchase additional common shares of the Bank. All administrative costs of the plan are paid by the Bank. For more information on participation in the plan, please contact the transfer agent. Listing of shares Common shares of the Bank are listed for trading on the Toronto and New York stock exchanges. Series 16, Series 17, Series 18, Series 19, Series 20, Series 21, Series 22, Series 23, Series 30, Series 31, Series 32, Series 33, Series 34, Series 36 and Series 38 preferred shares of the Bank are listed on the Toronto Stock Exchange. Stock Symbols STOCK Common shares Series 16, Preferred Series 17, Preferred Series 18, Preferred Series 19, Preferred Series 20, Preferred Series 21, Preferred Series 22, Preferred Series 23, Preferred Series 30, Preferred Series 31, Preferred Series 32, Preferred Series 33, Preferred Series 34, Preferred Series 36, Preferred Series 38, Preferred TICKER SYMBOL BNS BNS.PR.N BNS.PR.O BNS.PR.P BNS.PR.A BNS.PR.Q BNS.PR.B BNS.PR.R BNS.PR.C BNS.PR.Y BNS.PR.D BNS.PR.Z BNS.PR.F BNS.PR.E BNS.PR.G BNS.PR.H CUSIP NO. 064149 10 7 064149 76 8 064149 75 0 064149 74 3 064149 73 5 064149 72 7 064149 71 9 064149 69 3 064149 68 5 064149 63 6 064149 62 8 064149 61 0 064149 59 4 064149 55 2 064151 20 2 064151 11 1 Dividend Dates for 2017 Record and payment dates for common and preferred shares, subject to approval by the Board of Directors. RECORD DATE January 3 April 4 July 4 October 3 PAYMENT DATE January 27 April 26 July 27 October 27 Valuation day price For Canadian income tax purposes, The Bank of Nova Scotia’s common stock was quoted at $31.13 per share on Valuation Day, December 22, 1971. This is equivalent to $2.594 after adjusting for the two-for-one stock split in 1976, the three-for-one stock split in 1984, and the two- for-one stock split in 1998. The stock dividend in 2004 did not affect the Valuation Day amount. The stock received as part of the 2004 stock dividend is not included in the pre-1972 pool. Duplicated communication Some registered holders of The Bank of Nova Scotia shares might receive more than one copy of shareholder mailings, such as this Annual Report. Every effort is made to avoid duplication; however, if you are registered with different names and/or addresses, multiple mailings may result. If you receive, but do not require, more than one mailing for the same ownership, please contact the transfer agent to combine the accounts. Credit ratings SENIOR LONG-TERM DEBT/DEPOSITS DBRS AA Fitch AA - Aa3 Moody’s Standard & Poor’s A+ SHORT TERM DEPOSITS/COMMERCIAL PAPER R-1(high) DBRS F1+ Fitch Moody’s P-1 Standard & Poor’s A-1 SUBORDINATED DEBT AA(low) DBRS A+ Fitch Moody’s A3 Standard & Poor’s A - NON-CUMULATIVE PREFERRED SHARES Pfd-2(high) DBRS Moody’s Baa2(hyb) Standard & Poor’s BBB/P-2* *Canadian scale Credit ratings are one of the factors that affect the Bank’s access to capital markets and borrowing costs, as well as the terms on which the Bank can conduct derivatives and hedging transactions and obtain related borrowings. The credit ratings and outlook that the rating agencies assign to the Bank are based on their own views and methodologies. The Bank continues to have strong credit ratings and is rated AA by DBRS, Aa3 by Moody’s, AA- by Fitch and A+ by Standard and Poor’s (S&P). On December 11, 2015, S&P affirmed the Bank’s A+ rating for deposits and senior debt, as well as the A-1 rating for short-term instruments. The Bank’s outlook was changed to stable from negative. The outlook change was predicated on S&P’s belief that the potential negative ratings impact from the proposed bail-in regime has subsided, with a view that the implementation timetable could be two years or more to 2018 or later. On January 25, 2016, Moody’s downgraded the Bank’s long-term ratings by one notch to Aa3 from Aa2, while affirming the Bank’s short-term deposit rating of P-1. On August 22, 2016, DBRS confirmed the Bank’s long and short-term rating of AA and R-1 (high), respectively. On October 27, 2016, Fitch affirmed the Bank’s long and short-term rating of AA- and F1+, respectively. Fitch and S&P have a stable outlook on the Bank. Meanwhile, DBRS and Moody’s continue to maintain their negative outlook for all Canadian banks citing the uncertainty around the federal government’s proposed new bail-in regime for senior unsecured debt, to reflect the greater likelihood that such debt may incur losses in the unlikely event of a distress scenario. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 211 Glossary Allowance for Credit Losses: An allowance set aside which, in management’s opinion, is adequate to absorb all incurred credit-related losses in the Bank’s portfolio of loans. It includes individual and collective allowances. Assets Under Administration (AUA): Assets administered by the Bank which are beneficially owned by clients and therefore not reported on the Bank’s Consolidated Statement of Financial Position. Services provided for AUA are of an administrative nature, such as trusteeship, custodial, safekeeping, income collection and distribution, securities trade settlements, customer reporting, and other similar services. Assets Under Management (AUM): Assets managed by the Bank on a discretionary basis and in respect of which the Bank earns investment management fees. AUM are beneficially owned by clients and are therefore not reported on the Bank’s Consolidated Statement of Financial Position. Some AUM are also administered assets and are therefore included in assets under administration. Bankers’ Acceptances (BAs): Negotiable, short-term debt securities, guaranteed for a fee by the issuer’s bank. Basis Point: A unit of measure defined as one-hundredth of one per cent. Capital: Consists of common shareholders’ equity, non-cumulative preferred shares, capital instruments and subordinated debentures. It can support asset growth, provide against loan losses and protect depositors. Common Equity Tier 1 (CET1), Tier 1 and Total Capital Ratios: Under Basel III, there are three primary regulatory capital ratios used to assess capital adequacy, CET1, Tier 1 and Total capital ratios, which are determined by dividing those capital components by their respective risk-weighted assets. Basel III introduced a new category of capital, CET1, which consists primarily of common shareholders’ equity net of regulatory adjustments. These regulatory adjustments include goodwill, intangible assets net of deferred tax liabilities, deferred tax assets that rely on future probability, defined-benefit pension fund net assets, shortfall of credit provision to expected losses and significant investments in common equity of other financial institution. Tier 1 includes CET1 and additional Tier 1 capital which consists primarily of qualifying non-cumulative preferred shares and non- qualifying instruments subject to phase-out. Tier 2 capital consists mainly of qualifying subordinated or non-qualifying debentures subject to phase-out and the eligible allowances for credit losses. Total capital is comprised of CET1 capital, Tier 1 capital and Tier 2 capital. Core Banking Margin: This ratio represents net interest income on average earning assets excluding bankers acceptances and total average assets relating to the Global Capital markets business within Global Banking and Markets. This is consistent with the fact that net interest from trading operations is recorded in trading revenues included in non-interest income. Covered Bonds: Debt obligations of the Bank for which the payment of all amounts of interest and principal are unconditionally and irrevocably guaranteed by a limited partnership or trust and secured by a pledge of the covered bond portfolio. The assets in the covered bond portfolio held by the limited partnership or trust consist of first lien Canadian uninsured residential mortgages or first lien Canadian residential mortgages insured under CMHC Mortgage Insurance, respectively, and their related security interest. Derivative Products: Financial contracts whose value is derived from an underlying price, interest rate, exchange rate or price index. Forwards, options and swaps are all derivative instruments. Fair Value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal, or in its absence, the most advantageous market to which the Bank has access at the measurement date. Foreign Exchange Contracts: Commitments to buy or sell a specified amount of foreign currency on a set date and at a predetermined rate of exchange. 212 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Forward Rate Agreement (FRA): A contract between two parties, whereby a designated interest rate, applied to a notional principal amount, is locked in for a specified period of time. The difference between the contracted rate and prevailing market rate is paid in cash on the settlement date. These agreements are used to protect against, or take advantage of, future interest rate movements. Futures: Commitments to buy or sell designated amounts of commodities, securities or currencies on a specified date at a predetermined price. Futures are traded on recognized exchanges. Gains and losses on these contracts are settled daily, based on closing market prices. Hedging: Protecting against price, interest rate or foreign exchange exposures by taking positions that are expected to react to market conditions in an offsetting manner. Impaired Loans: Loans on which the Bank no longer has reasonable assurance as to the timely collection of interest and principal, or where a contractual payment is past due for a prescribed period or the customer is declared to be bankrupt. Excludes Federal Deposit Insurance Corporation (FDIC) guaranteed loans. Leverage Ratio: The ratio of Basel III Tier 1 capital to a leverage exposure measure which includes on-balance sheet assets and off- balance sheet commitments, derivatives and securities financing transactions, as defined within the OSFI Leverage Requirements Guideline. Liquidity Coverage Ratio (LCR): The ratio of high quality liquid assets to stressed net cash outflows over a 30 calendar day time horizon, as defined within the OSFI Liquidity Adequacy Requirements Guideline. Marked-To-Market: The valuation of certain financial instruments at fair value as of the Consolidated Statement of Financial Position date. Notional Principal Amounts: The contract or principal amounts used to determine payments for certain off-balance sheet instruments and derivatives, such as FRAs, interest rate swaps and cross-currency swaps. The amounts are termed “notional” because they are not usually exchanged themselves, serving only as the basis for calculating amounts that do change hands. Off-Balance Sheet Instruments: These are indirect credit commitments, including undrawn commitments to extend credit and derivative instruments. Operating Leverage: This financial metric measures the rate of growth in total revenue less the rate of growth in operating expenses. Options: Contracts between buyer and seller giving the buyer of the option the right, but not the obligation, to buy (call) or sell (put) a specified commodity, financial instrument or currency at a set price or rate on or before a specified future date. OSFI: The Office of the Superintendent of Financial Institutions Canada, the regulator of Canadian banks. Pacific Alliance: Comprises the countries of Chile, Colombia, Mexico and Peru. Productivity Ratio: Management uses the productivity ratio as a measure of the Bank’s efficiency. This ratio represents operating expenses as a percentage of total revenue. A lower ratio indicates improved productivity. Repos: Repos is short for “obligations related to securities sold under repurchase agreements” – a short-term transaction where the Bank sells assets, normally government bonds, to a client and simultaneously agrees to repurchase them on a specified date and at a specified price. It is a form of short-term funding. Return on Equity (ROE): Net income attributable to common shareholders, expressed as a percentage of average common shareholders’ equity. With respect to the Bank’s main business segments, the Bank attributes capital that approximates 9.5% of Basel III common equity capital requirements based on credit, market and operational risks and leverage inherent in each business segment. Return on equity for the business segments is calculated as a ratio of net income attributable to common shareholders of the business segment and the capital attributed. Reverse Repos: Reverse repos is short for “securities purchased under resale agreements” – a short-term transaction where the Bank purchases assets, normally government bonds, from a client and simultaneously agrees to resell them on a specified date and at a specified price. It is a form of short-term collateralized lending. Risk-Weighted Assets: Comprised of three broad categories including credit risk, market risk and operational risk, which are computed under the Basel III Framework. Risk-weighted assets for credit risk are calculated using formulas specified by the Basel III Framework. The formulas are based on the degree of credit risk for each class of counterparty. Off-balance sheet instruments are converted to on balance sheet equivalents, using specified conversion factors, before the appropriate risk measurements are applied. The Bank uses both internal models and standardized approaches to calculate market risk capital and standardized approach to calculate operational risk capital. These capital requirements are converted to risk weighted assets equivalent by multiplying by a 12.5 factor. Securitization: The process by which financial assets (typically loans) are transferred to a trust, which normally issues a series of different classes of asset-backed securities to investors to fund the purchase of loans. Structured Entities: A structured entity is defined as an entity created to accomplish a narrow and well-defined objective. A structured entity may take the form of a corporation, trust, partnership or unincorporated entity. Structured entities are often created with legal arrangements that impose strict and sometimes permanent limits on the decision-making powers of their governing board, trustee or management over the operations of the entity. Standby Letters of Credit and Letters of Guarantee: Written undertakings by the Bank, at the request of the customer, to provide assurance of payment to a third-party regarding the customer’s obligations and liabilities to that third-party. Basel III Glossary Credit Risk Parameters Exposure at Default (EAD): Generally represents the expected gross exposure – outstanding amount for on-balance sheet exposure and loan equivalent amount for off-balance sheet exposure at default. Probability of Default (PD): Measures the likelihood that a borrower will default within a one-year time horizon, expressed as a percentage. Loss Given Default (LGD): Measures the severity of loss on a facility in the event of a borrower’s default, expressed as a percentage of exposure at default. Exposure Types Non-retail Corporate: Defined as a debt obligation of a corporation, partnership, or proprietorship. Bank: Defined as a debt obligation of a bank or bank equivalent (including certain public sector entities (PSEs) treated as bank equivalent exposures). Sovereign: Defined as a debt obligation of a sovereign, central bank, certain multi development banks and certain PSEs treated as sovereign. Securitization: On-balance sheet investments in asset-backed securities, mortgage backed securities, collateralized loan obligations and collateralized debt obligations, off-balance sheet liquidity lines to Bank’s own sponsored and third-party conduits and credit enhancements. Retail Residential Mortgage: Loans to individuals against residential property (four units or less). Secured Lines Of Credit: Revolving personal lines of credit secured by residential real estate. Qualifying Revolving Retail Exposures: Credit cards and unsecured lines of credit for individuals. Other Retail: All other personal loans. Structured Credit Instruments: A wide range of financial products which includes Collateralized Debt Obligations, Collateralized Loan Obligations, Structured Investment Vehicles, and Asset-Backed Securities. These instruments represent investments in pools of credit- related assets, whose values are primarily dependent on the performance of the underlying pools. Swaps: Interest rate swaps are agreements to exchange streams of interest payments, typically one at a floating rate, the other at a fixed rate, over a specified period of time, based on notional principal amounts. Cross-currency swaps are agreements to exchange payments in different currencies over predetermined periods of time. Taxable Equivalent Basis (TEB): The Bank analyzes net interest income, non-interest income, and total revenue on a taxable equivalent basis (TEB). This methodology grosses up tax-exempt income earned on certain securities reported in either net interest income or non-interest income to an equivalent before tax basis. A corresponding increase is made to the provision for income taxes; hence, there is no impact on net income. Management believes that this basis for measurement provides a uniform comparability of net interest income and non- interest income arising from both taxable and non-taxable sources and facilitates a consistent basis of measurement. While other banks also use TEB, their methodology may not be comparable to the Bank’s methodology. For purposes of segmented reporting, a segment’s revenue and provision for income taxes are grossed up by the taxable equivalent amount. The elimination of the TEB gross up is recorded in the Other segment. Value At Risk (VaR): An estimate of the potential loss that might result from holding a position for a specified period of time, with a given level of statistical confidence. Yield Curve: A graph showing the term structure of interest rates, plotting the yields of similar quality bonds by term to maturity. Exposure Sub-types Drawn: Outstanding amounts for loans, leases, acceptances, deposits with banks and available-for-sale debt securities. Undrawn: Unutilized portion of an authorized committed credit lines. Other Exposures Repo-Style Transactions: Reverse repurchase agreements (reverse repos) and repurchase agreements (repos), securities lending and borrowing. OTC Derivatives: Over-the-counter derivatives contracts refers to financial instruments which are traded through a dealer network rather than through an exchange. Other Off-balance Sheet: Direct credit substitutes, such as standby letters of credit and guarantees, trade letters of credit, and performance letters of credit and guarantees. Exchange-Traded Derivative Contracts: Exchange-traded derivative contracts are derivative contracts (e.g., futures contracts and options) that are transacted on an organized futures exchange. These include futures contracts (both long and short positions), purchased options and written options. Qualifying Central Counterparty (QCCP): A licensed central counterparty is considered “qualifying” when it is compliant with the International Organization of Securities Commissions (IOSCO) standards and is able to assist clearing member banks in properly capitalizing for CCP exposures. Asset Value Correlation Multiplier (AVC): Basel III has increased the risk-weights on exposures to certain Financial Institutions (FIs) relative to the non-financial corporate sector by introducing an AVC. The correlation factor in the risk-weight formula is multiplied by this AVC factor of 1.25 for all exposures to regulated FIs whose total assets are greater than or equal to US$100 billion and all exposures to unregulated FIs. Specific Wrong-Way Risk (WWR): Specific Wrong-Way Risk arises when the exposure to a particular counterparty is positively correlated with the probability of default of the counterparty due to the nature of the transactions with the counterparty. 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T | 213 Additional information CORPORATE HEADQUARTERS FOR FURTHER INFORMATION Scotiabank Scotia Plaza 44 King Street West, Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-6161 E-mail: email@scotiabank.com Customer Service Centre 1-800-4-SCOTIA @ScotiabankHelps Finance Department Scotiabank CONNECT WITH US @ScotiabankViews ScotiabankSnaps 44 King Street West, Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-4790 Fax: (416) 866-4048 E-mail: corporate.secretary@scotiabank.com Financial Analysts, Portfolio Managers and other Institutional Investors Tel: (416) 775-0798 Fax: (416) 866-7867 E-mail: investor.relations@scotiabank.com Online For product, corporate, financial and shareholder information: scotiabank.com Public, Corporate and Government Affairs Scotiabank 44 King Street West, Toronto, Ontario Canada M5H 1H1 Tel: (416) 933-2927 Fax: (416) 866-4988 E-mail: corporate.communications@scotiabank.com Shareholder Services Transfer Agent and Registrar Main Agent Computershare Trust Company of Canada 100 University Avenue, 8th Floor, Toronto, Ontario Canada M5J 2Y1 Tel: 1-877-982-8767 Fax: 1-888-453-0330 E-mail: service@computershare.com Co-transfer Agent (U.S.A.) Computershare Trust Company N.A. 250 Royall Street, Canton, MA 02021, U.S.A. Tel: 1-800-962-4284 214 | 2 0 1 6 S C O T I A B A N K A N N U A L R E P O R T Scotiabank’s Digital Transformation Highlights Spring 2014 | Embraced innovative and progressive banking alternatives with Tangerine. Sept. 2015 | First Canadian bank to take its Board of Directors to Silicon Valley. Spring 2014 | First Scotiabank Rapid Lab launched to tackle the mortgage onboarding process in Canada. Fall 2015 | Scotiabank’s donation establishes new Master’s program and professorship at Saint Mary’s University in Halifax. Oct. 2015 | Scotiabank Digital Factory launched to deliver customer-centric digital solutions. Feb. 2016 | Mexico unveils enhanced online and mobile platforms. Winter 2016 | Scotiabank hosts hackathon, with over 150 developers, designers and entrepreneurs teaming up to create creative solutions to help Canadians better manage debt. March 2016 | Announced the Scotiabank Digital Banking Lab at Ivey Business School, University of Western Ontario. May 2016 | Scotiabank Centre for Customer Analytics opens at Queen’s University’s Smith School of Business. May 2016 | Named Global Bank with the Best Digital Strategy Award for 2016 by Retail Banker International. June 2016 | Scotiabank and Kabbage partner to provide small business loans to customers. Sept. 2016 | Scotiabank gives $1.7 million to create The Scotiabank Emerging Technologies Program at Rotman School of Management at the University of Toronto. Summer 2016 | New Express and Solutions concept branches open in Canada offering digital tools to better meet the needs of customers. Scotiabank’s Digital Transformation Highlights Spring 2014 | Embraced innovative and progressive banking alternatives with Tangerine. Sept. 2015 | First Canadian bank to take its Board of Directors to Silicon Valley. Oct. 2015 | Scotiabank Digital Factory launched to deliver customer-centric digital solutions. Winter 2016 | Scotiabank hosts first hackathon, with over 150 developers, designers and entrepreneurs teaming up to create creative solutions to help Canadians better manage debt. May 2016 | Scotiabank Centre for Customer Analytics opens at Queen’s University’s Smith School of Business. Kabbage June 2016 | Scotiabank and Kabbage partner to provide small business loans to customers. Summer 2016 | New Express and Solutions concept branches open in Canada offering digital tools to better meet the needs of cutomers. Spring 2014 | First Scotiabank Rapid Lab launched to tackle the mortgage onboarding process in Canada. Fall 2015 | Scotiabank’s donation establishes new Master’s program and professorship at Saint Mary’s University in Halifax. Feb. 2016 | Mexico unveils enhanced online and mobile platforms. March 2016 | Announced the Scotiabank Digital Banking Lab at lvey Business School, University of Western Ontario. May 2016 | Named Global Bank with the Best Digital Strategy Award for 2016 by Retail Banker International. Sept. 2016 | Scotiabank gives $1.7 million to create The Scotiabank Emerging Technologies Program at Rotman School of Management at the University of Toronto. Scotiabank is Canada’s international bank and a leading financial services provider in North America, Latin America, the Caribbean and Central America, and Asia-Pacific. We are dedicated to helping our 23 million customers become better off through a broad range of advice, products and services, including personal and commercial banking, wealth management and private banking, corporate and investment banking, and capital markets. ® Registered trademark of The Bank of Nova Scotia. 

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