The Bank of Nova Scotia (BNS) 40-F 2010 FY Annual report (Canada)

Management’s Discussionand Analysis

TABLE OF CONTENTS

23	Forward-looking statements
24	Financial highlights
Overview
25	Financial results
25	Outlook
26	Shareholder returns
27	Impact of foreign currency translation
27	Impact of acquisitions
27	Non-GAAP measures
Group Financial Performance
28	Total revenue
28	Net interest income
29	Other income
31	Non-interest expenses
32	Taxes
33	Non-controlling interest
33	Credit quality
36	Fourth quarter review
38	Summary of quarterly results
Group Financial Condition
39	Balance sheet
40	Capital management
45	Changing regulatory landscape
46	Off-balance sheet arrangements
49	Financial instruments
50	Selected credit instruments
Business Lines
52	Overview
53	Canadian Banking
55	International Banking
57	Scotia Capital
59	Other
60	Looking ahead
Risk Management
62	Overview
66	Credit risk
69	Market risk
73	Liquidity risk
75	Operational risk
76	Reputational risk
77	Environmental risk
Controls and Accounting Policies
78	Controls and procedures
78	Critical accounting estimates
82	Changes in accounting policies
83	Transition to International Financial
	Reporting Standards (IFRS)
87	Related party transactions
Supplementary Data
88	Geographic information
90	Credit risk
95	Revenues and expenses
96	Other information
98	Eleven-year statistical review

22     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| OVERVIEW

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 harbour” provisions of the United States Private Securities Litigation Reform Act of 1995 and any applicable Canadian securities legislation. Forward-looking statements may include comments with respect to the Bank’s objectives, strategies to achieve those objectives, expected financial results (including those in the area of risk management), and the outlook for the Bank’s businesses and for the Canadian, United States 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,” “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 our control, 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; significant market volatility and interruptions; the failure of third parties to comply with their obligations to us and our affiliates; the effect of changes in monetary policy; legislative and regulatory developments in Canada and elsewhere, including changes in tax laws; the effect of changes to our credit ratings; amendments to, and interpretations of, risk-based capital guidelines and reporting instructions and liquidity regulatory guidance; operational and 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; changes in accounting policies and methods the Bank uses to report its financial condition and the results of its operations, including uncertainties associated with critical accounting assumptions and estimates; the effect of applying future accounting changes; 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 by internal or external parties, including the use of new technologies in unprecedented ways to defraud the Bank or its customers; consolidation in the Canadian financial services sector; competition, both from new entrants and established competitors; judicial and regulatory proceedings; acts of God, such as earthquakes and hurricanes; the possible impact of international conflicts and other developments, including terrorist acts and war on terrorism; the effects of disease or illness on local, national or international economies; disruptions to public infrastructure, including transportation, communication, power and water; 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 discussion starting on page 62 of the Bank’s 2010 Annual Report.

     The preceding list of important factors is not exhaustive. 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.

     The “Outlook” sections in this document are based on the Bank’s views and the actual outcome is uncertain. Readers should consider the above-noted factors when reviewing these sections.

     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

December 3, 2010

Scotiabank Annual Report2010     23

MANAGEMENT’S DISCUSSION AND ANALYSIS

T1 Financial highlights

As at and for the years ended October 31	2010		2009		2008		2007		2006
Operating results ($ millions)
Net interest income		8,621		8,328		7,574		7,098		6,408
Net interest income (TEB(1))		8,907		8,616		7,990		7,629		6,848
Total revenue		15,505		14,457		11,876		12,490		11,208
Total revenue (TEB(1))		15,791		14,745		12,292		13,021		11,648
Provision for credit losses		1,239		1,744		630		270		216
Non-interest expenses		8,182		7,919		7,296		6,994		6,443
Provision for income taxes		1,745		1,133		691		1,063		872
Provision for income taxes (TEB(1))		2,031		1,421		1,107		1,594		1,312
Net income		4,239		3,547		3,140		4,045		3,579
Net income available to common shareholders		4,038		3,361		3,033		3,994		3,549
Operating performance
Basic earnings per share ($)		3.91		3.32		3.07		4.04		3.59
Diluted earnings per share ($)		3.91		3.31		3.05		4.01		3.55
Diluted cash earnings per share(1) ($)		3.97		3.37		3.11		4.05		3.58
Return on equity(1) (%)		18.3		16.7		16.7		22.0		22.1
Productivity ratio (%) (TEB(1))		51.8		53.7		59.4		53.7		55.3
Net interest margin on total average assets (%) (TEB(1))		1.73		1.68		1.75		1.89		1.95
Balance sheet information ($ millions)
Cash resources and securities		162,590		160,572		125,353		118,030		118,878
Loans and acceptances		291,840		275,885		300,649		238,685		212,329
Total assets		526,657		496,516		507,625		411,510		379,006
Deposits		361,650		350,419		346,580		288,458		263,914
Preferred shares		3,975		3,710		2,860		1,635		600
Common shareholders’ equity		23,656		21,062		18,782		17,169		16,947
Assets under administration		243,817		215,097		203,147		195,095		191,869
Assets under management		48,363		41,602		36,745		31,403		27,843
Capital measures(2)
Tier 1 capital ratio (%)		11.8		10.7		9.3		9.3		10.2
Total capital ratio (%)		13.8		12.9		11.1		10.5		11.7
Tangible common equity to risk-weighted assets(1) (%)		9.6		8.2		6.6		7.4		8.3
Assets-to-capital multiple		17.0		16.6		18.0		18.2		17.1
Risk-weighted assets ($ millions)		215,034		221,656		250,591		218,337		197,010
Credit quality
Net impaired loans(3) ($ millions)		3,044		2,563		1,191		601		570
General allowance for credit losses ($ millions)		1,410		1,450		1,323		1,298		1,307
Sectoral allowance ($ millions)		—		44		—		—		—
Net impaired loans as a % of loans and acceptances(3)		1.04		0.93		0.40		0.25		0.27
Specific provision for credit losses as a % of average loans and acceptances		0.48		0.54		0.24		0.13		0.14
Common share information
Share price ($)
High		55.76		49.19		54.00		54.73		49.80
Low		44.12		23.99		35.25		46.70		41.55
Close		54.67		45.25		40.19		53.48		49.30
Shares outstanding (millions)
Average — Basic		1,032		1,013		987		989		988
Average — Diluted		1,034		1,016		993		997		1,001
End of period		1,043		1,025		992		984		990
Dividends per share ($)		1.96		1.96		1.92		1.74		1.50
Dividend yield (%)(4)		3.9		5.4		4.3		3.4		3.3
Market capitalization ($ millions)		57,016		46,379		39,865		52,612		48,783
Book value per common share ($)		22.68		20.55		18.94		17.45		17.13
Market value to book value multiple		2.4		2.2		2.1		3.1		2.9
Price to earnings multiple		14.0		13.6		13.1		13.2		13.7
Other information
Employees		70,772		67,802		69,049		58,113		54,199
Branches and offices		2,784		2,686		2,672		2,331		2,191

(1)	Non-GAAP measure. Refer to the non-GAAP measures on page 27.
(2)	Effective November 1, 2007, regulatory capital, risk weighted assets and capital ratios are determined in accordance with Basel II rules. Comparative amounts for prior periods are determined in accordance with Basel I rules.
(3)	Net impaired loans are impaired loans less the specific allowance for credit losses.
(4)	Based on the average of the high and low common share price for the year.

24     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| OVERVIEW

MD&AOVERVIEW

Financial results

Scotiabank had record results in 2010 and met or exceeded all of its financial objectives. Net income was $4,239 million, $692 million or 20% higher than last year. Diluted earnings per share (EPS) were $3.91, up 18% from $3.31 in 2009. The impact of foreign currency translation was significant this year, reducing our EPS by 28 cents or 7%. This strong performance resulted in a return on equity of 18.3%.

The Bank’s results continued to be significantly affected by foreign currency translation arising from a stronger Canadian dollar and a slow economic recovery in many markets. Notwithstanding, all of Scotiabank’s business lines continued to report solid results, including strong earnings in Canadian Banking.

Total revenues increased 7% from last year to $15,791 million on a taxable equivalent basis (TEB), notwithstanding a $719 million negative impact of foreign currency translation. Net interest income (TEB) rose $291 million due to an increase in the total interest margin, strong organic retail loan growth domestically and internationally, the positive impact of changes in the fair value of financial instruments used for asset/liability management purposes and the contribution from recent acquisitions.

Other income was $6,884 million up $755 million or 12% from last year, or $1,061 million or 17% excluding the impact of foreign currency translation. The increase reflected record mutual fund fees, higher net gains on securities due partly to a positive rebound from 2009, growth in brokerage revenues and the contribution from recent acquisitions. The results were negatively impacted by lower trading revenues, and decreased underwriting and credit fees. Securitization revenues were also down from last year due to a reduced level of participation in the Canada Mortgage Bond and Insured Mortgage Purchase Program.

Non-interest expenses were $8,182 million in 2010, an increase of $263 million or 3% from last year, including a benefit of $252 million from the positive impact of foreign currency translation. The increase was primarily from acquisitions, higher performance and stock based compensation, growth in business volumes and expenditures to support revenue initiatives. The productivity ratio was a record low 51.8%, an improvement from 53.7% in 2009.

The provision for credit losses was $1,239 million in 2010, down from $1,744 million last year. The decline reflects net recoveries in Scotia Capital as compared to net provisions last year and the stabilization of retail credit quality in Canadian Banking and most of the International Banking units. In addition, 2010 saw a decrease in the general allowance and a reversal of the sectoral allowance that was established in 2009, as our credit portfolio continued to improve.

The overall tax rate was 28.7%, up from 23.6% last year, due mainly to a higher proportion of income in relatively higher tax jurisdictions. These were partly offset by lower adjustments to future tax assets and a decline in the statutory tax rate in Canada.

The Tier 1 capital ratio at 11.8% and the total capital ratio at 13.8% remained well above the regulatory minimum and were strong by international standards and our highest level in five years.

Outlook

Looking ahead, we remain optimistic despite the high degree of uncertainty that remains in many world economies and continued weakness in a number of global financial markets. However, developing markets are expected to outperform the growth of most developed countries. Due to our longstanding presence in these developing economies, we are well-positioned to capitalize on the growth opportunities that exist.

In addition, we will remain focused on the overarching strategic priorities and values that have led to consistently strong results. This will be reinforced by disciplined risk management, diversification of operations and focus on execution in all our business lines.

Our strong capital position also gives us confidence and ability to grow our existing business, invest in new businesses, and continue a prudent dividend policy consistent with our earnings growth.

As a result, the Bank expects continued growth in 2011 with solid contributions from each of its four business lines.

Scotiabank Annual Report2010     25

MANAGEMENT’S DISCUSSION AND ANALYSIS

Shareholder returns

The Bank delivered a strong total shareholder return of 25.7% in 2010, a substantial increase from 18.8% in 2009 as shown in Table 2.

The total compounded annual shareholder return on the Bank’s shares over the past five years was 9.1% and 13.1% over the past 10 years. This exceeded the total return of the S&P/TSX Composite Index of 7.0% over the past five years and 5.1% over the last ten years, as shown in Chart 4. Furthermore, the Bank’s 10 years total shareholder return was the highest among the major Canadian banks.

Quarterly dividends were maintained during the year. Dividends per share totaled $1.96 for the year, unchanged from 2009.

The Bank’s Return on Equity was 18.3% for fiscal 2010 an increase from 16.7% in the previous year.

T2 Shareholder return

For the years ended October 31	2010		2009		2008			2007		2006		5-yr CAGR(1)
Closing market price per common share ($)		54.67		45.25		40.19			53.48		49.30		4.9	%
Dividends paid ($  per share)		1.96		1.96		1.92			1.74		1.50		8.2	%
Dividends paid (%)		4.3		4.9		3.6			3.5		3.5
Increase (decrease) in share price (%)		20.8		12.6		(24.9	)		8.5		14.7
Total annual shareholder return (%)(2)		25.7		18.8		(21.6	)		12.2		18.4

(1)	Compound annual growth rate (CAGR)
(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.

T3 Impact of foreign currency translation

Average exchange rate	2010		2009		2008
U.S. dollar/Canadian dollar		0.963		0.855		0.974
Mexican peso/Canadian dollar		12.265		11.585		10.473

	2010			2009			2008
Impact on income ($ millions except EPS)	vs. 2009			vs. 2008			vs. 2007
Net interest income	$	(413	)	$	235		$	(221	)
Other income		(306	)		111			(80	)
Non-interest expenses		252			(55	)		146
Other items (net of tax)		178			(84	)		51
Net income	$	(289	)	$	207		$	(104	)
Earnings per share (diluted)	$	(0.28	)	$	0.20		$	(0.10	)
Impact by business line ($ millions)
International Banking	$	(129	)	$	82		$	(83	)
Scotia Capital	$	(91	)	$	103		$	(7	)
Canadian Banking	$	(13	)	$	16		$	(21	)
Other	$	(56	)	$	6		$	7

T4 Impact of acquisitions⁽¹⁾

($ millions)	2010			2009
Net interest income	$	248		$	48
Other income		47			5
Non-interest expenses		(85	)		(12	)
Other items (net of tax)		(67	)		(14	)
Net income	$	143		$	27

(1) Includes acquisitions and investments in associated corporations made in 2009 and 2010, excluding funding costs.

26     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| OVERVIEW

Impact of foreign currency translation

The movement in foreign currency average exchange rates had a negative impact on the Bank’s earnings in 2010. On average, the Canadian dollar appreciated 13% relative to the U.S. dollar and 6% against the Mexican peso. The Canadian dollar also strengthened against the Jamaican dollar, the Peruvian sol, and many other currencies in which the Bank conducts its business. Changes in the average exchange rates affected net income, as shown in Table 3.

Impact of acquisitions

The Bank made a number of acquisitions in 2009 and 2010 which contributed to growth in Canada and in its International Banking operations. The impact on selected income statement categorized is shown in Table 4.

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), are not defined by GAAP and do not have standardized meanings that would ensure consistency and comparability between companies using these measures. These non-GAAP measures are used throughout this report and defined below.

Taxable equivalent basis

The Bank analyzes net interest income and total revenues on a taxable equivalent basis (TEB). This methodology grosses up tax-exempt income earned on certain securities reported in net 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 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. The TEB gross-up to net interest income and to the provision for income taxes for 2010 was $286 million versus $288 million in the prior year. The TEB gross-up to net interest income and to the provision for income taxes for the fourth quarter was $70 million, compared to $73 million in the same period last year and unchanged from $70 million in the prior quarter.

For purposes of segmented reporting, a segment’s net interest income 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.

Diluted cash earnings per share

The diluted cash earnings per share is calculated by adjusting the diluted earnings per share to add back the non-cash after-tax amortization of intangible assets.

Productivity ratio (TEB)

Management uses the productivity ratio as a measure of the Bank’s efficiency. This ratio represents non-interest expenses as a percentage of total revenue on a taxable equivalent basis.

Net interest margin on total average assets (TEB)

This ratio represents net interest income on a taxable equivalent basis as a percentage of total average assets.

Operating leverage

The Bank defines operating leverage as the rate of growth in total revenue, on a taxable equivalent basis, less the rate of growth in expenses.

Return on equity

Return on equity is a profitability measure that presents the net income available to common shareholders as a percentage of common shareholders’ equity. The Bank calculates its return on equity using average common shareholders’ equity.

Economic equity and Return on economic equity

For internal reporting purposes, the Bank attributes capital to its business segments based on their risk profile and uses a methodology that considers credit, market, operational and other risks inherent in each business segment. The amount of risk capital attributed is commonly referred to as economic equity. Return on economic equity for the business segments is based on the economic equity attributed.

Tangible common equity to risk-weighted assets

Tangible common equity to risk-weighted assets is an important financial measure for rating agencies and the investing community. Tangible common equity is total common shareholders’ equity plus non-controlling interest in subsidiaries, less goodwill and unamortized intangible assets. Tangible common equity is presented as a percentage of risk-weighted assets.

Regulatory capital ratios, such as Tier 1 and Total Capital ratios, have standardized meanings as defined by the Office of the Superintendent of Financial Institutions Canada (OSFI).

Scotiabank Annual Report2010     27

MANAGEMENT’S DISCUSSION AND ANALYSIS

GROUP FINANCIAL PERFORMANCE

Total revenue

Total revenue on a taxable equivalent basis was $15,791 million in 2010, an increase of $1,046 million or 7% from the prior year, notwithstanding a $719 million or 5% negative impact from foreign currency translation. Both net interest income and other income rose in 2010. The increase in net interest income was due to a wider margin, growth in average assets and the positive impact of changes in fair value of financial instruments used for asset/liability management purposes. Other income was up $755 million year over year, primarily from substantially higher net gains on securities and stronger mutual fund revenues.

Canadian Banking revenues grew 11% over last year in both net interest income and other income. Higher net interest income reflected volume growth and a slightly wider margin. Other income had substantial growth in mutual fund revenues, net gains on securities and retail brokerage fees.

International Banking revenues were up 4% in 2010, which included a $429 million negative impact from foreign currency translation. Interest income was relatively flat year over year as a higher margin was offset by a reduction in average earning assets, which were also negatively impacted by foreign currency translation. The increase in other income was driven by higher net gains on securities, higher mutual fund and insurance revenues, and the contribution from R-G Premier Bank of Puerto Rico.

Total revenues in Scotia Capital fell 11% from 2009 with declines in both net interest income and other income, although the latter was caused largely by the negative impact from foreign currency translation. The lower interest income was due to a significant decline in corporate lending volumes as well as lower spreads on capital market assets. Other income was modestly down from the record level in 2009, with lower investment banking revenues from a reduction in new issues, as well as slightly lower trading revenues, primarily in foreign exchange.

Net interest income

Net interest income on a taxable equivalent basis was $8,907 million in 2010, an increase of $291 million or 3% over last year. This included a negative impact of $413 million from foreign currency translation.

Average assets grew by $3 billion over the year to $516 billion. Growth in deposits with banks was $14 billion or 38%, securities were up $13 billion or 13%, residential mortgages grew $4 billion or 4% and securities purchased under resale agreements rose $5 billion or 28% in 2010. These increases were offset by lower volumes of business and government lending, down $21 billion or 18%, and a decline in non-earning assets of $15 billion or 20%.

Canadian Banking’s average earning assets grew by 6% or $12 billion to $204 billion, primarily in residential mortgages and personal lines of credit.

International Banking’s average earning assets fell by $3 billion or 3% to $87 billion partly reflecting foreign currency translation. Business lending was down in Chile and Mexico and reverse repos declined in Mexico.

Scotia Capital’s average earning assets fell by $8 billion or 5% to $139 billion, with declines in US, Europe and Canadian corporate lending. This was partially offset by higher volumes of trading securities, derivatives and deposits with banks.

The Bank’s net interest margin was 1.73%, a five basis point improvement from last year, mainly from wider spreads on the Canadian floating rate portfolio. As well, the margin benefitted from lower volumes of non-earning assets, a favourable change in the fair value of financial instruments used for asset/liability management purposes, and higher earnings from associated corporations. These factors were partially offset by higher volumes of low spread deposits with banks, narrower spreads on our foreign currency treasury funding and lower spreads in business lending in Asia.

28     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL PERFORMANCE

Canadian Banking’s margin improved from the impact of asset re-pricing and lower short term wholesale funding rates. Scotia Capital’s margin fell during 2010 from a changing business mix as an increasing proportion of narrower spread capital markets assets more than offset wider corporate loan spreads. International Banking’s margin improved year over year from higher earnings from associated corporations and acquisitions, and wider margins in both Mexico and Peru.

Outlook

The Bank’s net interest income is expected to increase in 2011, driven by moderate asset growth and a wider margin, as well as the full year impact of the acquisitions made in 2010.

Other income

Other income was a record $6,884 million in 2010, an increase of $755 million or 12% from the prior year, notwithstanding a negative impact of $306 million from foreign currency translation. This increase was primarily from substantially higher net gains on securities (as 2009 included negative valuation adjustments), and stronger mutual fund fees partially offset by lower securitization revenues.

Card revenues of $426 million were $2 million higher than the previous year. Canadian Banking revenues were 11% higher than 2009 mainly from the full year impact of the Momentum Visa card. International Banking revenues fell 10%, mainly in Peru in part from lower late payment fees driven by improved delinquency ratios.

Revenues from deposit and payment services earned from retail, commercial and corporate customers of $883 million were 3% below 2009. Canadian Banking revenues were 2% below the prior year and International Banking were 4% lower, primarily in Mexico and Chile from regulatory reductions in ATM fees.

Mutual fund revenues rose a substantial $211 million or 57% to a record $582 million. This increase was driven by a 27% growth in average assets under

T5 Net interest income and margin⁽¹⁾

($ millions,
except percentage amounts)	2010			2009			2008			2007			2006
Average assets		515,991			513,149			455,539			403,475			350,709
Net interest income(1)		8,907			8,616			7,990			7,629			6,848
Net interest margin		1.73	%		1.68	%		1.75	%		1.89	%		1.95	%

⁽¹⁾ Taxable equivalent basis. Refer to the non-GAAP measures on page 27.

T6 Average balance sheet⁽¹⁾ and interest margin

	2010					2009
Taxable equivalent basis(2)	Average		Average			Average		Average
For the fiscal years ($ billions)	balance		rate			balance		rate
Assets
Deposits with banks	$	52.2		0.56	%	$	37.7		1.28	%
Securities		117.6		3.84			104.4		4.19
Securities purchased under resale agreements		23.6		0.85			18.4		2.13
Loans:
Residential mortgages		111.6		3.97			107.6		4.39
Personal and credit cards		60.5		6.80			59.4		7.08
Business and government		92.1		3.94			112.7		4.48
		264.2		4.61			279.7		5.00
Total earning assets		457.6		3.75			440.2		4.37
Customers’ liability under acceptances		8.1		—			12.0		—
Other assets		50.3		—			60.9		—
Total assets	$	516.0		3.33	%	$	513.1		3.75	%
Liabilities and shareholders’ equity
Deposits:
Personal	$	124.4		2.04	%	$	122.5		2.74	%
Business and government		212.9		1.93			202.8		2.32
Banks		23.2		0.54			24.1		1.19
		360.5		1.88			349.4		2.39
Obligations related to securities sold under repurchase agreements		40.3		0.72			40.8		1.66
Subordinated debentures		5.9		4.87			5.5		5.18
Capital instrument liabilities		0.5		7.34			0.5		7.36
Other interest-bearing liabilities		33.7		2.63			28.8		4.41
Total interest-bearing liabilities		440.9		1.88			425.0		2.50
Other liabilities including acceptances		49.2		—			64.4		—
Shareholders’ equity		25.9		—			23.7		—
Total liabilities and equity	$	516.0		1.60	%	$	513.1		2.07	%
Net interest margin				1.73	%				1.68	%

(1)	Average of daily balances.
(2)	Refer to the non-GAAP measures on page 27.

T7 Trading revenue

Taxable equivalent basis(1)
For the fiscal years ($ millions)	2010			2009			2008			2007			2006
Reported in:
Other income	$	1,016		$	1,057		$	188		$	450		$	637
Net interest income		405			423			417			519			394
Total trading revenue	$	1,421		$	1,480		$	605		$	969		$	1,031
By trading products:
Securities trading	$	314		$	572		$	(27	)	$	65		$	145
Foreign exchange and precious metals trading		478			534			384			323			301
Derivatives trading		629			374			248			581			585
Total trading revenue	$	1,421		$	1,480		$	605		$	969		$	1,031
% of total revenues (net interest income plus other income)		9	%		10	%		5	%		7	%		9	%

(1) Refer to the non-GAAP measures on page 27.

Scotiabank Annual Report2010     29

MANAGEMENT’S DISCUSSION AND ANALYSIS

management in Scotia Funds, and stronger earnings from associated corporations. The average asset growth was from strong sales throughout 2010 as well as favorable market conditions. Mutual fund fees in International Banking grew a strong 36%, with Mexico, Chile and Peru all contributing to this increase.

Revenues from investment management, brokerage and trust services were up a solid 7% year over year to $781 million, mainly in ScotiaMcLeod full service brokerage reflecting higher fee based revenues. This was partly offset by lower discount brokerage revenues as a result of lower commissions per trade.

Credit fees fell $35 million from the high levels in 2009. Average banker’s acceptance rates reached record levels during 2010 but were offset by lower volumes. Standby loan fees grew substantially year over year, primarily from lower loan utilization.

Trading revenues were $41 million below the record levels set in 2009, but still higher than in previous years. Global fixed income business results improved year over year, partially offset by lower foreign exchange trading revenues. Precious metals revenues were $4 million below last year’s record level.

Underwriting fees and commissions were 10% lower than last year as new issue fees fell in Scotia Capital. Non-trading foreign exchange revenues were 10% below 2009, driven by lower transactions in Mexico from reduced US dollar/Peso volatility.

Net gain on securities were $355 million in 2010, compared to a loss of $412 million in the previous year. These net gains were higher in each business line from a combination of both higher gains on sales of securities and lower valuation adjustments. Securitization revenues of $124 million were $285 million below the prior year, as 2010 reflected a lower level of participation in the Canada Mortgage Bond and Insured Mortgage Purchase Program, and lower spreads.

Other revenues were up $200 million from the prior year, due to growth in insurance revenues, higher positive impact of changes in the fair value of non-trading financial instruments, a net gain on the sale of the pension administration business in Mexico, and the contribution from R-G Premier Bank of Puerto Rico.

Outlook

The Bank expects increases in most other income categories in 2011, from acquisitions, higher customer activity and improved market conditions.

T8 Other income

																2010
																versus
For the fiscal years ($ millions)	2010			2009			2008			2007			2006			2009
Card revenues	$	426		$	424		$	397		$	366		$	307			—	%
Deposit and payment services
Deposit services		686			707			675			652			622			(3	)
Other payment services		197			198			187			165			144			(1	)
		883			905			862			817			766			(3	)
Mutual funds		582			371			317			296			241			57
Investment management, brokerage and trust services
Retail brokerage		541			507			538			553			481			7
Investment management and custody		106			94			96			87			70			13
Personal and corporate trust		134			127			126			120			115			6
		781			728			760			760			666			7
Credit fees
Commitment and other credit fees		652			658			436			403			414			(1	)
Acceptance fees		179			208			143			127			116			(14	)
		831			866			579			530			530			(4	)
Trading revenues		1,016			1,057			188			450			637			(4	)
Underwriting fees and other commissions		561			620			402			498			453			(10	)
Foreign exchange, other than trading		337			373			314			239			206			(10	)
Net gain (loss) on securities, other than trading		355			(412	)		(374	)		488			371			100	+
Securitizaton revenues		124			409			130			34			43			(70	)
Other		988			788			727			914			580			25
Total other income	$	6,884		$	6,129		$	4,302		$	5,392		$	4,800			12	%
Percentage increase (decrease) over previous year		12	%		42	%		(20	)%		12	%		6	%

30     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL PERFORMANCE

Non-interest expenses

Non-interest expenses were $8,182 million in 2010, an increase of $263 million or 3% from last year, including a benefit from the positive impact of foreign currency translation of $252 million. Acquisitions accounted for approximately $73 million or 28% of the underlying growth in non-interest expenses.

Salaries and employee benefits were $4,647 million in 2010, up $303 million or 7% from last year. Salaries were up 3%, reflecting annual pay increases, as well as higher staffing in Canada to support growth initiatives, branch openings in Mexico, and the impact of acquisitions. Performance-based compensation was $53 million or 5% higher than last year, due to the Bank’s stronger financial performance in 2010. Stock-based compensation increased $126 million over last year due in part to changes in incentive plans and a higher stock price. Pension and other employee benefits increased $49 million, due primarily to an increase in pension costs and higher payroll taxes.

Premises and technology expenses were $1,526 million in 2010, a decrease of $17 million or 1% from last year. Excluding acquisitions and the favourable impact of foreign currency translation, premises and technology expenses rose $18 million or 1%. The increase in premises costs reflected new branches (5 in Canada, 51 in Mexico), and higher depreciation charges.

Advertising and business development expenses were $364 million in 2010, an increase of $57 million or 18% over last year, as a result of various marketing initiatives including advertising campaigns and sponsorships in Canada, the Caribbean and Mexico, and other initiatives to acquire new customers.

T9 Non-interest expenses and productivity

																2010
																versus
For the fiscal years ($ millions)	2010			2009			2008			2007			2006			2009
Salaries and employee benefits
Salaries	$	2,751		$	2,676		$	2,549		$	2,315		$	2,100			3	%
Performance-based compensation		1,088			1,035			913			1,017			936			5
Stock-based compensation		205			79			89			133			164			100	+
Pensions and other employee benefits		603			554			558			518			568			9
		4,647			4,344			4,109			3,983			3,768			7
Premises and technology
Net premises rent		243			243			217			197			181			—
Premises repairs and maintenance		85			87			83			75			60			(2	)
Property taxes		73			72			65			65			61			1
Computer equipment, software and data processing		685			687			650			603			549			—
Depreciation		236			234			208			203			184			1
Other premises costs		204			220			194			192			171			(7	)
		1,526			1,543			1,417			1,335			1,206			(1	)
Communications
Telecommunications		79			80			79			73			68			(1	)
Stationery, postage and courier		261			266			247			227			208			(2	)
		340			346			326			300			276			(2	)
Advertising and business development
Advertising and promotion		250			202			206			193			126			24
Travel and business development		114			105			114			118			106			9
		364			307			320			311			232			19
Professional		224			216			227			227			174			4
Business and capital taxes
Business taxes		125			129			90			107			98			(3	)
Capital taxes		46			48			26			36			35			(4	)
		171			177			116			143			133			(4	)
Other
Employee training		39			26			43			53			47			50
Amortization of goodwill and other intangibles		98			96			83			64			46			2
Other		773			864			655			578			561			(11	)
		910			986			781			695			654			(8	)
Total non-interest expenses	$	8,182		$	7,919		$	7,296		$	6,994		$	6,443			3	%
Productivity ratio (TEB)(1)		51.8	%		53.7	%		59.4	%		53.7	%		55.3	%

(1) Taxable equivalent basis. Refer to the non-GAAP measures on page 27.

Scotiabank Annual Report2010     31

MANAGEMENT’S DISCUSSION AND ANALYSIS

Professional fees rose $8 million or 4% to $224 million, due mainly to project related spending. Business and capital taxes were $171 million, $6 million or 4% lower than last year, due to the positive impact of foreign currency translation.

Other expenses were $910 million in 2010, down $76 million or 8% from last year, due largely to reductions in legal provisions, securitization expenses and loyalty reward point costs.

Our productivity ratio — a measure of efficiency in the banking industry — was 51.8% for 2010, an improvement from 53.7% in 2009. The Bank continued to have positive operating leverage, with 7% revenue growth versus 3% expense growth.

Outlook

Expense control remains a key strength of the Bank. However, non-interest expenses are expected to increase in 2011, driven mainly by acquisitions and volume-related growth. Pension costs are also expected to rise from the impact of a lower discount rate on actuarial liabilities. The productivity ratio is not expected to remain at the record low level achieved in 2010.

Taxes

The provision for income taxes was $1,745 million in 2010, an increase from $1,133 million last year. The Bank’s overall effective tax rate for the year was 28.7%, up from 23.6% last year. This increase was due primarily to a higher proportion of income in high tax rate jurisdictions. These items were partially offset by a reduction in the statutory tax rate in Canada and lower writedowns of future tax assets.

Outlook

The Bank’s consolidated effective tax rate is expected to be in the range of 21% to 25% in 2011.

Non-controlling interest

The deduction for non-controlling interest in subsidiaries was $100 million in 2010, a decrease of $14 million from 2009, due primarily to the lower level of income in certain international subsidiaries.

Credit quality

Provision for credit losses

The provision for credit losses was $1,239 million in 2010, down from $1,744 million last year.

The specific provision for credit losses in Canadian Banking was $713 million, an increase of $18 million from $695 million last year, with moderately higher retail provisions somewhat offset by moderately lower commercial provisions.

The specific provision for credit losses in International Banking was $616 million in 2010, an increase of $39 million from last year. Higher provisions in the Caribbean were partially offset by lower provisions in Asia, Mexico, and Latin America.

Scotia Capital experienced a net recovery of specific provisions of $6 million in 2010, primarily in Canada and the U.S., versus specific provisions of $301 million in 2009.

The general allowance for credit losses decreased by $40 million in 2010 compared to an increase of $127 million

T10 Impaired loans by business line

	Net impaired						Allowance for
	loans						credit losses								Gross impaired loans
As at October 31 ($ millions)	2010			2009			2010			2009			2010		2009		2008			2007			2006
Canadian Banking
Retail	$	424		$	508		$	(451	)	$	(361	)	$	875	$	869	$	523		$	391		$	374
Commercial		184			138			(157	)		(164	)		341		302		238			197			263
		608			646			(608	)		(525	)		1,216		1,171		761			588			637
International Banking
Mexico		110			95			(140	)		(143	)		250		238		216			188			213
Caribbean and Central America		1,502			744			(188	)		(187	)		1,690		931		560			397			375
Latin America		588			572			(346	)		(443	)		934		1,015		801			285			357
Asia and Europe		9			77			(31	)		(6	)		40		83		32			27			35
		2,209			1,488			(705	)		(779	)		2,914		2,267		1,609			897			980
Scotia Capital
Canada		34			73			(26	)		(14	)		60		87		—			18			18
United States		154			354			(25	)		(54	)		179		408		107			11			119
Europe		39			2			(13	)		(4	)		52		6		17			30			116
		227			429			(64	)		(72	)		291		501		124			59			253
Gross impaired loans													$	4,421	$	3,939	$	2,494		$	1,544		$	1,870
Specific allowance for credit losses							$	(1,377	)	$	(1,376	)					$	(1,303	)	$	(943	)	$	(1,300	)
Net impaired loans(1)	$	3,044		$	2,563												$	1,191		$	601		$	570
General allowance for credit losses		(1,410	)		(1,450	)												(1,323	)		(1,298	)		(1,307	)
Sectoral allowance		—			(44	)												—			—			—
Net impaired loans after general and sectoral allowances	$	1,634		$	1,069												$	(132	)	$	(697	)	$	(737	)
Gross impaired loans as a % of total allowance for credit losses and shareholders’ equity		14.5	%		14.3	%												10.3	%		7.3	%		9.3	%
Net impaired loans(1) as a % of loans and acceptances		1.04	%		0.93	%												0.40	%		0.25	%		0.27	%
Specific allowance for credit losses as a % of gross impaired loans		31	%		35	%												52	%		61	%		70	%

(1) Net impaired loans after deducting specific allowance for credit losses.

32     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL PERFORMANCE

in 2009. Factors contributing to this change include improved credit quality, and to a lesser extent, a stronger Canadian dollar.

The sectoral allowance established for the automotive industry, was $44 million as at October 31, 2009 ($7 million in Canadian Banking and $37 million in Scotia Capital). This reserve was fully reversed in 2010, reflecting the stabilization of the automotive industry.

Allowance for credit losses

The total allowance for credit losses decreased to $2,796 million as at October 31, 2010 from $2,875 million last year. The $79 million decline was attributable primarily to the $44 million reversal of the sectoral allowance during the year, and a $40 million reduction in the general allowance in the fourth quarter of 2010. Specific allowances of $1,377 million were largely unchanged from the previous year.

Specific allowances in Canadian Banking increased $83 million, primarily in the retail portfolios, where new provisions exceeded loan write-offs.

In International Banking, specific allowances declined by $74 million to $705 million, with reductions in most regions in Latin America partially offset by increases in Asia.

Scotia Capital’s specific allowances declined slightly to $64 million from $72 million, with declines in the U.S. portfolio offsetting increases in the Canadian and European portfolios.

T11 Specific provisions for credit losses by business line

For the fiscal years ($ millions)	2010			2009		2008			2007			2006
Canadian Banking
Retail	$	574		$	544	$	316		$	274		$	229
Commercial		139			151		83			21			50
		713			695		399			295			279
International Banking
Mexico		168			185		141			68			27
Caribbean and Central America		243			150		89			48			15
Latin America		193			202		—			(11	)		14
Asia and Europe		12			40		6			(4	)		4
		616			577		236			101			60
Scotia Capital
Canada		(1	)		109		(11	)		—			(6	)
United States		(13	)		192		16			(91	)		(41	)
Europe		8			—		(10	)		(10	)		(16	)
		(6	)		301		(5	)		(101	)		(63	)
Total	$	1,323		$	1,573	$	630		$	295		$	276

T12 Provisions for credit losses as a percentage of average loans and acceptances

For the fiscal years (%)	2010			2009			2008			2007			2006
Canadian Banking
Retail		0.32	%		0.33	%		0.22	%		0.22	%		0.20	%
Commercial		0.57			0.60			0.31			0.09			0.22
		0.35			0.37			0.23			0.19			0.20
International Banking		0.99			0.90			0.44			0.25			0.18
Scotia Capital(1)		(0.02	)		0.61			(0.01	)		(0.33	)		(0.25	)
Weighted subtotal — specific provisions		0.48			0.54			0.24			0.13			0.14
General and sectoral provisions		(0.03	)		0.06			—			(0.01	)		(0.03	)
Weighted total		0.45	%		0.60	%		0.24	%		0.12	%		0.11	%

(1) Corporate Banking only.

T13 Net charge-offs⁽¹⁾ as a percentage of average loans and acceptances

For the fiscal years (%)	2010			2009			2008			2007			2006
Canadian Banking
Retail		0.30	%		0.27	%		0.20	%		0.20	%		0.18	%
Commercial		0.59			0.51			0.23			0.25			0.12
		0.34			0.30			0.20			0.21			0.17
International Banking		1.05			0.93			0.53			0.51			0.36
Scotia Capital(2)		(0.01	)		0.53			0.03			(0.05	)		0.03
Weighted total		0.49	%		0.49	%		0.24	%		0.23	%		0.19	%

(1)	Write-offs net of recoveries.
(2)	Corporate Banking only.

Scotiabank Annual Report2010     33

MANAGEMENT’S DISCUSSION AND ANALYSIS

Impaired Loans

Gross impaired loans increased to $4,421 million as at October 31, 2010 from $3,939 million last year.

Impaired loans in Canadian Banking increased $45 million, primarily in the commercial portfolios.

In International Banking, impaired loans increased by $647 million largely due to the inclusion of impaired loans from the acquisition of R-G Premier Bank of Puerto Rico. These impaired loans are carried at fair value on the date of acquisition and no allowance for credit losses is recorded at the acquisition date, as credit losses are included in the determination of the fair value. Under the terms of the acquisition, the Federal Deposit Insurance Corporation (FDIC) absorbs 80% of any losses on the acquired loans. The remaining increase in International Banking impaired loans was attributable primarily to the Caribbean region.

Scotia Capital’s impaired loans decreased by $210 million, attributable primarily to the U.S. portfolio.

Net impaired loans, after deducting the specific allowance for credit losses, were $3,044 million as at October 31, 2010, an increase of $481 million from a year ago.

As shown in Chart 13, net impaired loans as a percentage of loans and acceptances were 1.04% as at October 31, 2010, compared to 0.93% a year ago.

Portfolio review

Canadian Banking

The overall credit quality of the consumer portfolio in Canada was stable year over year. Reportable delinquency decreased 12 basis points to 1.59%. The specific provision for credit losses in the Canadian retail portfolio was $574 million, up $30 million or 6% from last year. The specific provision for credit losses as a percentage of average loans was 0.32%, compared to 0.33% last year.

Gross impaired loans in the retail portfolio were in line with last year, increasing by 1% or $6 million. Portfolio quality continued to benefit from high secured lending, with 92% of total retail loans being secured by an underlying asset such as a house or an automobile. This high level of secured lending reflects the growth in Scotia Total Equity Plan, where all products, including lines of credit and credit cards, are secured by residential real estate. Currently, 65% of the ScotiaLine line of credit and ScotiaLine Visa portfolios are secured.

The specific provision for credit losses in the Canadian commercial loan portfolio was $139 million, down $12 million or 8% from last year. Gross impaired loans increased by $39 million to $341 million.

International Banking

Retail credit quality stabilized in most regions with the exception of the Caribbean, where economic conditions declined during the year. Gross retail impaired loans increased by $444 million to $1,575 million during the year with 55% of the increase attributable to the acquisition of R-G Premier Bank of Puerto Rico and the remaining portion related to mortgage portfolios in the Caribbean, Mexico and Chile.

Specific provisions for credit losses in the retail portfolio declined to $502 million from $523 million last year, with lower provisions in Peru somewhat offset by higher provisions in the Caribbean. Total reported delinquency increased 38 basis points year over year to 9.04%, primarily related to mortgage portfolios in the Caribbean region. Delinquency improved year over year in Peru and Chile.

In commercial banking, gross impaired loans were $1,339 million, an increase of $203 million over the prior year as increases in the Caribbean and in Puerto Rico, the latter attributable to the recent acquisition, more than offset reductions in other regions.

34     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL PERFORMANCE

Specific provisions for credit losses in the commercial portfolio were $114 million in 2010 versus $54 million in 2009. The increase was attributable to higher provisions in the Caribbean and lower levels of reversals and recoveries in Peru, partially offset by lower provisions in Chile and in the Asia/Pacific regions.

Scotia Capital

Scotia Capital experienced net recoveries of $6 million in 2010, primarily in Canada and the U.S., versus specific provisions of $301 million in 2009.

Gross impaired loans in Scotia Capital declined by $210 million in 2010 to $291 million. Most of the decline was attributable to the U.S. portfolio, which decreased by $229 million year over year to $179 million. The Canadian portfolio declined by $27 million to $60 million, while the Europe portfolio increased by $46 million to $52 million.

Risk diversification

The Bank’s exposures to various countries and types of borrowers are well diversified. (See Charts 16 and 17; Tables 38 and 43 on pages 88 and 90). Chart 16 shows loans and acceptances by geography. Ontario represents the largest Canadian exposure, at 36% of the total. Latin America has 8% of the total exposure and the U. S. has 6%.

Chart 17 shows loans and acceptances by type of borrower. Excluding loans to households, the largest industry exposures were in financial services, 6.6%; real estate, 3.6%; and wholesale and retail, 3.5%.

The Bank actively monitors industry and country concentrations. The North American automotive industry, forestry, hotel, gaming and media sectors are being closely managed. 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.

Sovereign credit risk

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’s exposure to certain European countries that have come under recent focus is not significant, with no non-trading sovereign risk exposure to Greece, Portugal or Spain as at October 31, 2010. The Bank had $142 million non-trading Irish sovereign exposure in the form of central bank deposits arising from regulatory reserve requirements to support the Bank’s operations in Ireland as at October 31, 2010. Net trading securities exposures to these countries was negligible as at October 31, 2010.

With respect to Irish banks, the Bank had exposures of $255 million as at October 31, 2010, primarily in the form of securities. The unrealized loss on these securities was $28 million (pre tax) as at October 31, 2010, and was reported in Other Comprehensive Income.

Other credit risk

There has been stabilization in the automotive sector as reflected by the reversal of the balance of the sectoral allowance. There were no significant changes in the Bank’s automotive industry exposure and consumer auto-based securities.

Risk mitigation

To mitigate exposures in its performing corporate portfolios, the Bank uses loan sales and credit derivatives. In 2010, loan sales totaled $192 million, compared to $500 million in 2009. The largest volume of loan sales in 2010 related to loans in the real estate industry.

Scotiabank Annual Report2010     35

MANAGEMENT’S DISCUSSION AND ANALYSIS

At October 31, 2010, credit derivatives used to mitigate exposures in the portfolios totaled $61 million (notional amount), compared to $236 million at October 31, 2009. The industries with significant protection purchased include the financial services and utilities sectors.

The current annualized cost (excluding mark-to-market adjustments) of the credit derivatives outstanding at October 31, 2010, was $0.1 million compared to $0.6 million in 2009.

Outlook

Overall, the provision for credit losses is expected to remain in line with 2010 as the global economies show modest economic improvement. Canadian Banking retail provisions are expected to improve modestly, while growth in International Banking’s retail portfolio should result in provisions in line with current levels. Provisions in the corporate and commercial portfolios are expected to have lower gross provisions, but will not benefit from as many recoveries as in 2010.

Fourth quarter review

Q4 2010 vs Q4 2009

Net Income

Net income was $1,092 million in the fourth quarter, a substantial increase of $190 million or 21% over the same quarter last year and the second highest quarterly net income ever. The increase was driven by positive contributions from recent acquisitions, higher net interest income and other income, and lower provision for credit losses, partly offset by higher expenses. The impact of foreign currency translation compared to the same quarter a year ago was not material.

Total revenue

Total revenue (on a taxable equivalent basis) was $4,012 million this quarter, an increase of $204 million or 5%.

Net interest income

Net interest income (on a taxable equivalent basis) was a record $2,313 million, an increase of $141 million or 7%. The increase in net interest income was mainly from growth in earning assets of $32 billion or 7%, comprised of residential mortgages, reverse repos and deposits with banks, as the margin was relatively flat compared to the fourth quarter last year.

The Bank’s net interest margin was 1.75% in the fourth quarter, comparable to 1.74% in the same quarter last year. Wider spreads in the Canadian floating rate portfolio, a positive impact from changes in the fair value of instruments used for asset/liability management purposes and higher earnings from associated corporations were offset by volume growth in low spread assets.

Other income

Other income was $1,699 million in the fourth quarter, $63 million or 4% higher than last year. The increase was primarily from higher securitization revenues, the contribution from the acquisition of R-G Premier Bank of Puerto Rico, growth in mutual fund revenues from a significant increase in assets under management and higher net gains on securities.

This was partly offset by lower credit and underwriting fees and reduced trading revenues.

Provision for credit losses

The provision for credit losses was $254 million this quarter, comprised of $294 million in specific provisions and a $40 million reduction in the general allowance. The total provision was down $166 million from the same period last year, reflecting lower provisions across all business lines and the reduced general allowance.

The provision for credit losses was $174 million in Canadian Banking, down from $190 million in the same quarter last year. The decrease was mainly due to lower retail provisions in credit cards and the indirect automotive portfolio, somewhat offset by higher provisions in personal lines of credit. Commercial provisions were in line with the same period last year.

International Banking’s provision for credit losses was $128 million in the fourth quarter, compared to $167 million in the same period last year. Higher retail provisions in the Caribbean and Mexico were more than offset by lower retail provisions in Peru and lower commercial provisions across most regions, particularly in Chile and Asia. The provision for credit losses was not affected this quarter by the acquisition of R-G Premier Bank of Puerto Rico, as all credit losses recorded at the acquisition date were included in the determination of fair value. Going forward, the Federal Deposit Insurance Corporation (FDIC) will absorb 80% of the losses on the acquired loans.

Scotia Capital experienced a net recovery of $8 million in the fourth quarter, an improvement from net provisions of $63 million in the fourth quarter of last year. The net recovery in this quarter relates mainly to reversals and recoveries in the U.S. portfolio.

Total net impaired loans, after deducting the allowance for specific credit losses, were $3,044 million as at October 31, 2010, an increase of $481 million from a year ago. This increase was attributable primarily to the acquisition of R-G Premier Bank of Puerto Rico whose impaired loans are recorded at fair value on the date of acquisition. As a result, gross and net impaired loans at October 31 include $553 million related to the acquisition.

The general allowance for credit losses was $1,410 million as at October 31, 2010, a decrease of $40 million from last year. Factors contributing to this change include improved credit quality and, to a lesser extent, a stronger Canadian dollar.

36     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL PERFORMANCE

Non-interest expenses and productivity

Non-interest expenses were $2,183 million in the fourth quarter, an increase of $119 million or 6% from the same quarter last year. Recent acquisitions accounted for approximately $30 million of this growth. The increase was mainly in salaries, reflecting annual pay increases, branch expansion and recent acquisitions, as well as higher performance-based and stock-based compensation. Technology and advertising expenses also rose, due to projects and initiatives to drive revenue growth. These were partly offset by lower loyalty reward point costs.

The productivity ratio was 54.4% in the fourth quarter, an increase of 20 basis points from last year.

Taxes

The Bank’s effective tax rate was 25.9%, compared to 25.7% reported for the same period last year. This marginal increase was due primarily to proportionately higher income in high tax rate jurisdictions partially offset by a reduction in the statutory tax rate in Canada and lower writedowns of future tax assets.

Q4 2010 vs Q3 2010

Net Income

Net income was $1,092 million for the fourth quarter, a $30 million increase from the previous quarter. The increase was driven by positive contributions from recent acquisitions, higher net interest income and other income, and lower provision for credit losses, partly offset by higher expenses. The negative impact of foreign currency translation was not material in this period.

Total revenue

Total revenue (on a taxable equivalent basis) of $4,012 million this quarter was an increase of $158 million or 4% above last quarter.

Net interest income

Net interest income (on a taxable equivalent basis) of $2,313 million, was up $70 million or 3% from the previous quarter. This increase came from a wider margin, as earning assets fell by $7 billion.

The Bank’s net interest margin was 1.75%, 7 basis points wider than the third quarter. The increase was a result of lower volumes of low spread deposits with banks, wider spreads in the Canadian floating rate portfolio, a positive impact from changes in the fair value of instruments used for asset/liability management purposes and higher earnings from associated corporations. These items more than offset the impact of higher volumes of non-earning assets.

Other income

Other income of $1,699 million in the fourth quarter was up $88 million or 6%. The increase was mainly from stronger securitization revenues, higher revenues in Chile and contribution from the acquisition of R-G Premier Bank of Puerto Rico, and improvements in the fair value of non-trading financial instruments. In addition, trading revenues were stronger reflecting improved performance in Scotia Capital, particularly the energy, fixed income and foreign exchange units. This was partly offset by much lower net gains on securities and lower mutual fund revenues.

Provision for credit losses

The provision for credit losses of $254 million this quarter was down $22 million from last quarter. Quarter-over-quarter changes in provisions were mixed, with moderate increases in Canadian Banking more than offset by lower provisions in International Banking and Scotia Capital, and the reduction in general allowance.

The provision for credit losses of $174 million in Canadian Banking was up from $163 million in the previous quarter. Retail provisions were slightly lower, particularly relating to the indirect automotive portfolio, while commercial provisions were somewhat higher than last quarter.

International Banking’s provision for credit losses was $128 million in the fourth quarter, compared to $138 million last quarter. Higher retail provisions in the Caribbean were more than offset by lower commercial provisions across most regions.

Scotia Capital experienced a net recovery of $8 million in the fourth quarter, compared to a net recovery of $25 million in the previous quarter, which included the reversal of the remaining auto sectoral allowance of $18 million. The net recovery in this quarter relates to reversals and recoveries mainly in the U.S. portfolio.

Total net impaired loans, after deducting the allowance for specific credit losses, were $3,044 million as at October 31, 2010, an increase of $446 million from last quarter. This increase was primarily attributable to the R-G Premier Bank of Puerto Rico acquisition, as the preliminary purchase price allocation was recorded in the fourth quarter. The impaired loans are recorded at fair value. As a result, gross and net impaired loans at October 31, 2010 include $553 million relating to this acquisition. The purchase price allocation had not been reflected in the third quarter.

The general allowance for credit losses was $1,410 million as at October 31, 2010, down $40 million from last quarter, due primarily to improved credit quality.

Non-interest expenses and productivity

Quarter over quarter, non-interest expenses were up $160 million or 8%, due mainly to higher performance-based compensation in line with exceeding performance targets. There was also a higher level of investment in customer acquisition and revenue growth through increased expenditures on advertising and business development, as well as higher spending on technology.

The productivity ratio was 54.4% in the fourth quarter, a 190 basis points increase from the prior quarter.

Taxes

The Bank’s effective tax rate was 25.9%, compared to 26.8% last quarter. The decrease from last quarter was due primarily to lower future tax adjustments partially offset by proportionately higher income in high tax rate jurisdictions.

Scotiabank Annual Report2010     37

MANAGEMENT’S DISCUSSION AND ANALYSIS

Summary of quarterly results

The Bank experienced four quarters of strong performance during a time of continued volatility and a sluggish global recovery. The Canadian dollar continued to strengthen throughout the year, almost reaching par by year end. This had a negative impact on whole year results.

Net interest income was relatively consistent throughout the year, and rose somewhat in the final quarter of the year. Average loan volumes grew in the latter part of the year due to acquisitions.

The Bank’s net interest margin showed slight improvement in the first quarter, with declines in the following six months. In the final quarter of the year the margin widened and was higher than the last eight quarters. Canadian Banking’s margin declined during the year, as short-term wholesale rates rose in 2010. International Banking’s margin was impacted by changes in the fair value of financial instruments, rising in the first quarter, falling in the second and then widening in the final two quarters. Spreads in Scotia Capital’s corporate lending portfolios widened slightly during the year.

Other income reached record levels in the first two quarters of 2010, declining somewhat in the third quarter and climbing again to end the year. Financial markets presented more opportunities for fixed income and equity trading in the early part of the year. The level of net gains on securities was impacted by the timing of write downs on available-for-sale securities and changes in the fair value of financial instruments. Securitization revenues varied over the year depending on the funding needs of the Bank.

The trend in loan losses reflected the gradual improvements in the current economy, with continuing signs of recovery as the year progressed.

Non-interest expenses declined in the first and second quarters and then increased in the second half of the year partly due to acquisitions. The final quarter reflected finalization of performance-driven compensation, growth initiatives and project spending. Overall, the Bank’s productivity level was a record low in 2010.

The effective tax rate ranged between 34% and 26% reflecting different levels of income earned in higher tax jurisdictions and changes in the valuation of future tax assets.

An eight quarter trend in net income and other selected information is provided on page 97.

38     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

GROUP FINANCIAL CONDITION

Balance sheet

Assets

The Bank’s total assets at October 31, 2010 were $527 billion, up $30 billion from last year. Excluding the negative impact of foreign currency translation total assets were up $41 billion or 8%.

Cash resources grew by $3 billion, primarily from interest bearing deposits with banks. Securities purchased under resale agreements increased by $10 billion.

Securities

Total securities were down $1 billion year over year. Excluding the negative impact of foreign currency translation total securities increased by $1 billion.

Trading securities rose by $7 billion due mainly to higher holdings of U.S. and other foreign government debt and Canadian equities.

There was a decline in available-for-sale securities of $8 billion from reduced holdings of government and corporate bonds and mortgage-backed securities.

Equity accounted investments increased by $1,123 million due mainly to an additional investment in Thanachart Bank to finance that entity’s acquisition of Siam City Bank.

As at October 31, 2010, the unrealized gain on available-for-sale securities, after the impact of qualifying hedges is taken into account, was $1,189 million, an increase of $361 million from last year. The increase was due mainly to changes in interest rates that increased values of Canadian government debt and mortgage-backed securities created and retained by the Bank. Increases in the values of corporate bonds and equity securities were also driven by an improvement in capital markets. These were partially offset by realized gains on the sale of foreign government bonds.

Loans

The Bank’s loan portfolio increased $18 billion from last year, or $22 billion or 8% excluding the negative impact of foreign currency translation.

In retail lending, residential mortgages increased $19 billion, with growth of $15 billion in Canadian Banking and $4 billion in International Banking. The latter was due primarily to the acquisition of R-G Premier Bank of Puerto Rico. Personal loans rose by $2 billion due mainly to growth in Canadian Banking.

Business and government loans decreased $3 billion from the negative impact of foreign currency translation.

T14 Condensed balance sheet

As at October 31 ($ billions)	2010		2009		2008		2007		2006
Assets
Cash resources	$	46.0	$	43.3	$	37.3	$	29.2	$	23.4
Securities		116.6		117.3		88.0		88.8		95.5
Securities purchased under resale agreements		27.9		17.8		19.5		22.5		25.7
Loans		284.2		266.3		288.7		227.2		202.8
Other		52.0		51.8		74.1		43.8		31.6
Total assets	$	526.7	$	496.5	$	507.6	$	411.5	$	379.0
Liabilities and shareholders’ equity
Deposits	$	361.7	$	350.4	$	346.6	$	288.5	$	263.9
Obligations related to securities sold under repurchase agreements		40.3		36.6		36.5		28.1		33.5
Other liabilities		90.7		78.3		98.0		73.9		61.0
Subordinated debentures		5.9		5.9		4.4		1.7		2.3
Capital instrument liabilities		0.5		0.5		0.5		0.5		0.8
Total liabilities		499.1		471.7		486.0		392.7		361.5
Shareholders’ equity		27.6		24.8		21.6		18.8		17.5
Total liabilities and shareholders’ equity	$	526.7	$	496.5	$	507.6	$	411.5	$	379.0

Scotiabank Annual Report2010     39

MANAGEMENT’S DISCUSSION AND ANALYSIS

Liabilities

Total liabilities were $499 billion as at October 31, 2010, up $27 billion from last year. Excluding the negative impact of foreign currency translation, total liabilities rose $38 billion or 8%.

Deposits

Total deposits increased by $11 billion, net of negative foreign currency translation of $9 billion. Business and government deposits grew by $7 billion, mainly in the U.S. and Canada. The increase includes the issuance of US$5 billion in covered bonds that are backed by residential mortgages through the Bank’s recently launched Covered Bond Program. Personal deposits increased by $5 billion, primarily from growth in high interest savings accounts in Canada and the acquisition of R-G Premier Bank of Puerto Rico. Deposits by banks decreased by $1 billion in 2010.

Other Liabilities

Obligations related to securities sold short and obligations related to securities sold under repurchase agreements grew by $7 billion and $4 billion, respectively. Derivative instrument liabilities increased by $3 billion. Other liabilities increased by $4 billion, due mainly to the FDIC deposit note liability of $3 billion that was part of the acquisition of R-G Premier Bank of Puerto Rico. These increases were partially offset by a decrease in acceptances, as well as the corresponding receivable from customers, of $2 billion.

Shareholders’ equity

Total shareholders’ equity increased $2,859 million from last year. This was driven by internal capital generation of $2,015 million. The Bank issued $804 million common shares through the Dividend Reinvestment Program, the Employee Share Purchase Plan and the exercise of options. Preferred shares of $265 million were also issued. Partially offsetting the growth was an increase of $251 million in accumulated other comprehensive loss. This arose from a $591 million increase in unrealized foreign exchanges losses from the strengthening of the Canadian dollar, partially offset by an improvement in the unrealized net gains on available-for-sale securities and cash flow hedges.

Outlook

The Bank expects moderate asset growth in its business lines in 2011. This reflects uneven economic growth globally, particularly in the developed economies.

Subsequent Events

Acquisitions of DundeeWealth Inc.

On November 22, 2010, the Bank announced an agreement to make an offer for all the issued and outstanding shares (other than Series 1 preference shares) of DundeeWealth Inc. (DundeeWealth). The Bank currently owns 18 per cent of DundeeWealth, (TSX: DW) which is a Canadian owned, independent wealth management company that currently oversees $78.5 billion in assets under management, assets under administration and bank deposits.

The transaction is in line with the Bank’s commitment to build its wealth management presence in Canada and aligns with the Bank’s global wealth management strategy. It introduces significant synergy and value enhancement opportunities and increases the Bank’s exposure to fee business and strengthens its ability to pursue global wealth opportunities.

As of the date the transaction was announced, the value of the offer to DundeeWealth shareholders was $21 per common share which results in an approximate cost of the transaction of $2.3 billion. For each DundeeWealth common share, the Bank will offer 0.2497 of its common shares and, at the election of each shareholder, either $5.00 in cash or 0.2 of its $25.00, 3.70% five year rate reset preferred shares. Prior to closing, DundeeWealth shareholders will also receive a special distribution of $2.00 per share in cash as well as an interest in Dundee Capital Markets, with an approximate value of $0.50 per DundeeWealth share, which DundeeWealth will spin out to its shareholders in connection with the transaction. The transaction will result in the issuance of approximately 32 million common shares (value of $1.7 billion) and up to $639 million of preferred shares.

Dundee Corporation, the largest shareholder of DundeeWealth with 48 per cent of the issued and outstanding shares, has irrevocably agreed to tender its shares to the offer, subject to obtaining the approval of its shareholders. The controlling shareholder of Dundee Corporation has irrevocably agreed to vote its shares in favour of the sale.

The offer is subject to customary conditions, including the receipt of all necessary regulatory and other approvals. The offer is not subject to a minimum tender condition. However, as a result of Dundee Corporation’s commitment to tender, on completion of the offer, the Bank will own at least 67% of DundeeWealth. After completion of the offer, the Bank expects to proceed with the acquisition of the balance of the shares of DundeeWealth. The transaction is expected to be completed in early 2011.

The transaction meets the Bank’s stated acquisition criteria. Based on the Bank’s forecasts and estimates, the transaction is expected to be accretive to earnings after the first year. There is no material impact on regulatory capital ratios.

Redemption of capital instrument

On November 26, 2010, the Bank announced BNS Capital Trust’s intention to redeem all issued and outstanding Scotiabank Trust Securities — Series 2000-1 on December 31, 2010, the redemption date.

Capital management

Overview

Scotiabank is committed to maintaining a solid 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 or share repurchases.

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 strategic objectives. Key components of the Bank’s ICAAP include sound corporate governance; creating a comprehensive risk appetite of the Bank; managing and monitoring capital, both currently and prospectively; and utilizing appropriate financial metrics which relate risk to capital, including economic and regulatory capital metrics.

40     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

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 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 is detailed in the Risk Management section “Risk appetite framework” on page 64. The framework encompasses medium to long-term targets with respect to regulatory capital thresholds, earnings, economic capital 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.

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, economic capital and tangible common equity. In addition, the Bank assesses its capital adequacy in the context of its current position and in relation to its expected future risk profile and position. The capital adequacy assessment considers the impact of various stress scenarios on the Bank’s current and future capital position. 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 consideration of the results of enterprise-wide stress testing. This testing is used to determine the extent to which severe, but plausible events, impact the Bank’s capital. These results are used in capital planning and strategic decision-making.

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, and that there is an appropriate balance between risk and return. Refer to the Risk Management section on page 62 for further discussions 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 balance sheet 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 always balanced against the goal of generating an appropriate return for the Bank’s shareholders.

Capital generation

Capital is generated through net earnings after dividend payments, refer to Chart 23 for an illustration. This is augmented by the issuance of common shares, preferred shares, Tier 1 innovative instruments and Tier 2 subordinated debentures, as required to meet growth plans and other strategic initiatives.

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 criteria include impact on earnings per share,

Scotiabank Annual Report2010     41

MANAGEMENT’S DISCUSSION AND ANALYSIS

T15 Regulatory capital⁽¹⁾

As at October 31	Basel II									Basel I
($ millions)	2010			2009			2008			2007			2006
Tier 1 capital
Common shareholders’ equity(2)	$	23,199		$	20,945		$	20,197		$	16,477		$	16,947
Innovative capital instruments		3,400			3,400			2,750			2,750			3,000
Non-cumulative preferred shares		3,975			3,710			2,860			1,635			600
Non-controlling interest in subsidiaries		579			554			502			497			435
Less: Goodwill		(3,050	)		(2,908	)		(2,273	)		(1,134	)		(873	)
Other capital items(3)		(2,769	)		(2,051	)		(773	)		—			—
		25,334			23,650			23,263			20,225			20,109
Tier 2 capital
Subordinated debentures(4)		5,790			5,833			4,227			1,452			2,046
Trust subordinated notes		1,000			1,000			1,000			1,000			—
Eligible amounts of general allowance(5)		574			570			534			1,298			1,307
Net unrealized equity gains(6)		176			6			—			298			—
		7,540			7,409			5,761			4,048			3,353
Less: other capital deductions(7)		(3,275	)		(2,471	)		(1,177	)		(1,292	)		(476	)
Total capital	$	29,599		$	28,588		$	27,847		$	22,981		$	22,986
Risk-weighted assets(1)($ billions)
Credit risk		180.5			187.8			214.5			208.3			192.0
Market risk		10.5			11.4			15.5			10.0			5.0
Operational risk		24.0			22.4			20.6			—			—
Total risk-weighted assets	$	215.0		$	221.6		$	250.6		$	218.3		$	197.0
Capital ratios(1)
Tier 1 capital ratio		11.8	%		10.7	%		9.3	%		9.3	%		10.2	%
Total capital ratio		13.8	%		12.9	%		11.1	%		10.5	%		11.7	%
Assets to capital multiple		17.0			16.6			18.0			18.2			17.1

(1)	Effective November 1, 2007, regulatory capital, risk weighted assets and capital ratios are determined in accordance with Basel II rules. Comparative amounts for prior periods are determined in accordance with Basel I rules.
(2)	Beginning in 2007, balance excludes unrealized gains and losses on available-for-sale securities and cash flow hedges.
(3)	Comprised of net after-tax losses on available-for-sale equity securities, 50/50 deduction of certain investments in associated corporations and other items.
(4)	Net of amortization.
(5)	Under Basel I, the general allowance is included in Tier 2 capital up to a maximum of 0.875% of risk-weighted assets as per OSFI guidelines. Under Basel II, eligible general allowances in excess of expected losses for advanced internal ratings based exposures and the allocated portion for standardized exposures can be included in capital, subject to certain limitations.
(6)	Net unrealized gains (after-tax) on available-for-sale equity securities.
(7)	Comprised of investments in insurance entities, 50/50 deduction of certain investments in associated corporations and other items.

T16 Changes in regulatory capital⁽¹⁾

For the fiscal years	Basel II									Basel I
($ millions)	2010			2009			2008			2007			2006
Total capital, beginning of year	$	28,588		$	27,847		$	22,981		$	22,986		$	21,532
Internally generated capital
Net income		4,239			3,547			3,140			4,045			3,579
Preferred and common share dividends		(2,224	)		(2,176	)		(2,003	)		(1,771	)		(1,513	)
		2,015			1,371			1,137			2,274			2,066
External financing
Subordinated debentures(2)		(43	)		1,606			2,775			(594	)		(374	)
Trust subordinated notes		—			—			—			1,000			—
Preferred shares		265			850			1,225			1,035			—
Innovative capital instruments		—			650			—			(250	)		750
Common shares and contributed surplus		829			1,117			263			141			108
Purchase of shares — premium on redemption		—			—			(37	)		(586	)		(324	)
		1,051			4,223			4,226			746			160
Other
Net after-tax unrealized gains/losses on available-for-sale equity securities		170			201			(493	)		298			—
Net unrealized foreign exchange translation gains (losses)		(590	)		(1,736	)		2,368			(2,228	)		(360	)
Non-controlling interest in subsidiaries		24			52			5			62			129
Other(3)		(1,659	)		(3,370	)		(2,377	)		(1,157	)		(541	)
		(2,055	)		(4,853	)		(497	)		(3,025	)		(772	)
Total capital generated (used)		1,011			741			4,866			(5	)		1,454
Total capital, end of year	$	29,599		$	28,588		$	27,847		$	22,981		$	22,986

(1)	Effective November 1, 2007, regulatory capital determined in accordance with Basel II rules. Comparative amounts for prior periods are determined in accordance with Basel I rules.
(2)	Net of amortization.
(3)	Represents changes to eligible general allowance, regulatory capital deductions for goodwill, investments in insurance entities and associated corporations, securitization-related amounts, and other charges (credits) to retained earnings.

42     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

capital ratios, return on invested capital, expected payback period and internal rate of return based on discounted cash flows. Any potential acquisitions, investments or strategic initiatives are reviewed and approved by the Bank’s Strategic Transaction Investment Committee, to ensure effective deployment of capital.

Regulatory capital

Capital adequacy for Canadian banks is regulated by OSFI and remains consistent with international standards set by the Bank for International Settlements (BIS).

Bank regulatory capital consists primarily of two components — Tier 1 capital and Tier 2 capital. Both components of capital provide support for banking operations and protect depositors. Tier 1 capital, which is more permanent, is of particular importance to regulators, financial markets and investors. Tier 1 capital consists primarily of common shareholders’ equity (excluding unrealized gains and losses on available-for-sale debt securities and cash flow hedges), non-cumulative preferred shares, innovative Tier 1 instruments and non-controlling interests less various capital deductions. Tier 2 capital consists mainly of subordinated debentures and the eligible allowances for credit losses less prescribed capital deductions.

Capital ratios are a means to monitor the capital adequacy and the financial strength of banks. The two primary regulatory capital ratios, Tier 1 and Total, are determined by dividing capital components by risk-weighted assets.

Regulatory capital and risk-weighted assets are determined in accordance with the capital framework based on the International Convergence of Capital Measurement and Capital Standards, commonly known as Basel II. Under this framework, the computation of risk-weighted assets aligns risk weight parameters with the individual risk profile of banks. Risk-weighted assets are calculated for credit, market and operational risks.

•	Credit Risk: There are two main methods for computing credit risk: the standardized approach, which uses prescribed risk weights; and internal ratings-based approaches, which allow the use of a bank’s internal models to calculate some, or all, of the key inputs into the regulatory capital calculation. Users of the Advanced Internal Ratings Based Approach (AIRB) are required to demonstrate that they have sophisticated risk management systems for the calculation of credit risk regulatory capital and obtain OSFI approval for the use of this approach. The Bank applies the AIRB approach for material Canadian, U.S. and European portfolios and uses the Standardized Approach for the other portfolios. The Bank is assessing the remaining portfolios for application of AIRB in the future.
•	Market Risk: The Bank uses both internal models and standardized approaches to calculate market risk capital. In July 2009, the Basel Committee revised the market risk framework, for implementation in fiscal 2011 for the Bank, in response to concerns arising from significant losses in trading books in the industry during 2007-2009. One of the key changes is the introduction of a Stressed Value at Risk (VaR) measure that will lead to an increase in market risk capital. BIS has also introduced an Incremental Risk Charge, to capture default and migration risk in debt portfolios over a one year period, at a 99.9% confidence level. In addition, securitized products in the trading book will receive the same capital charge as in the banking book, unless they are in a correlation trading portfolio that meets a number of conditions. During 2010, the Basel Committee clarified that these new measures will become effective in fiscal 2011. The Bank is in the process of preparing the necessary changes in systems, processes and assessing the impact on the required capital levels.
•	Operational Risk: the Bank uses the Standardized Approach to calculate the operational risk capital requirements.
	Since the Basel II capital framework has only been in effect since November 1, 2007, capital floors are in place for those applying the AIRB approach. These minimum capital floors are based on a percentage of capital required under the previous capital framework (Basel I).

Tier 1 capital

Tier 1 capital rose to $25.3 billion, an increase of $1.7 billion over last year primarily due to:

• growth in retained earnings of $2.0 billion;

• capital issuance of $829 million through the Dividend and Share Purchase Plan and employee share-ownership and option plans; and

• the issuance of $265 million in non-cumulative preferred shares.

T17 Selected capital management activity

For the fiscal years ($ millions)	2010			2009			2008
Dividends
Common	$	2,023		$	1,990		$	1,896
Preferred		201			186			107
Common shares issued(1)(2)		804			1,117			266
Repurchase of common shares — normal course issuer bid(2)		—			—			(40	)
Preferred shares issued(3)		265			850			1,225
Subordinated debentures issued(4)		—			2,000			3,144
Repurchase and redemption of subordinated debentures(4)		(11	)		(359	)		(691	)
Issuance of trust subordinated notes and trust securities(5)		—			650			—

(1)	Represents primarily cash received for stock options exercised during the year and common shares issued pursuant to the Dividend and Share Purchase Plan.
(2)	For further details, refer to Note 15 of the Consolidated Financial Statements.
(3)	For further details, refer to Note 14 of the Consolidated Financial Statements.
(4)	For further details, refer to Note 12 of the Consolidated Financial Statements.
(5)	For further details, refer to Note 13 of the Consolidated Financial Statements.

Scotiabank Annual Report2010     43

MANAGEMENT’S DISCUSSION AND ANALYSIS

These were partially offset by:

• capital deductions of $0.8 billion, largely relating to the Bank’s increased investment in Thanachart Bank and;

• an increase in cumulative unrealized foreign currency translation losses of $0.6 billion, net of hedges and related taxes, due to the strengthening of the Canadian dollar.

Over the past five years, the Bank’s level of internal capital generation has been consistently strong. The Bank has generated $8.9 billion of internal capital, notwithstanding an increase in dividends of 65% during this period.

Tier 2 capital

Tier 2 capital decreased by $0.7 billion to $4.3 billion in 2010, due to an increase in capital deductions from the Bank’s additional investment in Thanachart Bank.

Risk-weighted assets

Risk-weighted assets decreased by $6.6 billion over the prior year to $215 billion. This decline was primarily due to the impact of a stronger Canadian dollar on foreign currency denominated assets and a reduction in non-retail credit exposures, partly offset by growth in the retail portfolio.

Regulatory capital ratios

In 2010, both of the Bank’s regulatory capital ratios remained strong as a result of prudent capital management and consistent earnings. Tier 1 and Total capital ratios as at year end were 11.8% and 13.8%. These ratios continued to be well in excess of OSFI’s minimum capital ratios of 7% and 10% and were strong by international standards.

In addition to the regulatory capital ratios, banks are also subject to a maximum leverage test, the assets to capital multiple (ACM). The ACM is calculated by dividing a bank’s total assets, including specified off-balance sheet items, such as direct credit substitutes and performance letters of credit, by its total capital. As at October 31, 2010 the Bank’s ACM of 17:1 was well within the regulatory thresholds.

Tangible common equity ratio

Tangible common equity (TCE) is generally considered to be an important measure of a bank’s capital strength, and is often used by rating agencies and investors in their assessment of the quality of a bank’s capital position. The Bank’s definition of TCE comprises total common shareholders’ equity plus non-controlling interest in subsidiaries, less goodwill and unamortized intangible assets. The TCE ratio is calculated by dividing tangible common equity by risk-weighted assets. At year end, the Bank’s TCE ratio continued to be strong at 9.6% up a significant 1.4% from 8.2% a year ago.

Economic capital

Economic capital is a measure of the unexpected losses inherent in the Bank’s business activities. Economic capital is also a key metric in the Bank’s ICAAP. The calculation of Economic Capital relies on models that are subject to objective 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 economic capital. The major risk categories included in economic capital are:

• Credit riskwhich measures the risk that a borrower or counterparty will fail to honour its financial or contractual obligations to the Bank. Measurement is based on the Bank’s internal credit risk ratings for derivatives, corporate or 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.

Financial stability forum disclosures

In 2008, the Financial Stability Forum, based on the request of G-7 ministers and central bank governors, released its report on market at that time. Among others, a key recommendation of the report was to improve transparency by providing enhanced risk disclosures on financial instruments that markets consider to be higher risk, including off-balance sheet vehicles and structured products. Based on these recommendations, the Bank continues to provide additional disclosures as follows:

Variable interest entities	p. 46
Mortgage-backed securities	p. 50
Montreal Accord Asset-Backed Commercial Paper (ABCP)	p. 50
Collateralized debt obligations and collateralized loan obligations	p. 50
Exposure to monoline insurers	p. 51

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MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

• Market riskwhich 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 among them, and their levels of volatility. Exposure is measured based on the internal VaR models used in the trading book; the VaR on the Bank’s structural interest rate risk, structural foreign exchange risk, and equity market risk; and embedded options risk.

• Operational riskwhich 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. Measurement is based on the distribution of the Bank’s actual losses, supplemented with external loss data where needed.

• Other riskincludes additional risks for which Economic Capital is attributed, such as business risk, goodwill, significant investments, insurance risk and real estate risk.

The Bank uses its Economic Capital framework to attribute capital to the business lines, refer to non-GAAP measures, page 27. Chart 24 shows the attribution of economic capital by business line which allows the Bank to appropriately compare and measure the returns from the business lines, based upon their inherent risk. For further discussion on risk management and details on credit, market and operational risks, refer to the Risk Management section.

Changing Regulatory Landscape

Basel III

In November 2010 the G20 leaders approved certain significant reforms proposed by the Basel Committee on Banking Supervision. The reforms include a number of changes to the existing capital rules and the introduction of a global liquidity standard. These new global standards, referred to as ‘Basel III’

T18Shares and other capital instruments
As at October 31

								Number
	Amount							outstanding
Share data	($ millions)		Dividend		Coupon (%)			(000s)
Common shares(1)	$	5,750	$	0.49		—			1,042,913
Preferred shares Series 12(2)	$	300	$	0.328125		5.25	%		12,000
Preferred shares Series 13(2)		300		0.300000		4.80			12,000
Preferred shares Series 14(2)		345		0.281250		4.50			13,800
Preferred shares Series 15(2)		345		0.281250		4.50			13,800
Preferred shares Series 16(2)		345		0.328125		5.25			13,800
Preferred shares Series 17(2)		230		0.350000		5.60			9,200
Preferred shares Series 18(2)(3)(4)		345		0.312500		5.00			13,800
Preferred shares Series 20(2)(3)(5)		350		0.312500		5.00			14,000
Preferred shares Series 22(2)(3)(6)		300		0.312500		5.00			12,000
Preferred shares Series 24(2)(3)(7)		250		0.390600		6.25			10,000
Preferred shares Series 26(2)(3)(8)		325		0.390625		6.25			13,000
Preferred shares Series 28(2)(3)(9)		275		0.390625		6.25			11,000
Preferred shares Series 30(2)(3)(10)		265		0.240625		3.85			10,600

								Number
	Amount							outstanding
Trust securities	($ millions)		Distribution		Yield (%)			(000s)
Scotiabank Trust Securities – Series 2000-1 issued by BNS Capital Trust(11)(12)	$	500	$	36.55		7.310	%		500
Scotiabank Trust Securities – Series 2002-1 issued by Scotiabank Capital Trust(12)(13)		750		33.13		6.626			750
Scotiabank Trust Securities – Series 2003-1 issued by Scotiabank Capital Trust(12)(13)		750		31.41		6.282			750
Scotiabank Trust Securities – Series 2006-1 issued by Scotiabank Capital Trust(12)(13)		750		28.25		5.650			750
Scotiabank Tier 1 Securities – Series 2009-1 issued by Scotiabank Tier 1 Trust(12)(13)		650		39.01		7.802			650

							Number
	Amount			Interest			outstanding
Trust and subordinated notes	($ millions)			rate (%)			(000s)
Scotiabank Trust Subordinated Notes – Series A issued by Scotiabank Subordinated Notes Trust(13)(14)	$	1,000	—		5.25	%		1,000

				Number
				outstanding
Options				(000s)
Outstanding options granted under the Stock Option Plans to purchase common shares(1)(15)	—	—	—		21,079

(1)	Dividends on common shares are paid quarterly. As at November 17, 2010, the number of outstanding common shares and options was 1,042,960 and 21,032, respectively. The number outstanding for the other securities disclosed in this table was unchanged.
(2)	These shares are entitled to non-cumulative preferential cash dividends payable quarterly.
(3)	These preferred shares have conversion features (refer to Note 14 of the Consolidated Financial Statements for further details).
(4)	Dividends, if and when declared, are for the initial five-year period ending on April 25, 2013. 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 2.05%, multiplied by $25.00.
(5)	Dividends, if and when declared, are for the initial five-year period ending on October 25, 2013. 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 1.70%, multiplied by $25.00.
(6)	Dividends, if and when declared, are for the initial five-year period ending on January 25, 2014. 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 1.88%, multiplied by $25.00.
(7)	Dividends, if and when declared, are for the initial five-year period ending on January 25, 2014. 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 3.84%, multiplied by $25.00.
(8)	Dividends, if and when declared, are the initial five-year period ending on April 25, 2014. 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 4.14%, multiplied by $25.00.
(9)	Dividends, if and when declared, during the initial five-year period ending on April 25, 2014. 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 4.46%, multiplied by $25.00.
(10)	The initial dividend was paid on July 28, 2010 in an amount of $0.2822 per share. Dividends, if and when declared, are for the initial five-year period ending on April 25, 2015. 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 1.00%, multiplied by $25.00.
(11)	Reported in capital instrument liabilities on the Consolidated Balance Sheet.
(12)	Each security is entitled to receive non-cumulative fixed cash distributions payable semi-annually (refer to Note 13 of the Consolidated Financial Statements for further details).
(13)	Reported in deposits on the Consolidated Balance Sheet.
(14)	Holders are entitled to receive interest semi-annually until October 31, 2012 (refer to Note 13 of the Consolidated Financial Statements for further details).
(15)	Included are 16,383 stock options with tandem stock appreciation right (SAR) features.

Scotiabank Annual Report2010     45

MANAGEMENT’S DISCUSSION AND ANALYSIS

aim to strengthen the financial system by improving the quality, consistency and transparency of the capital base to better absorb losses and promote a more resilient banking sector.

Basel III requires increased capital requirements, including higher minimum common equity, introduces additional capital buffers and requires all existing and new capital deductions to be taken from common equity. The focus of the new rules is high quality capital and therefore there is greater emphasis on common equity and a more restrictive definition of other qualifying capital instruments. The new requirements introduce an internationally harmonized leverage ratio, an expansion of OSFI’s existing Asset to Capital Multiple, to contain build-up of excessive leverage. The new regulations contain transitional arrangements to enable banks to meet the new standards while supporting the global economic recovery. The Bank has performed extensive scenario analyses and projections and is satisfied that it will meet the capital and liquidity requirements as they are implemented.

Dividends

The strong earnings and capital position of the Bank allowed the quarterly dividend to be maintained at 49 cents in 2010. Dividends have risen at a compound annual rate of 15% over the past 10 years.

Share data and other capital instruments

The Bank’s common and preferred share data, as well as other capital instruments, are shown in Table 18. Further details, including exchangeability features, are discussed in Notes 12, 13, 14 and 15 of the Consolidated Financial Statements.

Credit ratings

Credit ratings 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 Bank continues to have strong credit ratings. The current ratings are AA by DBRS, Aa1 by Moody’s and AA- by Standard and Poor’s and Fitch.

Outlook

The Bank will maintain its strong capital position. Capital will continue to be prudently managed to support organic growth initiatives, selective acquisitions and evolving regulatory changes.

Off-balance sheet arrangements

In the normal course of business, the Bank enters into contractual arrangements with entities that are not required to be consolidated in its financial statements, but could have a current or future impact on the Bank’s results of operations or financial condition. These arrangements can be classified into the following categories: variable interest entities (VIEs), securitizations, and guarantees and other commitments.

Variable interest entities (VIEs)

Off-balance sheet arrangements with VIEs include:

• VIEs that are used to provide a wide range of services to customers. These include VIEs established to allow clients to securitize their financial assets while facilitating cost-efficient financing, and also to provide investment opportunities. In addition, the Bank creates, administers and manages personal and corporate trusts on behalf of its customers. The Bank also sponsors and actively manages mutual funds.

• VIEs that are used to provide alternative sources of funding to the Bank and manage its capital position. The Bank may utilize these VIEs to securitize its own assets, primarily residential mortgages. The Bank may also establish VIEs in order to issue capital instruments that qualify as regulatory capital, such as Scotiabank Trust Securities, and Scotiabank Subordinated Trust Notes.

All VIEs are subject to a rigorous review and approval process to ensure that all relevant risks, as well as accounting, related party, reputational and ownership issues, are properly identified and addressed. For many of the VIEs that are used to provide services to customers, the Bank does not guarantee the performance of the VIE’s underlying assets, and does not absorb any related losses. For other VIEs, 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 VIE.

As at October 31, 2010, total consolidated assets related to VIEs were $9.2 billion, compared to $2.6 billion at the end of 2009. The increase is due to consolidation of the Scotia Covered Bond Trust which was created to facilitate the Bank’s covered bond program.

The Bank earned fees of $42 million and $64 million in 2010 and 2009, respectively, from certain VIEs in which it had a significant variable interest at the end of the year but did not consolidate. More information with respect to the Bank’s involvement with VIEs, including details of liquidity facilities and maximum loss exposure by VIE category is provided below and in Note 6 to the Consolidated Financial Statements on pages 125 and 126.

There are three primary types of association the Bank has with VIEs:

• Multi-seller conduits sponsored by the Bank,

• Funding vehicles, and

• Collateralized debt obligation entities.

Multi-seller conduits sponsored by the Bank

The Bank sponsors three multi-seller conduits, two of which are Canadian-based and one in the United States. The Bank earned commercial paper issuance fees, program management fees, liquidity fees and other fees from these multi-seller conduits, which totaled $40 million in 2010, compared to $63 million in the prior year.

The multi-seller conduits purchase high-quality financial assets and finance these assets through the issuance of highly rated commercial paper. For assets purchased, there are supporting backstop liquidity facilities that are generally equal to 102% of the assets purchased or committed to be purchased. 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 commercial paper market.

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MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

As further described below, the Bank’s exposure to these off-balance sheet conduits primarily consists of liquidity support, program-wide credit enhancement and temporary holdings of commercial paper. The Bank has a process to monitor these exposures and significant events impacting the conduits to ensure there is no change in the primary beneficiary, which could require the Bank to consolidate the assets and liabilities of the conduits at fair value.

Canada

The Bank’s primary exposure to the Canadian-based conduits is the liquidity support provided, with total liquidity facilities of $1.4 billion as at October 31, 2010 (October 31, 2009 — $1.8 billion). The year-over-year decrease was due to repayments and asset amortization. As at October 31, 2010, total commercial paper outstanding for the Canadian-based conduits was $0.9 billion (October 31, 2009 — $1.6 billion) and the Bank held less than 1% of the total commercial paper issued by these conduits. Table 19 presents a summary of assets purchased and held by the Bank’s two Canadian multi-seller conduits as at October 31, 2010 and 2009, by underlying exposure.

Substantially all of the conduits’ assets have been structured to receive credit enhancements from the sellers, including overcollateralization protection and cash reserve accounts. Approximately 21% of the funded assets were externally rated AAA as at October 31, 2010, with the balance having an equivalent rating of AA- or higher based on the Bank’s internal rating program. There were no non-investment grade assets held in these conduits as at October 31, 2010. While 68% of the total funded assets have final maturities falling within three years, the weighted average repayment period, based on cash flows, approximates one year. There is no exposure to U.S. subprime mortgage risk within these two conduits.

United States

The Bank’s primary exposure to the U.S.-based conduit is the liquidity support and program-wide credit enhancement provided, with total liquidity facilities of $6.5 billion as at October 31, 2010 (October 31, 2009 — $7.5 billion). The year over year decline was from a general reduction in client business ($0.6 billion) and the impact of foreign currency translation. As at October 31, 2010, total commercial paper outstanding for the U.S.-based conduit was $3.1 billion (October 31, 2009 — $4.2 billion) of which none was held by the Bank.

A significant portion of the conduit’s assets have been structured to receive credit enhancements from the sellers, including overcollateralization protection and cash reserve accounts. Each asset purchased by the conduit has a deal-

T19 Assets held by Scotiabank-sponsored Canadian-based multi-seller conduits

				2010								2009
	Funded			Unfunded		Total			Funded			Unfunded		Total
As at October 31 ($ millions)	assets		(1)	commitments		exposure		(2)	assets		(1)	commitments		exposure		(2)
Auto loans/leases	$	331		$	305	$	636		$	505		$	138	$	643
Equipment loans		339			7		346			723			43		766
Trade receivables		206			122		328			165			59		224
Canadian residential mortgages		19			—		19			67			1		68
Retirement savings plan loans		49			2		51			92			2		94
Total(3)	$	944		$	436	$	1,380		$	1,552		$	243	$	1,795

(1)	Funded assets are reflected at original cost, which approximates estimated fair value.
(2)	Exposure to the Bank is through global-style liquidity facilities and letters of guarantee.
(3)	These assets are substantially sourced from Canada.

T20 Assets held by Scotiabank-sponsored U.S.-based multi-seller conduit

				2010								2009
	Funded			Unfunded		Total			Funded			Unfunded		Total
As at October 31 ($ millions)	assets		(1)	commitments		exposure		(2)	assets		(1)	commitments		exposure		(2)
Credit card/consumer receivables	$	22		$	45	$	67		$	253		$	45	$	298
Auto loans/leases		1,198			902		2,100			1,501			620		2,121
Trade receivables		798			2,476		3,274			1,049			2,712		3,761
Loans to closed-end mutual funds		367			7		374			115			73		188
Diversified asset-backed securities		622			12		634			741			15		756
Corporate loans(3)		69			23		92			348			46		394
Total(4)	$	3,076		$	3,465	$	6,541		$	4,007		$	3,511	$	7,518

(1)	Funded assets are reflected at original cost. The fair value of these assets as at October 31, 2010 was estimated to be $2.7 billion (October 31, 2009 – $3.6 billion).
(2)	Exposure to the Bank is through global-style liquidity facilities in the form of asset purchase agreements.
(3)	These assets represent secured loans that are externally rated investment grade.
(4)	These assets are sourced from the U.S.

Scotiabank Annual Report2010     47

MANAGEMENT’S DISCUSSION AND ANALYSIS

specific liquidity facility provided by the Bank in the form of an asset purchase agreement, which is available to absorb the losses on defaulted assets, if any, in excess of losses absorbed by deal-specific seller credit enhancement, and the subordinated note issued by the conduit. The Bank’s liquidity agreements with the conduit generally call for the Bank to fund full par value of all assets, including defaulted assets, if any, of the conduit.

Table 20 presents a summary of assets purchased and held by the Bank’s U.S. multi-seller conduit as at October 31, 2010 and 2009, by underlying exposure.

The conduit has investments in two pools of diversified asset-backed securities. The assets underlying these securities are primarily retail loans, including U.S. home equity, student loans and residential mortgage-backed securities. These pools are guaranteed by monoline insurers which are rated non-investment grade by the external rating agencies.

As at October 31, 2010, approximately 76% of the conduit’s funded assets were rated A or higher, either 33% external or 43% internal based on the Bank’s rating program. Substantially all of the assets held in this conduit were rated investment grade as at October 31, 2010. While 50% of the total funded assets have final maturities falling within five years, the weighted average repayment period, based on expected cash flows, approximates 1.4 years.

During fiscal 2010, there were no events that required a reassessment of the primary beneficiary of this conduit.

Funding vehicles

The Bank uses special purpose entities (SPEs) to facilitate the cost-efficient financing of its operations. The Bank has three such SPEs that facilitate the issuance of certain regulatory capital instruments of the Bank. These are Scotiabank Capital Trust, Scotiabank Subordinated Notes Trust and Scotiabank Tier 1 Trust. These SPEs are not consolidated on the Bank’s balance sheet, as the Bank is not the primary beneficiary. Scotiabank Trust Securities, Scotiabank Tier 1 Securities and Scotiabank Trust Subordinated Notes issued by the trusts are not reported on the Consolidated Balance Sheet, but qualify as regulatory capital. The deposit notes issued by the Bank to Scotiabank Capital Trust, Scotiabank Subordinated Notes Trust and Scotiabank Tier 1 Trust are reported in deposits. Total deposits recorded by the Bank as at October 31, 2010 from these trusts were $4 billion (October 31, 2009 — $4 billion). The Bank recorded interest expense of $243 million on these deposits in 2010 (2009 – $216 million).

Collateralized debt obligation entities

The Bank holds an interest in VIEs structured to match specific investor requirements. Loans or credit derivatives are held by the VIE to create security offerings for investors that match their investment needs and preferences. The Bank’s maximum exposure to loss from VIEs in which the Bank has a significant variable interest was $23 million as at October 31, 2010 (October 31, 2009 – $307 million) including the credit risk amounts relating to derivative contracts with these VIEs. The decrease from 2009 is due primarily to early maturity and termination of certain entities.

Securitizations

The Bank securitizes a portion of its residential mortgages and personal loans by transferring the assets on a serviced basis to trusts. Residential mortgage securitizations are principally conducted through the Bank’s participation in the Canadian Government’s Canada Mortgage Bond (CMB) program. If certain requirements are met, these transfers are treated as sales, and the transferred assets are removed from the Consolidated Balance Sheet which are discussed in Note 1 to the Consolidated Financial Statements on pages 115 to 120. These securitizations enable the Bank to access alternative and more efficient funding sources, and manage liquidity and other risks. The Bank does not provide liquidity facilities to the CMB program, as such, the Bank is not exposed to significant liquidity risks in connection with these off-balance sheet arrangements.

The outstanding amount of off-balance sheet securitized mortgages was $16 billion as at October 31, 2010, compared to $17.5 billion last year. The activity in 2010 was primarily from ongoing sales through the CMB program. Last year’s activity included the Bank’s participation in the Government of Canada Insured Mortgage Purchase Program.

The amount of off-balance sheet securitized personal loans was $10 million as at October 31, 2010, compared to $199 million last year. The decrease was due to the maturity of the revolving credit facility of a securitization trust.

Subsequent to the transfer of assets, the Bank may retain interests in securities issued by the trusts, may make payments to the trusts under certain limited circumstances, maintains relationships with the underlying customers, and provides administrative services to the trusts. Additional information on the commitments to the trusts is disclosed in Note 24 to the Consolidated Financial Statements on pages 143 to 145.

The Bank recorded securitization revenues of $124 million in 2010, compared to $409 million in 2009. This decrease was mostly due to lower securitization volumes.

Additional information on the amount of securitizations and associated cash flows, servicing fees and retained interests is provided in Note 4(c) to the Consolidated Financial Statements on page 124.

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:

• Standby letters of credit and letters of guarantee. As at October 31, 2010, these amounted to $20.5 billion, compared to $21.9 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 decrease reflects a general decrease in customer activity, as well as the weakening of the U.S. dollar;

• Liquidity facilities. These generally provide an alternate source of funding to asset-backed commercial paper conduits in the event a general market disruption prevents

48     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

	the conduits from issuing commercial paper or, in some cases, when certain specified conditions or performance measures are not met. Within liquidity facilities are credit enhancements that the Bank provides, in the form of financial standby letters of credit, to commercial paper conduits sponsored by the Bank. As at October 31, 2010, these credit enhancements amounted to $669 million, compared to $760 million last year. Refer to the liquidity discussions under VIEs beginning on page 46;
•	Indemnification contracts. In the ordinary course of business, the Bank enters into many contracts where the Bank may indemnify contract counterparties for certain aspects of the Bank’s past conduct if other parties fail to perform, 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;
•	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, 2010, these commitments amounted to $104 billion, relatively in line with last year. Approximately half of these commitments are short-term in nature, with remaining terms to maturity of less than one year.

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 $426 million in 2010, compared to $386 million in the prior year. Detailed information on guarantees and loan commitments is disclosed in Note 24 to the Consolidated Financial Statements on pages 143 to 145.

Financial instruments

Given the nature of the Bank’s main business activities, financial instruments make up a substantial portion of the balance sheet 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 non-trading purposes, such as asset/liability management.

During fiscal 2009, the Bank reclassified certain debt securities from available-for-sale securities to loans pursuant to changes in accounting standards for financial instruments. Refer to Changes in accounting policies on page 82.

Financial instruments are generally carried at fair value, except for loans and receivables, certain securities and most financial liabilities, which are carried at amortized cost unless designated as held for trading at inception.

Unrealized gains and losses on available-for-sale securities, net of related hedges, as well as gains and losses on derivatives designated as cash flow hedges, are recorded in other comprehensive income. Gains and losses on available-for-sale securities are recorded in the Consolidated Statement of Income when realized and cash flow hedges are recorded when the hedged item affects income.

All changes in the fair value of derivatives 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 1 to the Consolidated Financial Statements (see pages 115 to 120).

Interest income and expense on interest-bearing financial instruments are recorded in the Bank’s Consolidated Statement of Income as part of net interest income. Credit losses resulting from loans are recorded in the provision for credit losses. Net gains and losses on trading securities are recorded in other income — trading revenues. Realized gains and losses and writedowns for other-than-temporary impairment on available-for-sale securities and equity accounted investments are recorded in other income — net gains (losses) on securities, other than trading.

Several risks arise from transacting financial instruments, including credit risk, liquidity risk, operational risk and market risk. Market risk arises from changes in market prices and rates including interest rates, credit spreads, foreign exchange rates, equity prices and commodity prices. 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 62 to 77. In addition, Note 25 to the Consolidated Financial Statements on pages 145 to 153 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 or 200 basis point increase in interest rates on annual income and the economic value of shareholders’ equity, as described on page 152. For trading activities, the table on page 153 discloses the average one-day Value at Risk by risk factor. For derivatives, based on the Bank’s maturity profile of derivative instruments, only 10% (2009 — 12%) had a term to maturity greater than five years.

Note 28 to the Consolidated Financial Statements (see pages 156 to 160) provides details about derivatives used in trading and non-trading activities, including notional amounts, remaining term to maturity, credit risk and fair values.

Scotiabank Annual Report2010     49

MANAGEMENT’S DISCUSSION AND ANALYSIS

The fair value of the Bank’s financial instruments is provided in Note 26 to the Consolidated Financial Statements (see pages 154 to 155) along with a description of how these amounts were determined.

The fair value of the Bank’s financial instruments was unfavorable when compared to their carrying value by $420 million as at October 31, 2010 (October 31, 2009 — $2,152 million). This difference relates to loan assets, deposit liabilities, subordinated debentures and capital instrument liabilities. The year-over-year change in the deficit of fair value over book value arose mainly from changes in interest rates and credit spreads. Fair value estimates are based on market conditions as at October 31, 2010, 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 pages 78 to 82.

Disclosures specific to certain financial instruments designated as held for trading under the fair value option can be found in Note 27 to the Consolidated Financial Statements (see page 156). These designations were made primarily to avoid an accounting mismatch between two instruments, or to better reflect how the performance of a specific portfolio is evaluated by the Bank.

Selected credit instruments

Mortgage-backed securities

Non-trading portfolio

Total mortgage-backed securities held as available-for-sale securities represent approximately 4% of the Bank’s total assets as at October 31, 2010 and are shown below in Table 21. Exposure to U.S. subprime mortgage risk is nominal.

Trading portfolio

Total mortgage-backed securities held as trading securities represent less than 0.1% of the Bank’s total assets as at October 31, 2010 and are shown in Table 21.

Montreal Accord Asset-Backed Commercial Paper (ABCP)

As a result of the Montreal Accord ABCP restructuring in the first quarter of 2009, the Bank received longer-dated securities which were classified as available-for-sale. Approximately 44% of the new notes are A-rated Class A-1 notes and 36% are BBB (low)-rated A-2 notes. The Bank’s carrying value of $144 million represents approximately 62% of par value.

As part of the restructuring, the Bank participated in a margin funding facility, which was recorded as an unfunded loan commitment. The Bank’s portion of the facility is $200 million. It is currently undrawn.

Collateralized debt obligations and collateralized loan obligations

Non-trading portfolio

The Bank has collateralized debt obligation (CDO) and collateralized loan obligation (CLO) investments in its non-trading portfolio. CDOs and CLOs generally achieve their structured credit exposure either synthetically through the use of credit derivatives, or by investing and holding corporate loans or bonds.

Since 2009, cash-based CDOs and CLOs are classified as loans and are carried at amortized cost. These are assessed for impairment like all other loans. Synthetic CDOs and CLOs continue to be classified as available-for-sale securities, with changes in the fair value reflected in net income.

As at October 31, 2010, the carrying value of cash-based CDOs and CLOs reported as loans on the Bank’s Consolidated Balance Sheet was $943 million (October 31, 2009 — $1,059 million). The fair value of these CDOs and CLOs was $623 million (October 31, 2009 — $688 million). None of these cash-based CDOs and CLOs are classified as impaired. Substantially all of the referenced assets of the Bank’s CDOs and CLOs are corporate exposures, with no U.S. mortgage-backed securities.

The Bank’s remaining exposure to synthetic CDOs and CLOs was $185 million as at October 31, 2010 (October 31, 2009 — $323 million). During the year, the Bank recorded a pre-tax gain of $85 million in net income for changes in fair value of synthetic CDOs and CLOs (2009 — pre-tax gain of $60 million). The

T21 Mortgage-backed securities

	2010						2009
As at October 31	Non-trading			Trading			Non-trading			Trading
Carrying value ($ millions)	portfolio			portfolio			portfolio			portfolio
Canadian NHA mortgage-backed securities(1)	$	18,370		$	416		$	21,287		$	253
Commercial mortgage-backed securities		10	(2)		28	(3)		4	(2)		44	(3)
Other residential mortgage-backed securities		201			—			93			—
Total	$	18,581		$	444		$	21,384		$	297

(1)	Canada Mortgage and Housing Corporation provides a guarantee of timely payment to NHA mortgage-backed security investors.
(2)	The assets underlying the commercial mortgage-backed securities in the non-trading portfolio relate primarily to non-Canadian properties.
(3)	The assets underlying the commercial mortgage-backed securities in the trading portfolio relate to Canadian properties.

50     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| GROUP FINANCIAL CONDITION

change in fair value of the synthetic CDOs and CLOs was mainly driven by the tightening of credit spreads in the current and prior year and the maturity of certain CDOs and CLOs in 2010.

The aggregate CDO and CLO portfolios are well diversified, with an average individual CDO and CLO holding of $12 million, and no single industry exceeding 12% of the referenced portfolio on a weighted average basis. Based on their carrying values, these CDOs and CLOs have a weighted average rating of BBB. More than 71% of their investments are senior tranches with subordination of 10% or more, and 6% of the investments are in equity tranches.

Based on positions held at October 31, 2010, a 50 basis point widening of relevant credit spreads would result in a pre-tax decrease of approximately $5 million in net income.

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 Table 22 below.

The decrease in the notional amount of the CDO portfolio is mainly due to trades that were unwound with counterparties during the year. The decrease in the fair value of the CDO portfolio is due to the reduced portfolio size and improved market conditions. Based on positions held at October 31, 2010, a 50 basis point widening of relevant credit spreads in this portfolio would result in a pre-tax increase of approximately $11 million in net income.

Over 57% of the Bank’s credit exposure to CDO swap counterparties is to entities which are externally or internally rated investment grade equivalent. The referenced assets underlying the trading book CDOs are substantially all corporate exposures, with no mortgage-backed securities.

Exposure to monoline insurers

The Bank has insignificant direct exposure to monoline insurers. The Bank has indirect exposures of $0.9 billion (October 31, 2009 — $1.3 billion) in the form of monoline guarantees, which provide enhancement to public finance and other transactions, where the Bank has provided credit facilities to either the issuers of securities or facilities which hold such securities. The Bank’s public finance exposures of $0.1 billion (October 31, 2009 — $0.4 billion) were primarily to U.S. municipalities and states. All of these securities are rated investment grade without the guarantee, and represent risk the Bank would take without the availability of the guarantee.

Other indirect exposures to monoline insurers were $0.8 billion (October 31, 2009 — $0.9 billion). These exposures were primarily composed of $0.6 billion (October 31, 2009 — $0.7 billion) of guarantees by two monolines on diversified asset-backed securities held by the Bank’s U.S. multi-seller conduit (as discussed on pages 47 and 48 in the section on Multi-seller conduits sponsored by the Bank). As at October 31, 2010, the two monoline insurers were rated non-investment grade by the external rating agencies.

Other

As at October 31, 2010, the Bank has insignificant exposure to highly leveraged loans awaiting syndication, auction-rate securities, Alt-A type loans and investments in structured investment vehicles.

T22 Collateralized debt obligations (CDOs)

Trading portfolio
	2010					2009
			Positive/					Positive/
As at October 31	Notional		(negative)			Notional		(negative)
Outstanding ($ millions)	Amount		fair value			Amount		fair value
CDOs — sold protection	$	2,890	$	(498	)	$	6,000	$	(1,620	)
CDOs — purchased protection	$	2,719	$	491		$	5,625	$	1,657

Scotiabank Annual Report2010     51

MANAGEMENT’S DISCUSSION AND ANALYSIS

BUSINESS LINE OVERVIEW

CANADIANBANKING

Canadian Banking had a record year in 2010, with net income of $2,315 million, an increase of $464 million or 25% over last year. This was driven by substantial growth in wealth management revenues, retail mortgages, personal lending and deposits, and a wider interest margin. Non-interest expenses were well maintained, up 5%.

INTERNATIONALBANKING

International Banking reported net income of $1,262 million, a decrease of 4% year-over-year, largely due to the impact of a 10% stronger Canadian dollar. Underlying growth resulted from contributions from recent strategic acquisitions, particularly in Puerto Rico and Thailand, and higher earnings in Asia, Mexico and Chile. Slow economic recovery in the Caribbean moderated growth in that region although loan volumes and core deposits are trending upwards.

SCOTIACAPITAL

Scotia Capital reported net income of $1,350 million in 2010, 7% below last year’s record earnings as market conditions in 2009 led to exceptional trading results. These strong results were maintained through the first part of 2010, but returned to more normalized levels to close out the year. As well, corporate loan volumes continued to decline. Partly offsetting, was a substantial improvement in the provisions for credit losses with net recoveries reported for 2010.

On October 1, 2010, Global Wealth Management was established as a fourth business line, combining our wealth management and insurance businesses in Canada and internationally. Refer to page 60 for details on the Bank’s four business lines.

T23 2010 financial performance

	Canadian			International
($ millions)	Banking			Banking			Scotia Capital			Other(1)			Total
Net interest income(2)	$	5,191		$	3,755		$	1,093		$	(1,418	)	$	8,621
Other income		2,626			1,696			2,086			476			6,884
Provision for credit losses		706			616			(43	)		(40	)		1,239
Non-interest expenses		3,926			2,931			1,195			130			8,182
Income taxes/non-controlling interest(2)		870			642			677			(344	)		1,845
Net income	$	2,315		$	1,262		$	1,350		$	(688	)	$	4,239
Return on equity(3)(%)		27.0	%		11.6	%		18.6	%		N/A			18.3	%
Average earning assets ($ billions)(3)	$	204		$	87		$	164		$	61		$	516

(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 elimination of the tax-exempt income gross-up reported in net interest income and provision for income taxes, changes in the general allowance, differences in the actual amount of costs incurred and charged to the operating segments, and the impact of securitizations.
(2)	Taxable equivalent basis. See non-GAAP measures on page 27.
(3)	Non-GAAP measure. Return on equity for the business segments is based on economic equity attributed. See non-GAAP measures on page 27.
N/A	Not applicable

52     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| BUSINESS LINES

Canadian Banking

2010 ACHIEVEMENTS

• Launched the first phase of Let the Saving Begin, a new program that has inspired thousands of Canadians to establish automatic saving habits when they use their debit and credit payment cards, by enrolling in “Bank the Rest”, setting aside a regular amount each month or opening a Momentum Visa to earn cashback on their purchases.

• Introduced a robust mobile banking solution that is the first to offer SMS/Text banking and both Domestic and International person-to-person transfers through Interac and Western Union.

• Implemented an automated sales reporting system in branches that delivers operational efficiencies and time savings so that sales officers can provide additional customers with excellent service and advice.

• Introduced Scotiabank’s EcoLiving Program to help Canadian homeowners discover what green renovation options are available and how they can save money by reducing their energy bills and taking full advantage of the available government rebates.

• LaunchedScotiaLifeAccidental Hospitalization Insurance, an expansion of ScotiaLife’s Life & Health product offering. Holders of this insurance will receive a daily cash benefit for each day they are hospitalized due to a covered accident.

• Expanded our branch network by nine branches to capitalize on high-potential market opportunities across the country.

• Enhanced the Scotiabank StartRight Program for Newcomers to Canada website. It’s now is available in eight languages — English, French, Traditional Chinese, Simplified Chinese, Spanish, Punjabi, Arabic and Farsi.

• Launched theTotal Wealth Credit Solution^TM, an unique Private Banking lending platform that allows high net worth clients to combine their investment portfolios with other assets to secure a single, highly flexible line of credit. This fully-integrated wealth management platform enables clients to maximize access to financing to take advantage of investment opportunities and is ideal for business builders and entrepreneurs who value simplified, convenient access to credit.

• Scotiabank’s Canadian mutual fund business continued its positive momentum through fiscal 2010. Scotiabank placed number one among banks for total net sales. Scotia INNOVA Portfolios has been a strong force behind this performance as it has surpassed $1.7 billion in assets under management.

• SCENE, the joint venture loyalty program with Cineplex has surpassed 2.6 million members and more than one million of those are Scotiabank customers.

T24 Canadian Banking financial performance

($ millions)	2010			2009			2008
Net interest income(1)	$	5,191		$	4,785		$	4,324
Other income		2,626			2,279			2,174
Provision for credit losses		706			702			399
Non-interest expenses		3,926			3,757			3,632
Income taxes/non-controlling interest(1)		870			754			743
Net income	$	2,315		$	1,851		$	1,724
Key ratios
Return on economic equity		27.0	%		22.3	%		35.6	%
Productivity(1)		50.2	%		53.2	%		55.9	%
Net interest margin(1)		2.54	%		2.49	%		2.46	%
PCL as a percentage of loans and acceptances		0.35	%		0.37	%		0.23	%
Selected balance sheet data (average balances)
Earning assets		204,077			192,262			175,464
Deposits		163,747			143,891			127,615
Economic equity		8,358			8,049			4,764

(1) Taxable equivalent basis.

Financial performance

Canadian Banking reported net income of $2,315 million in 2010, $464 million or 25% higher than last year. Return on economic equity was 27.0% versus 22.3% last year. Retail and small business banking, commercial banking and wealth management all generated solid performances.

Assets and liabilities

Average assets before securitization rose $12 billion or 6% in 2010. This was led by substantial growth in residential mortgages (before securitization) of $10 billion or 8%, which resulted in market share growth of 39 basis points versus the other major banks. Personal lines of credit were up $3 billion or 12% year over year. Average deposits grew $20 billion or 14%. This includes $10 billion of broker-sourced deposits transferred from group treasury in the first quarter of this year. In addition, strong growth was recorded in current accounts and high interest savings accounts. Assets under administration grew 13% to $155 billion in 2010, through stronger sales and marketing initiatives.

Revenues

Total revenues were $7,817 million, up $753 million or 11% from last year. Net interest income increased $406 million to $5,191 million, due to strong volume growth in both assets and deposits. The margin increased by five basis points to 2.54%, reflecting higher spreads on assets due to re-pricing and lower

Scotiabank Annual Report2010     53

MANAGEMENT’S DISCUSSION AND ANALYSIS

wholesale funding and liquidity costs. Partly offsetting was the impact of prime/BA spread compression and lower spreads on deposits due to intense competition. Other income for the year was $2,626 million, including growth of $347 million or 15% mainly from increases in wealth management revenues, new sales and market improvements, and higher commercial banking revenues.

Retail & Small Business Banking

Total revenues were $4,805 million, up $402 million or 9% from last year. Net interest income rose by $375 million or 11% due to growth in assets and deposits and a higher margin. Other income rose $26 million or 3% mainly in transaction-based fees and higher insurance revenues. Partly offsetting were a decrease in ABM fees and lower personal service charges reflecting a growing trend toward electronic payments.

Commercial Banking

Total revenues rose $98 million or 6% to $1,624 million in 2010. Net interest income grew 2% from last year mainly from a substantial growth in deposits entirely in current accounts. Partly offsetting was a lower margin and reduced asset volumes, reflecting the slower business climate in 2010. Year over year, other income was up $79 million or 24% to $407 million.

Wealth Management

Total revenues were up $253 million or 22% to $1,388 million. There was growth in multiple businesses, particularly in mutual funds, full service brokerage and private client group, as well as contributions from associated corporations. This growth was driven by new sales and improved market conditions.

Non-interest expenses

Non-interest expenses rose $169 million or 5% to $3,926 million in 2010. The increase was due mainly to increased investment in growth initiatives, higher stock-based and performance-based compensation, pension and benefits costs, advertising costs relating to “Let the Saving Begin” and other marketing campaigns, and the impact of the new harmonized sales tax in certain Canadian provinces.

Credit quality

The provision for credit losses in Canadian Banking was $706 million in 2010, comprised of $713 million in specific provisions and a $7 million reversal this year of the sectoral allowance established for the automotive industry. Specific provisions in 2010 represent an increase of $18 million from $695 million last year, with moderately higher retail provisions somewhat offset by moderately lower commercial provisions.

54     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| BUSINESS LINES

International Banking

2010 ACHIEVEMENTS

• Revenue growth programs implemented to:

– Improve the capacity of our sales forces;

– Enhance the customer experience through upgraded contact centres and new mobile banking capabilities;

– Develop and promote new products for insurance and wealth management.

• Credit risk management improved by implementing industry-leading retail account management and pricing platforms in key markets.

• Added 88 branches, upgraded contact centre in Mexico and began construction of a new contact centre in Peru.

• Expanded presence in Puerto Rico by acquiring R-G Premier Bank of Puerto Rico in an FDIC-assisted transaction.

• Further investment in Thailand, where an affiliate, Thanachart Bank, acquired Siam City Bank and is now the third largest bank in Bangkok and the fifth largest bank in the country.

• Entered Colombia through the acquisition of Royal Bank of Scotland’s local wholesale operations and agreed to acquire Dresdner Bank’s wholesale banking operations in Brazil.

• Recognized for excellence:

– Global Financemagazine named Scotiabank Costa Rica, Scotiabank Jamaica and Scotiabank Peru as the top foreign exchange providers in their respective countries.

– Trade Financerecognized Scotiabank as the Best Trade Bank in Central America and the Caribbean for the second year in a row. The magazine also named Scotiabank the Best International Trade Bank in Peru.

– Global Financemagazine named Scotiabank the Best Consumer Internet Bank in 20 Caribbean countries.

– The Bank’s contact centre in the Dominican Republic was recognized as World Class in a study that benchmarked the top 450 Contact Centres in North America.

T25 International Banking financial performance

($ millions)	2010			2009			2008
Net interest income(1)	$	3,755		$	3,773		$	3,315
Other income		1,696			1,480			1,282
Provision for credit losses		616			577			236
Non-interest expenses		2,931			2,960			2,634
Income taxes/non-controlling interest(1)		642			401			541
Net income	$	1,262		$	1,315		$	1,186
Key ratios
Return on economic equity		11.6	%		12.5	%		15.5	%
Productivity(1)		53.8	%		56.3	%		57.3	%
Net interest margin(1)		4.32	%		4.21	%		4.17	%
PCL as a percentage of loans and acceptances		0.99	%		0.90	%		0.44	%
Selected balance sheet data (average balances)
Earning assets		86,842			89,528			79,403
Deposits		45,920			49,810			45,438
Economic equity		10,283			9,968			7,353

(1) Taxable equivalent basis.

Financial performance

International Banking’s net income in 2010 was $1,262 million, a decrease of $53 million or 4% from last year. The results were adversely impacted by a stronger Canadian dollar. Excluding this, earnings increased by $76 million or 6% reflecting the favourable impact of acquisitions, partly offset by credit weakness in a few corporate loans as well as a higher effective tax rate. Return on economic equity was 11.6% compared to 12.5% last year.

Assets and liabilities

Average assets decreased $3 billion or 3%. After adjusting for the negative impact of the foreign currency translation and the acquisition of R-G Premier Bank of Puerto Rico, average assets were up 1% over last year. Underlying growth was moderated by slow economic recovery, although the quarterly trend in performing loan volumes showed a steady return to growth compared to declines in 2009. Overall, retail loans increased $1 billion or 4%, mainly from residential mortgages in Mexico and Peru. Commercial loans were down slightly from last year, with modest growth of 4% in Asia more than offset by selective portfolio run-off in Mexico and Chile. Average securities volumes increased $2 billion, due to additional investment in Thanachart Bank in Thailand and growth in Mexico. Under-lying growth in low-cost deposits was strong at 10%, with the Caribbean, Central America and Peru showing double digit growth.

Revenues

Total revenues were $5,451 million in 2010, an increase of $198 million or 4% from last year, despite a $429 million negative impact of foreign currency translation.

Scotiabank Annual Report2010     55

MANAGEMENT’S DISCUSSION AND ANALYSIS

Net interest income was $3,755 million in 2010, in line with 2009 despite a $296 million negative impact of foreign currency translation. Underlying net interest income was up $279 million or 7% driven mainly by the acquisition of R-G Premier Bank of Puerto Rico, and higher contributions from associated corporations. The net interest margin was 4.32%, up 11 basis points from last year, partly due to the combined impact of increased retail volumes and wider margins in Mexico and Peru.

Other income increased $216 million or 15% year over year to $1,696 million. The increase reflected the positive impact of higher gains on sales of securities this year and contributions from acquisitions. The year was also marked by strong growth in insurance and wealth management revenues and higher credit fees. These were partly offset by the $133 million negative impact of foreign currency translation.

Caribbean and Central America

Total revenues were $1,973 million in 2010, an increase of $130 million or 7%. The increase resulted from a combination of the R-G Premier Bank of Puerto Rico acquisition, lower write-downs on investments in 2010, and underlying fee income growth of 4%. Adverse foreign exchange translation was partially offsetting.

Net interest income was $1,472 million in 2010, unchanged from 2009. The contribution of the R-G Premier Bank of Puerto Rico acquisition and higher earnings from associated corporations were offset by a negative impact of foreign currency translation. Overall volumes and margins were relatively unchanged from last year.

Other income of $501 million was up a substantial $133 million or 36% from last year. This mainly reflected the inclusion of fee revenue from R-G Premier Bank of Puerto Rico, lower write-downs on securities this year, and higher insurance related revenues. Adverse foreign exchange translation was partly offsetting.

Mexico

Total revenues were $1,239 million in 2010, a nominal decrease of $6 million from last year, due mainly to the negative impact of foreign currency translation. Underlying revenues were up 5% including higher net gains on securities, increased mutual fund revenues and higher loan spreads.

Net interest income was $800 million, a decrease of $20 million from 2009, including negative foreign currency translation of $48 million. Underlying net interest income increased by 3% due to growth in retail asset volumes and spreads, partially offset by lower funding spreads.

Other income was $438 million in 2010, up $14 million from last year, or $36 million excluding the adverse impact of foreign currency translation. Higher insurance, and wealth management revenues and transaction-driven income contributed to the increase. Lower treasury revenue resulted from reduced market volatility in 2010.

Latin America, Asia and Other

Total revenues were $2,239 million in 2010, an increase of $74 million over last year, primarily due to contributions from associated corporations in Asia and higher net gains on securities. Partly offsetting were adverse foreign currency translation, and a loss on the Bank’s investment in an affiliate in Venezuela from a significant devaluation of the Venezuelan bolivar.

Non-interest expenses

Non-interest expenses were $2,931 million in 2010, down 1% or $29 million from last year, due mainly to the beneficial impact of $185 million from foreign currency translation. Excluding this, expenses were up $156 million, of which $82 million was due to the impact of acquisitions. The remaining growth of 3% was due to higher compensation, premises and technology, advertising and business development costs.

Credit quality

The provision for credit losses in International Banking was $616 million in 2010, an increase of $39 million from last year. Higher provisions in the Caribbean were somewhat offset by lower provisions in Asia, Mexico, and Latin America.

56     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| BUSINESS LINES

Scotia Capital

2010 ACHIEVEMENTS

• Scotia Capital ranked #1 for Canadian Corporate Debt Underwriting in Bloomberg’s League Tables (2009), for the second year in a row.

• Scotia Capital was acknowledged by Global Finance magazine as:

– Best Infrastructure Bank globally, for the second consecutive year;

– Best Foreign Exchange Bank in Canada, for the sixth consecutive year; and

– Best Investment Bank in Canada, for the fourth time in six years.

• For the eighth consecutive year, Scotia Capital’s Corporate Derivatives team has been recognized as the best in Canada by an independent third party survey firm.

• For the second year in a row, ScotiaMocatta was acknowledged as “Best Bullion Bank” by the Bombay Bullion Association, a major hub for gold and silver trading in India.

• Notable transactions during the year:

– Scotia Capital acted as Exclusive Financial Advisor to Red Back Mining Inc. on its merger with Kinross Gold Corporation. Kinross acquired all of the outstanding common shares of Red Back for approximately US$8 billion. The transaction was one of the largest M&A transactions in the gold industry and resulted in the creation of a US$20+ billion pure gold senior producer.

– Scotia Waterous acted as Exclusive Financial Advisor to Sinopec Corp., the largest petroleum and petrochemicals company in China, on its purchase of a 40% interest in Repsol Brasil, through a share capital increase of US$7.1 billion.

The alliance created one of Latin America’s largest energy companies, valued at US$17.8 billion.

T26 Scotia Capital financial performance

($ millions)	2010			2009			2008
Net interest income(1)	$	1,093		$	1,427		$	1,120
Other income		2,086			2,138			707
Provision for (recovery of) credit losses		(43	)		338			(5	)
Non-interest expenses		1,195			1,072			937
Income taxes(1)		677			704			108
Net income	$	1,350		$	1,451		$	787
Key ratios
Return on economic equity		18.6	%		20.0	%		21.5	%
Productivity(1)		37.6	%		30.1	%		51.3	%
Net interest margin(1)		0.67	%		0.78	%		0.68	%
PCL as a percentage of loans and acceptances(2)		(0.02	)%		0.61	%		(0.01	)%
Selected balance sheet data (average balances)
Total assets		164,083			183,079			163,664
Earning assets		139,332			146,966			140,570
Loans and acceptances		45,728			67,257			54,147
Securities purchased under resale agreements		19,888			14,123			15,844
Securities		60,372			54,973			63,716
Economic equity		6,980			7,013			3,571

(1)	Taxable equivalent basis.
(2)	Corporate Banking only.

Financial performance

Scotia Capital contributed net income of $1,350 million in 2010, 7% lower than $1,451 million reported in 2009 which was a record year. This year’s performance represents the second best year ever for Scotia Capital for both revenue and net income. The year-over-year decline in net income was due primarily to lower revenues from market conditions. Further, there were higher expenses for growth initiatives, as well as a slightly higher effective tax rate. Although total revenues declined 11% when compared to the record levels achieved in 2009, many of the businesses within Global Capital Markets reported their second highest year, which demonstrates the strength of the diversified platform.

Due to improving market conditions, provisions for credit losses declined substantially with a net recovery of $43 million this year. In comparison, the provision for credit losses in the previous year totaled $338 million. Return on economic equity was 18.6% this year, slightly lower than last year as earnings did not reach the record levels of the prior year.

Scotiabank Annual Report2010     57

MANAGEMENT’S DISCUSSION AND ANALYSIS

Assets and liabilities

Total average assets were $164 billion, down 10% from last year. This decline was mainly from corporate loans and acceptances which fell by $18 billion across all lending businesses. There was also a decrease of $11 billion in average derivative assets with a corresponding decrease in derivative and other liabilities. These decreases were partly offset by higher securities, loans and other assets to support both client-driven activity and trading opportunities.

Revenues

Total revenues this year of $3,179 million compared to $3,565 million last year. The decline of 11% was primarily due to more normalized business conditions, especially during the latter half of 2010. Overall, revenues in 2010 were strong, the second highest compared to the prior year when record revenues were achieved in both Global Capital Markets and Global Corporate and Investment Banking.

Net interest income fell 23% to $1,093 million, due primarily to a substantial decline in corporate loan volumes. Interest from trading operations also declined.

Other income fell slightly to $2,086 million as higher securities gains were more than offset by lower trading revenues, credit-related fees and investment banking revenues.

Global Corporate and Investment Banking

Total revenue decreased 22% to $1,404 million. Interest income fell 31% due to substantial declines in asset volumes in all lending markets, although portfolio spreads remained stable. Loan origination fees also fell. Other income was down 13% from the prior year due partly to reduced credit fees, including lower acceptance fees in Canada. As well, there were lower investment banking revenues as new issues declined significantly. Advisory fees earned by Scotia Waterous fell moderately compared to last year. These declines were partly offset by higher fair value changes in non-trading financial instruments.

Global Capital Markets

Total revenues increased slightly to a record $1,775 million. Interest income from trading operations declined 11%. However, other income increased 5% primarily reflecting growth in the global fixed income business. The first half of 2010 continued the strong revenue trend which commenced in 2009 but the latter half of the year reflected more normalized business levels; most businesses achieved their second highest level of revenues.

Non-interest expenses

Non-interest expenses were $1,195 million in 2010, an 11% increase from last year, due mainly to higher performance-related compensation partly offset by lower legal provisions. Salaries, technology costs and support costs also increased to assist business growth. Performance-based and stock-based compensation rose $61 million largely reflecting changes in incentive plans in 2009.

Credit quality

Provisions for credit losses in Scotia Capital reflected a net recovery of $43 million this year, comprised of a net recovery of $6 million in specific provisions and a reversal of the $37 million sectoral provision related to the automotive industry. Last year’s amount included $301 million of specific provisions as well as the initial set up of the $37 million sectoral allowance.

Provision for income taxes

The higher effective tax rate in 2010 reflects a greater proportion of income earned in jurisdictions with higher tax rates.

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MANAGEMENT’S DISCUSSION AND ANALYSIS| BUSINESS LINES

Other

The Other category includes Group Treasury and other corporate items, which are not allocated to a business line.

Financial performance

The Other segment had a net loss of $688 million in 2010, compared to a net loss of $1,070 million in 2009.

Net interest income and the provision for income taxes 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 $286 million in 2010, compared to $288 million in 2009.

Revenues

Net interest income was negative $1,418 million this year, compared to negative $1,657 million in 2009. The improvement was due to the transfer of broker-sourced deposits from the Other business segment to Canadian Banking in the first quarter of 2010, and a favourable change in the fair value of financial instruments used for asset/liability management purposes. These were offset in part by a flattening of the money market yield curve that compressed funding spreads.

Other income was $476 million in 2010, compared to $232 million last year. The increase was mainly attributable to a lower level of writedowns on available-for-sale securities, partly offset by reduced securitization revenues.

Non-interest expenses

Non-interest expenses were $130 million in 2010, unchanged from the prior year.

Credit quality

The provision for credit losses in 2010 included a $40 million decrease in the general allowance. This compares to an increase of $127 million in the general allowance in 2009. At the end of 2010, the general allowance totaled $1,410 million.

Income taxes

The provision for income taxes was a credit of $344 million in 2010, a decline of $268 million from the prior year. The reduction in the provision for income taxes was mainly driven by a lower net loss before taxes.

Outlook

Net income is expected to improve in 2011. Net interest income is anticipated to improve due to lower long-term funding costs and an increase in whole year average short-term interest rates used for transfer pricing with the business segments.

T27 Other financial performance

($ millions)	2010			2009			2008
Net interest income(1)	$	(1,418	)	$	(1,657	)	$	(1,185	)
Other income		476			232			139
Provision for (recovery of) credit losses		(40	)		127			—
Non-interest expenses		130			130			93
Income taxes(1)		(344	)		(612	)		(582	)
Net income	$	(688	)	$	(1,070	)	$	(557	)

(1) Includes the elimination of the tax-exempt income gross-up reported in net interest income and provision for income taxes in Canadian Banking, International Banking and Scotia Capital to arrive at the amount reported in the Consolidated Statement of Income (2010 — $286; 2009 — $288; 2008 — $416).

KEY PERFORMANCE INDICATORS FOR ALL BUSINESS LINES

Management uses a number of key metrics to monitor business line performance:

• Net income

• Customer loyalty

• Collaboration across business line

• Return on economic equity

• Employee engagement

• Productivity ratio

Scotiabank Annual Report2010     59

MANAGEMENT’S DISCUSSION AND ANALYSIS

Looking ahead

CANADIAN BANKING

2011 Priorities

• Continue to invest in deposits and payments businesses.

• Partner with Global Wealth Management to drive revenue growth in mutual funds and other retail products.

• Refine customer value proposition to become a truly customer-centric organization delivering advice and solutions, supported by service excellence.

• Invest in the following enablers to support the strategy and customer value proposition:

– Optimize distribution channels

– Achieve operational efficiencies through organizational streamlining, process re-engineering and product/service rationalization.

– Strengthen MIS infrastructure to better support and manage capital, pricing, risk and customer profitability.

– Leadership development.

Business profile

Canadian Banking provides a full range of banking and investing services to more than 7.6 million customers across Canada, through a network of 1,024 branches, 2,998 ABMs, as well as telephone, Internet banking and third party channels. Canadian Banking includes two main businesses which are Retail and Small Business Banking and Commercial Banking, a description of each is outlined below:

• Retail and Small Business Banking provides mortgages, loans, credit cards, investments, and day-to-day banking products to individuals and small businesses.

• Commercial Banking delivers a full product suite to medium and large businesses, including banking, cash management, lending and leasing.

Strategy

Canadian Banking will significantly improve its competitive position by achieving superior growth across the deposits and payments businesses, while sustaining the growth of our other core businesses. The business line will support its Global Wealth Management partners by distributing Global Transaction Banking and Wealth Management products. This will be achieved by offering practical advice and solutions tailored to customers financial priorities, supported by an excellent customer experience.

Outlook

Entering 2011, the outlook for the Canadian economy remains uncertain. Asset growth is expected to be somewhat slower than in recent years as consumers retrench. Deposit growth is also expected to moderate as interest rates remain relatively low and funds return to recovering equity markets.

The interest margin will remain under pressure from competition in a slower growth environment, as well as from higher wholesale funding costs due to the full year impact of interest rate increases in 2010. Other income growth will likely be tempered by the environment but opportunities will arise from new products and delivery channels.

Provisions for credit losses are expected to stabilize in 2011.

Expenses remain a management focus but will increase reflecting higher pension costs, the effect of the harmonized sales tax in several provinces, as well as continuing reinvestment in products and services.

INTERNATIONAL BANKING

2011 Priorities

• Retail Banking: Develop a differentiated value proposition across all segments to drive new customer acquisition and cross-sales. Expand multi-channel capabilities, improve sales and service model, and strengthen new product offering and customer contact practices. Expand in the emerging retail and microfinance segments in Peru, Chile, Mexico and Dominican Republic and selectively expand into other high potential markets.

• Corporate and Commercial: Strengthen cross-sell of ancillary products and deepen partnership with Scotia Capital. Increase focus on mid-market segment and efficiency of credit processes.

• Partner with Global Wealth Management to accelerate growth of wealth management and insurance.

• Continue to enhance risk management framework and systems.

• Seek opportunistic acquisitions and investments in existing markets and enter select new markets.

Business profile

International Banking encompasses Scotiabank’s retail and commercial banking operations in more than 45 countries outside Canada — an international presence unmatched by our domestic competitors. More than 48,000 employees, including subsidiaries and affiliates, provide a full range of financial services to 11 million customers through a network of over 2,000 branches and offices, 3,686 ABMs, telephone and Internet banking, in-store banking kiosks, and specialized sales forces. The Bank operates in the following geographic regions: the Caribbean and Central America, Mexico, Latin America and Asia.

Strategy

International Banking is growing through a combination of organic growth and acquisitions. In personal banking, the business line is expanding its sales capacity and multi-channel capabilities, as well as improving the sales and service model and customer contact practices. International Banking is broadening its focus beyond its traditional retail customer base by expanding into the emerging retail segment and partnering with Global Wealth Management to increase wealth management and insurance in international markets.

International Banking is leveraging in-depth local knowledge and expertise from across the Scotiabank Group in areas such as power, mining, oil and gas, and hospitality to deliver unique financial solutions to commercial clients. The business line continues to deepen its partnership with Scotia Capital to build capital market business in Latin America and Asia and to optimize growth opportunities for global clients.

The acquisition strategy is focused primarily on acquiring financial services companies in Latin America and Asia to achieve scale where the Bank has an existing presence and enter new markets on a selective basis.

Outlook

Improved economic conditions and selective acquisitions will support continued growth. Both loans and deposits are expected to increase, which together with continued strong margins, will drive revenue growth. Expenses will continue to be carefully managed while investing in initiatives to improve operational efficiencies and enhance revenue opportunities.

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MANAGEMENT’S DISCUSSION AND ANALYSIS| BUSINESS LINES

SCOTIA CAPITAL

2011 Priorities

• Grow sustainable revenue in core sectors — Oil and Gas, Mining, Power, Infrastructure, and in specific businesses including Fixed Income, Equities, and Base Metals.

• Execute the reorganization of the Bank’s global wholesale activities under Scotia Capital to generate sustainable incremental revenue, particularly through cross-sell of capital markets products to corporate lending clients.

• Enhance client focus to increase market share.

• Continue to prudently manage risks with global oversight and governance.

• Invest in systems and operational infrastructure to generate revenue and enhance efficiency and competitiveness.

• Continue to build leadership capability.

Business profile

Scotia Capital is the wholesale banking arm of the Scotiabank group. It offers a wide variety of products to corporate, government and institutional investor clients. Scotia Capital is a full-service lender and investment dealer in Canada and Mexico and offers a wide range of products in the U.S. and other parts of Latin America. It also provides select products and services to niche markets in Europe and Asia. Since October 1, 2010, this includes wholesale banking products and services in Latin America and Asia-Pacific previously offered through Scotiabank’s International Banking business line.

Scotia Capital provides corporate lending, equity and debt underwriting, and mergers and acquisitions advisory services, as well as capital markets products and services, such as fixed income, derivatives, prime brokerage, securitization, foreign exchange, equity sales, trading and research and, through ScotiaMocatta, precious and base metals.

Strategy

Scotia Capital’s strategy remains focused on achieving sustainable revenue growth and earning strong returns on capital while prudently managing risk.

Scotia Capital’s strategic vision:Achieve superior growth by being a leading financial partner for our clients and a recognized global leader in key sectors. We will do this by leveraging our people, international reach, market intelligence and technical expertise.

A key focus in 2011 will be the successful implementation of the recent reorganization of the Bank’s wholesale activities under Scotia Capital. This initiative will help position Scotia Capital for the long term to expand and better capture opportunities in high growth markets, as it leverages the existing Scotia Capital wholesale platform and combines it with International Banking’s existing wholesale operations in Latin America and Asia-Pacific. A key objective will be to cross-sell capital markets products and services to lending relationships in these two high potential regions. Scotia Capital will also integrate recent acquisitions in Brazil, Chile and Colombia into our global wholesale platform.

Outlook

The more normalized market conditions experienced in the second half of 2010 are likely to continue, however, Scotia Capital expects to benefit from growth in the businesses and products in which it has invested. Stronger activity in the corporate finance and mergers and acquisitions markets could benefit new issue and advisory fees, as well as provide opportunities for growth in lending volumes.

Loan loss provisions are expected to remain below historical levels but are unlikely to benefit from net recoveries.

Scotia Capital will continue to manage operating costs closely but will invest in the business to provide sustainable revenue growth.

GLOBAL WEALTH MANAGEMENT

2011 Priorities

• Drive diversified organic revenue growth across all business lines.

• Optimize the DundeeWealth opportunity and further explore strategic acquisition opportunities.

• Capitalize on our people, systems, expertise and international reach to accelerate growth.

• Work closely with and build on strong partnerships with Canadian Banking, International Banking and Scotia Capital.

Business profile

Global Wealth Management (GWM) is comprised of wealth management insurance and Global Transaction Banking businesses. This new business line brings together a number of the Bank’s global growth platforms to drive revenue growth across multiple geographies and businesses, with a strong global perspective. GWM will collaborate with and strengthen partnership relationships with Canadian Banking, International Banking and Scotia Capital.

Wealth Management

GWM provides a full range of wealth management products and services to mass market, emerging affluent and high net worth clients in Canada, including: full service and on-line brokerage, investment management, private banking, estate and trust and philanthropic services. Institutional clients are served through the Private Client Group.

Internationally, the Bank provides a variety of products and services to the emerging affluent segments including private client services, investment products and offshore brokerage. Operations are concentrated in international locations where the Bank has a strong retail banking footprint, particularly the Caribbean and Latin America. Key centres are located in Mexico, Costa Rica, Panama, Peru, Jamaica, Bahamas and Thailand.

Insurance

Insurance is provided to retail customers in Canada and internationally. In Canada, the Bank generates revenue from the sale of creditor insurance products sold through distribution neworks and from the distribution of non-creditor related, third-party insurance products.

Internationally, the Bank operates in Mexico, Chile, Peru, El Salvador, Central America and the Caribbean and sells creditor, collateral, home, auto, life, health and ATM insurance. Insurance products are sold through normal bank channels where regulations allow and via brokers in other cases. Non-creditor insurance is sold in Jamaica, El Salvador, Trinidad and the Dominican Republic.

Global Transaction Banking

Global Transaction Banking (GTB) which reports through GWM offers comprehensive business solutions – cash management and payment services, business deposits, and trade services, to the small business, commercial, and corporate customer segments of the Bank’s business lines as well as correspondent banking services to other financial institutions globally.

Strategy

GWM is focussed on delivering tailored advice, solutions and an excellent customer services experience by leveraging the Bank’s international reach and expertise. GWM will continue to improve its competitive position by building on its existing client service strengths and exploring strategic opportunities as they arise.

Outlook

GWM’s new organizational structure will leverage existing global strengths in wealth management, insurance and Global Transaction Banking to drive organic revenue growth. In 2011, this growth will be enhanced by improving market conditions both in Canada and internationally.

The Bank’s recent acquisition of DundeeWealth will provide opportunities for driving additional revenue growth by leveraging DundeeWealth’s scale and highly complimentary asset management capabilities in the Bank’s existing Canadian and international operations. The acquisition also enhances the Bank’s presence in the independent advisor channel.

Scotiabank Annual Report2010     61

MANAGEMENT’S DISCUSSION AND ANALYSIS

RISKMANAGEMENT

Effective risk management is fundamental to the success of the Bank. Risk management is a strategic priority that is a responsibility shared by all of the Bank’s employees. Scotiabank has a strong, disciplined risk management culture. A key aspect of this culture is to be well-diversified across business lines, countries, products, and industries.

Risk management framework

The primary goals of risk management are to ensure that the outcomes of risk-taking activities are predictable and 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 returns. In 2009, the Bank conducted a self-assessment against the Final Report of the Institute of International Finance (IIF) Committee on Market Best Practices, and provided the Board of Directors with a report of its findings. This self-assessment confirmed that the Bank has a robust, enterprise-wide risk management framework in place and that its risk management practices are considered a core strength.

The risk management programs of the Bank’s subsidiaries also conform in all material respects to the Bank’s risk management framework, although the actual execution of their programs may be different. For new acquisitions, or situations where control of a subsidiary has been recently established, the Bank assesses existing risk management programs and, if necessary, develops an action plan to make improvements in a timely fashion.

The Bank’s risk management framework is applied on an enterprise-wide basis and consists of three key elements:

• Risk Governance,

• Risk Appetite, and

• Risk Management Techniques.

The Bank’s strong risk management culture provides the foundation for the framework. The framework is constantly evaluated to ensure that it meets the challenges of a dynamic market. As part of the evaluation process, the Bank places high importance on adherence to regulatory standards and industry best practices.

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 senior management team and a centralized risk management group that is independent of the business lines. Decision-making is highly centralized through a number of senior and executive risk management committees.

The Board of Directors

The Bank’s risk management governance structure begins with oversight by the Board of Directors, either directly or through its committees to ensure that decision-making is aligned with the Bank’s risk appetite. The Board receives regular updates on the key risks of the Bank — including a comprehensive summary of the Bank’s risk profile and performance of the portfolio against defined goals, which is presented quarterly to the Executive and Risk Committee of the Board — and approves key risk policies, limits, strategies, and risk appetite. The Bank’s Internal Audit department reports independently to the Board (through the Audit and Conduct Review Committee) on the effectiveness of the risk governance structure and risk management framework.

Management

Executive management, and in particular the Chief Executive Officer (CEO) and the Chief Risk Officer (CRO), are responsible for risk management under the direct oversight of the Board. The CRO, who oversees the Global Risk Management (GRM) division of the Bank, reports to the CEO but also has direct access to the Executive and Risk Committee of the Board.

The CEO, CRO, and other senior executives chair the Bank’s senior and executive risk management committees. Committee structures and key accountabilities are outlined on page 63.

Global Risk Management (GRM)

GRM is responsible for the design and application of the Bank’s risk management framework, and is independent of the Bank’s business units. It provides oversight of credit, market, liquidity, structural foreign exchange, structural interest rate, and operational risks.

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MANAGEMENT’S DISCUSSION AND ANALYSIS| RISK MANAGEMENT

SCOTIABANK’SRISK GOVERNANCE STRUCTURE

Executive Committees:

Risk Policy Committee: reviews key risk exposures and risk policies, and adjudicates risk issues referred by the Senior Credit, Market, Operational and Reputational Risk committees.

Liability Committee: provides strategic direction in the management of global interest rate risk, foreign exchange risk, liquidity and funding risk, trading and investment portfolio decisions, and capital management.

Strategic Transaction and Investment Committee: reviews and approves all potential acquisitions, investments and strategic initiatives that require a major allocation of the Bank’s capital.

Systems Planning and Policy Committee: reviews and approves significant business initiatives involving system and computing facilities in excess of designated executive approval limits.

Human Investment Committee: reviews and approves all senior management appointments and the staffing of key positions, as well as broad compensation issues.

Senior Management Committees:

Senior Credit Committees: adjudicate credits within prescribed limits and establish the operating rules and guidelines for the implementation of credit policies. Separate committees cover commercial, international and corporate counterparties, and Canadian and international retail and small business.

Market Risk Management and Policy Committee: oversees and establishes standards for market and liquidity risk management processes within the Bank, including the review and approval of new products, limits, practices and policies for the Bank’s principal trading and treasury activities.

Operational Risk Committee: promotes an enterprise-wide operational risk framework to ensure risks are understood, communicated, and appropriate actions are taken to mitigate related losses.

Stress Testing Committee: sets overall direction and makes key decisions relating to stress testing activities across the Bank, and guides the design, execution, and results assessment of the Enterprise Stress Testing program.

Reputational Risk Committee: upon referral from business lines or risk committees, reviews business activities, initiatives, products or transactions, and recommends either proceeding or not proceeding, based on an assessment of reputational risk, to ensure that the Bank is, and is seen to be, acting with high ethical standards.

Scotiabank Annual Report2010     63

MANAGEMENT’S DISCUSSION AND ANALYSIS

Risk Management Culture

Effective risk management requires a strong, robust, and pervasive risk management culture.

The Business Lines are responsible for the development and execution of business plans that are aligned with the Bank’s risk management framework, and are accountable for the risks they incur. Understanding and managing these risks is a fundamental element of each business plan. Business units work in partnership with Global Risk Management to ensure that risks arising from their business are thoroughly evaluated and appropriately addressed.

Risk education programs, and documented policies and procedures are jointly available to staff in the Business Lines and Global Risk Management.

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, includes Business Line Heads and senior risk officers from Global Risk Management. The flow of 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 framework.

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 governs risk taking activities on an enterprise-wide basis.

Risk management principles

Provide the qualitative foundation of the risk appetite framework. These principles include:

•     promotion of a robust risk culture,

•     accountability for risk by the business lines,

•     independent oversight exercised by Global Risk Management (GRM),

•     avoidance of excessive risk concentrations, and

•     ensuring risks are clearly understood, measurable, and manageable.

Strategic principles

Provide qualitative benchmarks to guide the Bank in its pursuit of the Governing Financial Objectives, and to gauge broad alignment between new initiatives and the Bank’s risk appetite. Strategic principles include:

• placing emphasis on the diversity, quality and stability of earnings,

• focusing on core businesses by leveraging competitive advantages, and

• making disciplined and selective strategic investments

Governing financial objectives

Focus on long-term shareholder value. These objectives include sustainable earnings growth, maintenance of adequate capital in relation to the Bank’s risk profile, and availability of financial resources to meet financial obligations on a timely basis at reasonable prices.

Risk appetite measures

Provide objective metrics that gauge risk and articulate the Bank’s risk appetite. They provide a link between actual risk taking activities and the risk management principles, strategic principles and governing financial objectives described above. These measures include capital and earnings ratios, market and liquidity risk limits, and credit and operational risk targets.

Risk management techniques

Effective risk management includes techniques that are guided by the Bank’s Risk Appetite Framework and integrated with the Bank’s strategies and business planning processes.

Strategies, Policies & Limits

Strategies

Provide quantitative and qualitative guidance for each component of the techniques. This guidance is, in turn, used to set limits and guidelines on the types of risk taking activities the Bank is prepared to assume in pursuit of its strategic and financial objectives.

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, audit, business lines, and senior executive management. They also reflect industry best practices and any regulatory requirements. Policies are guided by the Bank’s risk appetite, and set the limits and controls within which the Bank and its subsidiaries can operate.

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MANAGEMENT’S DISCUSSION AND ANALYSIS| RISK MANAGEMENT

• Key risk policies are approved by the Board of Directors, either directly or through the Board’s Executive and Risk Committee (the Board).

• Management level risk policies associated with processes such as model development and stress testing are approved by executive management and/or key risk committees.

Limits

Control risk-taking activities within the tolerances established by the Board and senior 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 underwrites only those risks that are well understood. Guidelines may change from time to time, due to market or other circumstances. Risk taking outside of guidelines usually requires approval of the Bank’s Senior Credit Committees, Market Risk Management and Policy Committee, or Risk Policy Committee.

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 developed on an enterprise-wide basis, and documented in a series of policies, manuals and handbooks under the purview of GRM. Key processes cover the review and approval of new products and model validation.

Measurement, Monitoring, and Reporting

Measurement

Tools quantify risk across products and businesses and are used, among other things, to determine risk exposure. GRM is responsible for developing and maintaining an appropriate suite of such tools to support the operations of the various business lines, and for supporting the measurement of economic capital on an enterprise-wide basis. The risk sections explain the application of these tools.

Measurement tools include the use of models and stress testing. Procedures for model development, approval, and on-going review are subject to a formalized policy. However, the Bank considers sound and experienced judgement to be the most effective mitigant against model risk, and avoids over reliance on quantitative risk methodologies and models.

The Bank uses stress testing programs at both enterprise-wide level and risk level 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. Each 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 strategy. Enterprise-wide stress testing is also integrated with both the strategic and financial planning processes. The development, approval and on-going review of the Bank’s stress testing programs are subject to formalized policy, and are under the oversight of the Stress Testing Committee, which reports to the Liability Committee.

Monitoring

The Bank regularly 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, policy committees, and/or the Board depending on the limit or guideline.

Reporting

Tools aggregate measures of risk across products and businesses, and are used to ensure compliance with policies, limits, and guidelines. They also provide a clear statement of the amounts, types, and sensitivities of the various risks in the Bank’s portfolios. Senior management and the Board use this information to understand the Bank’s risk profile and the performance of the portfolios.

Control and audit functions are also established that are independent of the organizations whose activities they review, and whose role includes ensuring that all of the components of the risk management framework are effective and being implemented on a day to day basis.

Basel II

The Basel II regulatory capital framework governs minimum regulatory capital requirements to cover three broad categories of risk — credit risk, market risk and operational risk. This framework is organized under three broad categories or pillars:

• Pillar 1 stipulates the methodologies and parameters that must be applied to calculate minimum capital requirements.

• Pillar 2 introduces the requirement for formal internal assessment of capital adequacy in relation to strategies, risk appetite, and actual risk profile. Regulators are required to review this internal capital adequacy assessment process (ICAAP — for further discussion, refer to the Capital Management section on page 40).

• Pillar 3 enhances public disclosure (both quantitative and qualitative) of specific details of risks being assumed, and how capital and risk are being managed under the Basel II framework.

The following sections on Credit Risk, Market Risk, and Operational Risk include descriptions of the Pillar 1 methodologies and risk parameters, as well as some of the enhanced disclosure requirements associated with Pillar 3.

Scotiabank Annual Report2010     65

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.

The effective management of credit risk requires the establishment of an appropriate credit risk culture. Key credit risk policies and credit risk management strategies are important elements used to create this culture.

The Board of Directors, either directly or through the Executive and Risk Committee (the Board), reviews and approves the Bank’s credit risk strategy and credit risk policy on an annual basis:

• The objectives of the credit risk strategy 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.

• The credit risk policy articulates the credit risk management framework, including:

– aggregate limits, beyond which credit applications must be escalated to the Board for approval; and

– single name/aggregation exposures, beyond which exposures must be reported to the Board.

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:

(i) credit risk rating methodologies and parameters are appropriately designed and developed, independently validated, and regularly reviewed; and

(ii) the review and validation processes represent an effective challenge to the design and development process.

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 general allowance for credit losses, and return on economic capital.

Corporate and commercial

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:

• 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.

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.

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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. Global Risk Management is the final arbiter of internal risk ratings.

The internal credit risk ratings are also considered as part of the Bank’s single borrower 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.

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, 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.

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.

Most traded products transactions benefit from credit mitigation techniques, such as netting and collateralization, which are taken into consideration in the calculation of counterparty credit risk exposure. A master netting agreement allows for a single net settlement of all transactions covered by that agreement in the event of a default or early termination of the transactions. Collateral agreements with a counterparty allow for variation margin to be called if total uncollateralized mark-to-market exposure exceeds an agreed upon threshold.

Investment grade counterparties account for approximately 91% of the credit risk amount arising from the Bank’s derivative transactions. Approximately 60% 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, 2010:

• no exposure to a non-investment grade counterparty exceeded $195 million pre-tax;

• no exposure to a corporate counterparty exceeded $197 million pre-tax.

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 Table 28.

T28 Internal rating scale⁽¹⁾ and mapping to external rating agencies

Internal		Equivalent Rating
Grade	Description	Moody’s	S&P	DBRS
99 – 98	Investment grade	Aaa to Aa1	AAA to AA+	AAA to AA (high)
95 – 90		Aa2 to A3	AA to A-	AA to A (low)
87 – 83		Baa1 to Baa3	BBB+ to BBB-	BBB (high) to BBB (low)
80 – 75	Non-investment grade	Ba1 to Ba3	BB+ to BB-	BB (high) to BB (low)
73 – 70		B1 to B3	B+ to B-	B (high) to B (low)
65 – 30	Watch list
27 – 21	Default

(1) Applies to non-retail portfolio.

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 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 Executive and Risk Committee of the Board of Directors.

Credit risk and capital

The Bank uses the Advanced Internal Ratings Based (AIRB) approach under Basel II to determine minimum regulatory capital requirements for its domestic, U.S. and European credit portfolios. The remaining credit portfolios are subject to the Standardized approach, which relies on the 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).

• Probability of default (PD) measures the likelihood that a borrower, with an assigned IG code, will default within a one-year time horizon. Each of the Bank’s internal borrower IG codes is mapped to a PD estimate.

• 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.

• Exposure-at-default (EAD) measures the expected exposure on a facility in the event of a borrower’s default.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

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. Further analytical adjustments, as required under the Basel II Framework and OSFI’s requirements set out in their Domestic Implementation Notes, are applied to estimates obtained from historical data. These analytical adjustments incorporate the regulatory requirements pertaining to:

(i)	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;
(ii)	downturn estimation for LGD and EAD, which requires that these estimates appropriately reflect conditions observed during periods of economic stress; and
(iii)	the addition of an adequate level of conservatism, which should reflect 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 Table 29.

Retail

Adjudication

The decision-making process for retail loans ensures that credit risks are adequately assessed, properly approved, continually monitored and actively managed. Generally, decisions on consumer loans are based on risk ratings, which are generated using predictive credit scoring models. Individual credit requests are processed by proprietary adjudication software.

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 risk modeling in Canada 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. The adjudication system calculates the maximum debt for which a customer qualifies, allowing customers to choose the products that satisfy all of their credit needs. International Banking uses a similar approach to risk modeling, adjudication and portfolio management, but is migrating toward the more customer-centric approach.

T29 Credit risk assessment of exposures
Non-retail AIRB portfolio⁽¹⁾

			Exposure		Exposure		Exposure
	Exposure		Weighted		Weighted		Weighted
	at default(3)		Average		Average		Average
As at Oct. 31, 2010	($ millions)		PD (%)(4)		LGD (%)(5)		RW (%)(6)
Investment grade(2)		179,892		0.10		27		16
Non-investment grade		38,341		0.78		40		63
Watch list		3,185		23.02		40		205
Default(7)		837		100.00		42		406
Total		222,255		0.92		29		28
Total as at Oct. 31, 2009		238,095		1.50		29		31

(1)	Excludes securitization exposures.
(2)	Includes government guaranteed residential mortgages.
(3)	After credit risk mitigation.
(4)	PD — Probability of Default.
(5)	LGD — downturn Loss Given Default including a certain conservative factor as per Basel accord.
(6)	RW — Risk Weight.
(7)	Gross defaulted exposures, before any related allowances. Defaulted exposures under Basel II definition may be higher than those under accounting definition.

Credit scoring and policy changes are proposed by risk departments in the business lines with governance, oversight and key approvals made by Global Risk Management. Risk models and parameters are also subject to Global Risk Management’s validation and ongoing review. 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 differentiation of risk, which allows for accurate, timely and consistent estimation of probability of default and loss, as well as early identification and management of problem loans.

The overall risk ratings system is reviewed annually with specific components evaluated frequently and more thoroughly if significant deterioration is detected in a portfolio or in the performance of a credit scorecard. Risk model validations are conducted independently from the areas responsible for rating system development and implementation, to ensure effective independence.

The Bank’s Canadian retail portfolio uses the AIRB approach under Basel II, while the International portfolios are subject to the Standardized approach at this time.

Canadian retail

The AIRB approach is used to determine minimum regulatory capital requirements for its retail credit portfolio. AIRB risk parameters — estimates of probability of default (PD), exposure at default (EAD), and loss given default (LGD) — are fundamental tools in credit review and risk management. They are used as part of the ongoing review and monitoring of policies and procedures. As well, these parameters, along with the estimation of expected loss, are also used to determine the Bank’s economic capital requirements. The expected loss calculation is also compared to the provisions in Canadian Banking to ensure they reflect reasonable market conditions.

This year, the Bank undertook a review of its parameter methodologies and implemented enhancements to refine risk segmentation by borrowers and products.

PD is estimated using a statistical model that is applied to all performing (non-defaulted) facilities on a monthly basis. The model predicts the probability that the facility will default within the next 12 months. The model uses all relevant information, including internal performance, credit bureau score, and certain macroeconomic factors. All retail portfolios use the Basel definition of default in calculating PD. The retail portfolio is comprised of the following Basel-based components:

• Residential mortgages consist 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;

• Qualifying revolving consists of all unsecured credit cards and lines of credit;

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• 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.

Fifteen PD bands are calculated for each retail portfolio, which are then summarized into fewer bands as shown in Table 30.

Retail facilities can generally be cancelled unconditionally at time of default, meaning no additional drawdown of a facility is possible after default. EAD measures the increases in the balance of revolving facilities from the time they are initially observed until the point of default. This historic experience is used to estimate the value of defaulted exposures in the portfolio in the next 12 months.

LGD is calculated by dividing the losses (less the net present value of recoveries and collection costs) by EAD. The historic LGD is used to forecast the LGD that will be experienced in the portfolio in the following 12 months.

These risk measures are then converted into regulatory capital requirements by means of formulas specified by the Basel Committee. The credit quality distribution of the Bank’s AIRB retail portfolio is shown below in Table 31.

International retail

International retail (Scotiabank does not have any U.S. retail branches) credit portfolios follow the Standardized approach and consist of the following components:

• Residential mortgages;

• Qualifying revolving consists of all credit cards and lines of credit;

• Other retail consists of term loans.

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 among them, and their levels of volatility. A description of each market risk category is provided below:

Interest rate risk

The risk of loss due to changes in the level, slope and curvature of the yield curve; the volatility of interest rates; and mortgage prepayment rates.

Credit spread risk

The risk of loss due to changes in the market price of credit, or the creditworthiness of a particular issuer.

Foreign currency risk

The risk of loss due to changes in spot and forward prices, and the volatility of currency exchange rates.

Equity risk

The risk of loss due to changes in the prices, and the volatility, of individual equity instruments and equity indices.

Commodity risk

The risk of loss due primarily to changes in, and volatility of, spot and forward prices of precious and base metals, and energy products.

FUNDING Interest rate risk	INVESTMENTS Interest rate risk	TRADING Interest rate risk
Foreign currency risk	Credit spread risk	Credit spread risk
	Foreign currency risk	Foreign currency risk
	Equities risk	Equities risk
		Commodities risk

The Board of Directors reviews and approves market risk policies and limits annually. The Bank’s Liability Committee (LCO) 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 LCO 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 or by the back offices. They provide senior management, business units, the LCO, and the MRMPC with a series of daily, weekly and monthly reports of market risk exposures by business line and risk type.

T30 Retail loan probability of default scale

Category of PD Grades	PD Range
Very low		0.0000% - 0.2099	%
Low		0.2100% - 0.4599	%
Medium		0.4600% - 3.1999	%
High		3.2000% - 17.2899	%
Very high		17.2900% - 99.9999	%
Default		100	%

T31 Credit risk assessment of exposures — Retail AIRB portfolio

	Exposure		Exposure		Exposure		Exposure
	at default		Weighted		Weighted		Weighted
	(EAD)(1)		Average		Average		Average
As at October 31, 2010	($ millions)		PD (%)(2)(5)		LGD (%)(3)(5)		RW (%)(4)(5)
Very low		84,182		0.09		24		5
Low		19,510		0.36		40		15
Medium		23,249		1.18		53		39
High		2,461		8.22		57		94
Very high		998		24.21		89		237
Default(6)		551		100.00		54		—
Total		130,951		1.08		33		16
Total as at October 31, 2009		120,439		1.13		30		14

(1)	After credit risk mitigation.
(2)	PD — Probability of Default.
(3)	LGD — Loss Given Default.
(4)	RW — Risk Weight
(5)	Exposure at default used as basis for estimated weightings.
(6)	Gross defaulted exposures, before any related allowances.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Risk measurement summary

Value at risk

Value at Risk (VaR) is a method of measuring market risk based upon a common confidence interval and time horizon. It is a statistical estimate of expected potential loss that is derived by translating the riskiness of any financial instrument into a common standard. The Bank calculates VaR daily using a 99% confidence level, and a one-day holding period for its trading portfolios. This means that about once in every 100 days, the trading positions are expected to lose more than the VaR estimate. The Bank calculates general market risk and equity specific risk VaR using historical simulation based on 300 days of market data. For debt specific risk VaR, the Bank uses a combination of Monte Carlo and historical simulation. Changes in VaR between reporting periods are generally due to changes in levels of exposure, volatilities and/or correlations among asset classes. VaR is also used to evaluate risks arising in certain funding and investment portfolios. Back testing is also an important and necessary part of the VaR process, by validating the quality and accuracy of the Bank’s VaR model. The Board reviews VaR results quarterly.

Stress testing

VaR measures potential losses in normally active markets. An inherent limitation of VaR is that it gives no information about how much losses could exceed their expected levels. Accordingly, stress testing examines 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 easily absorb potential losses from abnormal events. The Bank subjects its trading portfolios to more than 75 stress tests on a daily basis, and more than 250 stress tests on a monthly basis. The Bank also evaluates risk in its investment portfolios on a monthly basis, 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 current VaR methodology and other risk measures and controls employed by the Bank. The Board reviews stress testing results quarterly.

Sensitivity analysis and simulation modeling

Sensitivity analysis assesses the effect of changes in interest rates on current earnings and on the economic value of shareholders’ equity related to non-trading portfolios. It is applied globally to each of the major currencies within the Bank’s operations. Simulation models enable the Bank to assess interest rate risk under a variety of scenarios over time. The models incorporate assumptions about changes in interest rates, shape of the yield curve, embedded product options, maturities and other factors. 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

Gap analysis is used to assess the interest rate sensitivity of the Bank’s Canadian and international operations. Under gap analysis, interest rate sensitive assets, liabilities and off-balance sheet instruments are assigned to defined time periods on the basis of expected re-pricing dates.

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), stress testing, sensitivity analysis and simulation modeling, and gap analysis. The use and attributes of each of these techniques are noted in the Risk Measurement Summary. Models are independently validated prior to implementation and are subject to formal periodic review.

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 LCO meets weekly to review risks and opportunities, and evaluate performance including the effectiveness of hedging strategies.

Interest rate risk

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 lending, funding and investment activities is managed in accordance with Board-approved policies and global limits, which are designed to control the risk to income and economic value of shareholders’ equity. The income limit measures the effect of a specified change in interest rates on the Bank’s annual net interest income, 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. Gap analysis, simulation modeling, sensitivity analysis and VaR are used to assess exposures and for planning purposes.

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. Common shareholders’ equity is assumed to be non-interest rate sensitive.

Table 32 shows the breakdown of the Canadian dollar and foreign currency interest rate gaps as at October 31, 2010. Chart 41 illustrates trends in the one-year gap and shows the Canadian dollar asset gap narrowed to $10.0 billion, while the one-year foreign currency gap transitioned from liability sensitive to an asset sensitive gap of $5.2 billion.

Table 33 shows the after-tax impact of a 100 and 200 basis point shift on annual income and economic value of shareholder’s equity. Based on the Bank’s interest rate positions at year-end 2010, an immediate and sustained 100 basis point rise in interest rates across all currencies and maturities would increase net income after-tax by approximately $50 million over the next

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12-months. During fiscal 2010, this measure ranged between $50 million and $180 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 $415 million. During fiscal 2010, this measure ranged between $239 million and $459 million.

Foreign currency risk

Foreign currency risk in the Bank’s unhedged funding and investment activities arises primarily from the Bank’s net investments in self-sustaining 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 self-sustaining 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 LCO 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.

In accordance with GAAP, foreign currency translation gains and losses from net investments in self-sustaining 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 foreign operations which are not self-sustaining. The Bank forecasts foreign currency revenues and expenses, which are primarily denominated in U.S. dollars, over a number of future fiscal quarters. The LCO 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 GAAP, foreign currency translation gains and losses from positions in operations that are not self-sustaining are recorded directly in earnings.

As at October 31, 2010, a one per cent increase in the Canadian dollar against all currencies in which the Bank operates, decreases the Bank’s before-tax annual earnings by approximately $34 million in the absence of hedging activity, primarily from exposure to U.S. dollars. A similar change in the Canadian dollar would increase the unrealized foreign currency translation losses in the accumulated other comprehensive income section of shareholders’ equity by approximately $199 million as at October 31, 2010, net of hedging.

T32 Interest rate gap

									Non-
Interest rate sensitivity position(1)	Within		3 to 12			Over			interest rate
As at October 31, 2010 ($ billions)	3 months		months			1 year			sensitive			Total
Canadian dollars
Assets	$	189.5	$	23.3		$	79.4		$	8.0		$	300.2
Liabilities		172.2		30.6			84.8			12.6			300.2
Gap		17.3		(7.3	)		(5.4	)		(4.6	)		—
Cumulative gap		17.3		10.0			4.6			—
Foreign currencies
Assets	$	164.0	$	13.9		$	25.8		$	22.8		$	226.5
Liabilities		156.6		16.1			14.0			39.8			226.5
Gap		7.4		(2.2	)		11.8			(17.0	)		—
Cumulative gap		7.4		5.2			17.0			—
Total
Gap	$	24.7	$	(9.5	)	$	6.4		$	(21.6	)
Cumulative gap		24.7		15.2			21.6			—
As at October 31, 2009:
Gap	$	37.0	$	(23.2	)	$	5.7		$	(19.5	)
Cumulative gap		37.0		13.8			19.5			—

(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.

T33 Structural interest sensitivity

	2010						2009
As at October 31	Economic Value of			Annual			Economic Value of			Annual
($ millions)	Shareholders’ Equity			Income			Shareholders’ Equity			Income
After-Tax Impact of
100bp increase in rates		(415	)		50			(188	)		150
100bp decrease in rates		411			(35	)		173			(178	)
After-Tax Impact of
200bp increase in rates		(829	)		102			(349	)		306
200bp decrease in rates		858			(80	)		555			(400	)

Scotiabank Annual Report2010     71

MANAGEMENT’S DISCUSSION AND ANALYSIS

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 activities

Scotiabank’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, but also include a proprietary component.

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 theoretical and actual profit and loss results.

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 or Global Risk Management units on a regular basis. These units also provide profit and loss reporting, as well as VaR and limit compliance reporting to business unit management and executive management for evaluation and action to be taken, where appropriate. In certain situations, the product valuation process requires the application of a valuation adjustment. For a discussion of valuation considerations, refer to the discussion of the fair value of financial instruments on page 78.

In fiscal 2010, the one-day VaR for trading activities averaged $12.5 million, compared to $17.0 million in 2009. The decrease was primarily due to lower interest rate risk together with reduced market volatility. Table 34 shows VaR by risk factor.

Chart 42 shows the distribution of daily trading revenue for fiscal 2010. Trading revenue averaged $5.6 million per day, compared to $5.8 million for 2009. Revenue was positive on more than 88% of trading days during the year, compared to 89% in 2009. During the year, the largest single day loss was $14.6 million which occurred on May 26, 2010, and was lower than the VaR exposure.

Calculation of market risk capital for trading

The assessment of market risk for trading activities includes both general market risk and specific risk. General market risk is defined as the risk of loss arising from adverse changes in market prices. Specific risk is defined as the risk of loss caused by an adverse price movement of a debt or equity instrument due principally to factors related to the issuer. Under the Basel II capital adequacy guidelines, the specific risk capital and general market risk capital requirements apply to interest rate risk and equity risk. The general market risk capital requirement also applies to commodities risk and foreign exchange risk.

For all material trading portfolios, the Bank applies its internal Value at Risk (VaR) model to calculate the capital charge for general market risk and specific risk. The attributes/parameters of this model are described in the Risk Measurement Summary on page 69. The Office of the Superintendent of Financial Institutions (OSFI) has approved the Bank’s internal VaR model for the determination of its General Market Risk Capital and Equity and Debt Specific Risk Capital requirements.

For non-material trading portfolios, the Bank applies the Standardized Approach for calculating general market risk and debt specific risk capital. The standardized method uses a “building block” approach with the capital charge for each risk category calculated separately.

The Bank is assessing the quantitative impact on market risk capital of the new trading book rules under the Basel II market risk framework.

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 lowers 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 in the Trading activities section. 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 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, and the 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.

T34 One-day VaR by risk factor

	2010										2009
($ millions)	Year end			Avg			High		Low		Year end			Avg			High		Low
Interest rate		9.0			11.7			19.0		7.3		15.6			16.3			26.1		10.9
Equities		3.4			5.1			14.1		2.3		3.0			4.6			9.3		2.0
Foreign exchange		0.9			1.7			4.6		0.6		3.4			2.2			4.7		0.5
Commodities		1.5			2.1			5.6		0.6		3.7			3.5			5.6		1.9
Diversification		(6.3	)		(8.1	)		N/A		N/A		(10.5	)		(9.6	)		N/A		N/A
All-Bank VaR		8.5			12.5			19.5		7.4		15.2			17.0			28.9		10.2

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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 in order to maintain the confidence of depositors and counterparties, and to enable the core businesses to continue to generate revenue, 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 Liability Committee (LCO) provides senior management oversight of liquidity risk and meets weekly to review the Bank’s liquidity profile.

The key elements of the liquidity risk framework are:

• 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 and a minimum level of core liquidity.

• Reporting — Global Risk Management provides independent oversight of all significant liquidity risks, supporting the LCO with analysis, risk measurement, stress testing, monitoring and reporting.

• Stress testing — the Bank performs liquidity stress testing on a regular basis, to evaluate the effect of both industry 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 positions on its balance sheet in circumstances of stress;

– Based on this knowledge, facilitating the development of risk mitigation and contingency plans; and

– Conveying an approximate range of risk.

	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 also performs industry standard stress tests required by regulators and rating agencies. The stress test results are reviewed at senior levels of the organization and are considered in making liquidity management decisions.
•	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 relevant subsidiaries.
•	Funding diversification — the Bank actively manages the diversification of its deposit liabilities by source, type of depositor, instrument, term and geographic market.
•	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 company specific events. The Bank also maintains liquid assets to support its intra-day settlement obligations in payment, depository and clearing systems.

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Liquidity profile

The Bank maintains large holdings of liquid assets to support its operations. These assets generally can be sold or pledged to meet the Banks’ obligations. As at October 31, 2010 liquid assets were $148 billion or 28% of total assets, compared to $146 billion or 29% of total assets as at October 31, 2009. The mix of these assets between securities and other liquid assets, including cash and deposits with banks, was 68% and 32%, respectively (October 31, 2009 — 69% and 31%, respectively).

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 sold under repurchase agreements. As at October 31, 2010, total assets pledged or sold under repurchase agreements were $96 billion, compared to $84 billion as at October 31, 2009. The year over year change was largely due to an increase in assets pledged to secure obligations relating to covered bonds issued by the Bank in 2009. 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 its obligations in the event of a downgrade of its ratings by one or more of the rating agencies.

Funding

The Bank ensures that its funding sources are well diversified. Funding source concentrations are regularly monitored and analyzed by type and by industry. The principal sources of funding are capital, core deposits from retail and commercial clients through the Canadian and international branch network, and wholesale funding. The Bank also securitizes mortgages through the Canada Mortgage Bonds program as an alternative source of funding, and for liquidity and asset/liability management purposes. To ensure that the Bank does not place undue reliance on a single entity as a funding source, the Bank maintains a limit on the amount of deposits it will accept from any one entity.

Core funds, represented by capital and core deposits of the Bank’s retail and commercial clients, were $256 billion as at October 31, 2010, versus $243 billion last year (see Chart 44). This increase was attributable primarily to higher balances of demand and notice deposits and personal term deposits. As at October 31, 2010, the Bank’s core funds represented 49% of total funding, unchanged from last year.

Contractual obligations

Table 36 provides aggregated information about the Bank’s contractual obligations as at October 31, 2010, which affect the Bank’s liquidity and capital resource needs.

The Bank’s contractual obligations include contracts and purchase obligations, including agreements to purchase goods and services, that are enforceable and legally binding on the Bank. The table excludes deposit liabilities (except term funding), pension and other retirement benefit obligations, lending commitments and other short-term financing arrangements which are discussed in Notes 10, 19, 23 and 24, respectively, of the 2010 Consolidated Financial Statements.

The Bank prudently diversifies its wholesale funding activities by using a number of different funding programs to access the global financial markets and extend its maturity profile, as appropriate. In 2010, the Bank issued approximately $24 billion of senior term funding in the domestic, United States and other markets. The outstanding balance of the Bank’s subordinated debentures decreased slightly in 2010 with the repurchase of an existing issue.

T35 Liquidity

As at October 31 ($ millions)	2010			2009			2008			2007			2006
Canadian dollar liquid assets
Cash and deposits with Bank of Canada	$	484		$	1,223		$	498		$	502		$	469
Deposits with other banks		2,558			1,371			1,654			4,152			2,445
Securities		79,086			81,613			46,558			53,429			53,762
		82,128			84,207			48,710			58,083			56,676
Foreign currency liquid assets
Cash and deposits with Bank of Canada		7,150			6,170			3,064			4,503			3,839
Deposits with other banks		35,835			34,513			32,102			20,039			16,623
Securities		21,654			19,649			21,298			19,809			20,824
Call and short loans		1,498			1,538			1,087			874			5
		66,137			61,870			57,551			45,225			41,291
Total liquid assets
Cash and deposits with Bank of Canada		7,634			7,393			3,562			5,005			4,308
Deposits with other banks		38,393			35,884			33,756			24,191			19,068
Securities		100,740			101,262			67,856			73,238			74,586
Call and short loans		1,498			1,538			1,087			874			5
	$	148,265		$	146,077		$	106,261		$	103,308		$	97,967
Liquid assets as a % of total assets		28.2	%		29.4	%		20.9	%		25.1	%		25.8	%

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Other long-term liabilities include transactions where the Bank is the paying agent on customer lease transactions, and term financing bonds in the Bank’s foreign subsidiaries.

The Bank leases a large number of its branches, offices and other locations. The vast majority of these leases are for a term of five years, with an option to renew. The total cost of these leases, net of rental income from subleases remained unchanged from last year at $243 million during fiscal 2010. Refer to Note 23 of the 2010 Consolidated Financial Statements.

Two major outsourcing contracts have been entered into by the Bank. 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 include the computer operations for the Caribbean and Mexico. The contract for Canadian operations was renewed in 2007 and is now extended until 2013, co-terminus with, Mexico and Caribbean contracts.

The second is a three-year contract, with two optional five-year renewals, entered into in 2003 with Symcor Inc. to manage the Bank’s cheque and bill payment processing, including associated statement and report printing activities across Canada. The final 5-year option has been exercised. These outsourcing contracts are cancellable with notice, including agreed upon fees.

Capital expenditures

Scotiabank has an ongoing program of capital investment to provide the necessary level of technology and real estate resources to service our customers and meet new product requirements. All major capital expenditures go through a rigorous review and approval process.

Total capital expenditures in 2010 are estimated to be $210 million, a decrease of 6% from 2009. The decrease is primarily in Technology, $17 million or 18%, due largely to the completion of a major project to upgrade branch equipment in Canada. This is partially offset by an increase in Real Estate spending of $3 million or 2%.

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.

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 program include:

• Accountability in the individual business lines for management and control of the significant operational risks to which they are exposed, reflected with allocation of economic capital to business units.

• An effective organization structure through which there is effective oversight and in which operational risk is managed to an established risk appetite, including:

– A Board of Directors responsible for sound corporate governance and which approves the Bank’s Operational Risk Management Policy;

– A senior level Operational Risk Committee chaired by the Group Head and Chief Risk Officer which provides consistent, Bank-wide oversight of risk management and includes the Heads of business lines and key control functions;

– Executive management who have clearly defined areas of responsibility;

– A central unit in Global Risk Management responsible for developing and applying methods to identify, assess, and monitor operational risks, and report on risks as well as actual loss events;

T36 Contractual obligations

	Under		1-3		4-5		Over
($ millions)	1 year		years		years		5 years		Total
Term funding
Wholesale deposit notes		7,504		12,818		8,275		1,301		29,898
Euro medium term notes		2,553		2,004		613		52		5,222
Covered bonds		—		2,550		2,554		—		5,104
Subordinated debentures		—		250		—		5,629		5,879
Other long-term liabilities		766		617		785		1,520		3,688
Subtotal		10,823		18,239		12,227		8,502		49,791
Operating leases		206		319		189		183		897
Outsourcing obligations		193		376		138		12		719
Total		11,222		18,934		12,554		8,697		51,407

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MANAGEMENT’S DISCUSSION AND ANALYSIS

– 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;

– Separation of duties between key functions; and,

– 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 following are key components of the Bank’s operational risk management framework:

• The Bank’s risk and control self-assessment program, which is managed by Global Risk Management’s central operational risk unit, includes formal reviews of significant operations and processes to identify and assess operational risks. Scenario analysis has been successfully introduced to risk assessments as a tool that provides a more forward looking view of key risks. Overall, this program provides a basis for management to ensure that controls are functioning effectively. Business line management attests to the accuracy of each assessment and develops action plans to mitigate risks if controls are not identified as effective. Results of these reviews are summarized and reported to executive management and the Board of Directors.

• The Bank’s centralized operational loss event database, which is managed and maintained by the central operational risk unit, 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 and trends.

• The Bank’s monitoring of industry events, which ensures that significant losses incurred at other financial institutions provide a reference for reviewing and assessing our own risk exposure.

• The compliance risk management program led by Group Compliance through an established network and a process that includes: monitoring regulatory changes; conducting compliance risk assessments; implementing policies and procedures; training; and monitoring and resolving issues.

• Processes in each business line for evaluation of risk in new businesses and products.

• The Bank’s business continuity management policy, which requires that all business units develop business continuity capabilities for their respective functions. 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 model risk policy, which provides for an annual presentation of model risk ratings to the Operational Risk Committee.

• The Bank’s training programs, such as the mandatory Anti-Money Laundering and Information Security examinations which ensure employees are aware and equipped to safeguard our customers’ and the Bank’s assets.

• Risk mitigation programs, which use insurance policies to transfer the risk of high severity losses, where feasible and appropriate.

The Bank applies the Standardized Approach for calculating operational risk capital under the Basel II capital framework. 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. Progress is underway to prepare for the more sophisticated Advanced Measurement Approach (AMA), which is expected to be fully implemented in fiscal 2014. Under AMA, regulatory capital measurement will more directly reflect the Bank’s operational risk environment.

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 the Scotiabank Guidelines for Business Conduct, and in a manner that minimizes reputational risk. 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 products and services.

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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 the Scotiabank Group or its customers could affect the Bank’s financial performance.

To safeguard the Bank and the interests of its stakeholders, Scotiabank has an environmental policy, which was updated and approved by the Bank’s Board of Directors in October 2009. 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. In 2009, additional resources were added to assist with implementation of the Policy.

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 where climate change would have a material impact (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 discussed on page 62.

In the area of project finance, the revised Equator Principles have been integrated into the Bank’s internal processes and procedures since 2006. These are environmental and social guidelines for project finance transactions with a capital cost of US $10 million or higher, based on the policies of the International Finance Corporation, the private sector arm of the World Bank. 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 child and forced labour.

Environmental concerns also play a prominent role in shaping the Bank’s real estate practices. The Real Estate Department adheres to an Environmental Compliance Policy to ensure responsible management of the Bank’s real estate holdings. In addition, considerable recycling and resource management programs are in place in the Bank’s corporate offices and branch networks. Internal tracking systems and reduction measures are in place with respect to energy use, greenhouse gas emissions (GHG) and paper consumption. In order to further reduce the Bank’s environmental footprint, it has developed an internal Environmental Paper Policy and is in the process of developing and implementing more definitive management processes on energy.

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 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 policies in these areas.

Scotiabank has a number of environmentally related products and services to meet demand and promote the “green” economy, including the Scotiabank Global Climate Change Fund, a newly created Environmental Markets group, and an eco-home renovation program, EcoLiving.

Scotiabank is also a signatory, participant and sponsor of the Carbon Disclosure Project in Canada, which provides corporate disclosure to the investment community on greenhouse gas emissions and climate change management. In 2010 Scotiabank was included on the Dow Jones Sustainability Index (DJSI)-(North America), an annual review that recognizes the world’s financial, social and environmental corporate leaders. The Bank was also recognized as one of Canada’s Green 30 by Maclean’s and Canadian Business Magazine. For more information on Scotiabank’s environmental policies and practices, please refer to:

• the Bank’s annual Public Accountability Statement/Corporate Social Responsibility Report, which is also available online at www.scotiabank.com;

• the Environment section of Scotiabank’s website at www.scotiabank.com/environment;

• the Bank’s EcoLiving website at www.scotiabank.com/ecoliving; and

• Scotiabank’s response to the Carbon Disclosure Project at www.cdproject.net.

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CONTROLS AND ACCOUNTING POLICIES

Controls and procedures

Management’s responsibility for financial information contained in this annual report is described on page 108.

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 Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure.

As of October 31, 2010, the Bank’s management, with the participation of the CEO and CFO, 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:

(i.) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Bank;

(ii.) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the Bank; and

(iii.) 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 Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework, and based on that assessment concluded that internal control over financial reporting was effective, as at October 31, 2010.

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, 2010.

Critical accounting estimates

The Bank’s accounting policies are integral to understanding and interpreting the financial results reported in this annual report. Note 1 on pages 115 to 120 summarizes the significant accounting policies used in preparing the Bank’s Consolidated Financial Statements. Certain of these policies require management to make estimates 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 judgements and estimates could have a material impact on the Bank’s Consolidated Financial Statements. These estimates 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, acceptances and other indirect credit commitments, such as letters of credit and guarantees. Management undertakes regular reviews of credit quality to assess the adequacy of the allowance for credit losses. This process requires the use of estimates 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 composed of specific, general, and sectoral allowances.

Specific allowances are an estimate of probable incurred losses related to existing impaired loans. In establishing specific allowances applicable to individual credit exposures, management first forms a judgement as to whether a 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 made on a timely basis. 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.

Management estimates specific allowances for certain homogenous portfolios, including residential mortgages, credit card loans and most personal loans on a group basis. This involves estimating the probable losses inherent in the portfolio by using a formulaic method that considers recent loss experience.

Specific provisions were lower in 2010 than in 2009, driven primarily by net recoveries in Scotia Capital, which more than offset moderate increases in Canadian Banking and International Banking.

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The general allowance is an estimate of probable incurred losses that are inherent in the portfolio of loans and loan commitments, but have not yet been specifically identified on an individual basis. Management establishes the general allowance through an assessment of quantitative and qualitative factors. Using an internally developed model, management arrives at an initial quantitative estimate of the general allowance based on numerous factors, including historical average default probabilities, loss given default rates and exposure at default factors. Material changes in any of these parameters or assumptions would affect the range of expected credit losses and, consequently, could affect the general 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 model would indicate an increase or decrease to the quantitative estimate of approximately $69 million (2009 – $103 million). Senior management determines whether it is necessary to adjust the quantitative estimate for the general allowance to account for portfolio conditions not reflected in the historically based credit parameters used in the model. A qualitative assessment of the general 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 model and model parameters. Management reviews the general 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. From time to time, the Bank may establish a sectoral allowance for specific adverse events and changes in economic conditions. These allowances are for losses which have not been specifically identified, and where the losses are not adequately covered by the general allowance. The level of the sectoral allowance considers the probability of default, loss given default and expected exposure at default.

The general allowance for credit losses as at October 31, 2010, was $1,410 million, a decrease of $40 million from a year earlier. The decrease was attributable to an improvement in portfolio quality and a stronger Canadian dollar. The general allowance amount is primarily attributable to business and government loans ($1,262 million), with the remainder allocated to personal and credit cards ($95 million) and residential mortgages ($53 million). As noted above, the specific allowance for credit losses for personal loans, credit cards and mortgages is formula-based and also reflects incurred but not yet identified losses.

As at October 31, 2009, the Bank held a sectoral allowance of $44 million to reflect the deterioration in the automotive industry. During fiscal 2010, $1 million of the sectoral allowance was reclassified to specific provisions for credit losses and the remaining $43 million was reversed as the provisions were no longer required.

Fair value of financial instruments

All financial instruments are measured at fair value on initial recognition except certain related party transactions. Subsequent measurement of a financial instrument depends on its classification. Loans and receivables, certain securities and most financial liabilities are carried at amortized cost unless classified or designated as held for trading or available-for-sale at inception. All other financial instruments, including those designated as held-for-trading at inception, are carried at fair value.

Financial instruments in the Bank’s trading portfolios are composed primarily of securities and derivatives. These trading instruments are carried at fair value on the Consolidated Balance Sheet, with changes in the fair values of trading instruments included in the Consolidated Statement of Income.

Securities designated as available-for-sale are recorded at fair value on the Consolidated Balance Sheet. Equity securities which do not have a quoted market price in an active market are measured at cost. The unrealized gains and losses as a result of changes in the fair values of available-for-sale securities are included in the Consolidated Statement of Comprehensive Income.

Derivatives used for asset/liability management are recorded at fair value on the Consolidated Balance Sheet. All changes in these derivative fair values other than those designated as cash flow hedges or net investment hedges are recorded in the Consolidated Statement of Income, while the latter flows through other comprehensive income.

Fair value is defined as the amount of consideration that would be agreed upon in an arms-length transaction, other than a forced sale or liquidation, between knowledgeable, willing parties who are under no compulsion to act. The best evidence of fair value is a quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument is used subject to appropriate adjustments, supplemented as required with internal valuation models. Where quoted market prices are not available, the quoted price of similar financial instruments (i.e. with similar characteristics and risk profile) or internal models with observable market-based inputs are used to estimate the fair value.

Fair values are calculated using quoted market prices or observable market inputs for models and require minimal judgement by management. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist.

Trading securities, available-for-sale securities, and obligations related to securities sold short are normally valued using quoted market prices, including prices obtained from external fund managers and dealers.

To determine the fair value of financial instruments in a less active or inactive market where market prices are not readily observable due to low trading volumes or lack of recent trades, appropriate adjustments are made to available indicative prices to reflect the lack of liquidity in the market for the instruments. Where quoted prices or observable market data is not readily available, for example due to less liquid markets, management’s judgement on valuation inputs is necessary to determine fair value.

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Most derivatives are not exchange traded and are therefore normally valued using models which incorporate significant observable market parameters. Securities that are fair valued using models include certain types of asset-backed securities. Market inputs used for the fair value determination include observable interest rates, foreign exchange rates, credit spreads, equity prices, commodity prices and option volatilities.

Certain derivative and other financial instruments are valued using significant unobservable market inputs such as default correlations, among others. These inputs are subject to significantly more quantitative analysis and management judgement. Where significant unobservable market data is used as a key input into the valuation of certain derivatives, the inception profit on those derivatives is deferred over the life of the derivative contract, or until the valuation inputs become observable. This amount was not material in fiscal 2010 and 2009.

Management also applies judgement in the selection of internal valuation models for financial assets and financial liabilities carried at fair value in trading and non-trading portfolios. This includes consideration of credit risk, liquidity and ongoing direct costs in the determination of the fair value of derivatives. Management therefore exercises judgement when establishing market valuation adjustments that would be required in order to arrive at the fair value. Valuation adjustments recorded against the fair value of financial assets and financial liabilities totaled $441 million as at October 31, 2010 (2009 – $496 million), net of any write-offs. These valuation adjustments are mainly due to counterparty credit risk considerations for derivative transactions.

Uncertainty in the estimates used in the models can affect the fair value and financial results recorded. Historically, the impact of any change in these estimates was not expected to be significant; however, in the recent volatile market conditions where significant and rapid changes in observable model inputs can occur, greater volatility in fair values derived from these models is possible.

Beginning 2009, the Bank provides disclosures based on the amendments to the Financial Instruments – Disclosure standard. The standard requires expanded disclosures of financial instruments and in particular with classification of all financial instruments carried at fair value into a hierarchy based on the determination of fair value. The valuation hierarchy is as follows:

• Level 1 – fair value is based on unadjusted quoted prices in active markets for identical instruments,

• Level 2 – fair value is based on models using inputs other than quoted prices for the instruments, or

• Level 3 – fair value is based on models using inputs that are not based on observable market data.

The Bank’s assets and liabilities which are carried at fair value as classified by the valuation hierarchy are reflected in Note 26 on page 155. The percentage of each asset and liability category by fair value hierarchy level are outlined as follows:

Fair value hierarchy of financial instruments

	Assets									Liabilities
										Obligations
				Available-						related to
Fair value	Trading			for-sale						securities
hierarchy	Securities			securities			Derivatives			sold short			Derivatives
Level 1		75	%		30	%		2	%		82	%		2	%
Level 2		23	%		67	%		95	%		18	%		90	%
Level 3		2	%		3	%		3	%		–			8	%
		100	%		100	%		100	%		100	%		100	%

Other-than-temporary impairment

Available-for-sale securities, except for equity securities which do not have a quoted market price in an active market, are recorded at fair value on the balance sheet. Any unrealized gains and losses on these available-for-sale securities are recorded in other comprehensive income until realized, at which time they are recorded in the Consolidated Statement of Income.

Management reviews the fair value of available-for-sale securities each quarter to determine whether a decline in fair value compared to cost or amortized cost is other-than-temporary. To assess whether an other than temporary impairment has occurred, management must make certain judgements and estimates, and consider factors such as the length of time and extent to which the fair value of a security has been below its cost or amortized cost, prospects for recovery in fair value, the issuer’s financial condition and future prospects, and the Bank’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery. Once management has determined that the security has experienced an other-than-temporary decline in value, the carrying value of the security is written down to its estimated fair value. To estimate fair value, management considers all of the data gathered during the impairment evaluation process, as well as the market liquidity and the Bank’s plans for the security. Other-than-temporary impairment charges are recorded in net gains on securities, other than trading in the Consolidated Statement of Income.

As at October 31, 2010, the gross unrealized gains on available-for-sale securities recorded in accumulated other comprehensive income were $1,687 million (2009 – $1,641 million), and the gross unrealized losses were $270 million (2009 – $628 million). Net unrealized gains were therefore $1,417 million (2009 – $1,013 million) before related derivative and other hedge amounts. The net unrealized gains after related derivative and other hedge amounts were $1,189 million (2009 – $828 million).

At October 31, 2010, the unrealized loss recorded in accumulated other comprehensive income relating to securities in an unrealized loss position for more than 12 months was $211 million (2009 – $376 million). This unrealized loss was comprised of $157 million (2009 – $205 million) in debt securities, $37 million (2009 – $137 million) related to preferred shares and $17 million (2009 – $34 million) related to equity securities. The unrealized losses on the debt securities arose primarily from changes in interest rates and credit spreads. Based on a number of considerations, including underlying credit of the issuers and the over-collateralization provided on certain debt securities, 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. The Bank also holds a

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diversified portfolio of available-for-sale equities. Since the Bank has the ability and intent to hold these securities until there is a recovery of fair value, which may be at maturity for debt securities, these unrealized losses are considered temporary in nature. The total fair value of the securities with continuous unrealized losses of more than 12 months was $3,064 million as at October 31, 2010, (2009 – $3,307 million).

Pensions and other employee future benefits

The Bank sponsors various pension and other future benefit plans for eligible employees in Canada, the United States, Mexico and other international operations. The pension benefits are generally based on years of service and average earnings at retirement. Other future benefits generally include post-retirement health care, dental care and life insurance, along with post-employment benefits such as long-term disability.

Employee future benefit expense and the related benefit obligation are calculated using actuarial methods and certain actuarial assumptions. Most of these assumptions are based on management’s best estimate and are reviewed and approved annually. The key assumptions include the long-term rate of investment return on plan assets, 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. Management also reviews historical investment returns, salary increases and health care costs. Another important assumption is the discount rate used for measuring the benefit obligation which is generally prescribed to be equal to the current yield on long term, high-quality corporate bonds with durations similar to the benefit obligation. The management assumption with the greatest potential impact is the assumed long-term rate of return on assets. If this assumed long-term rate of return on assets was 1% lower (higher), the benefit expense for 2010 would have been $52 million higher (lower).

The Bank uses a measurement date of July 31 or August 31, depending on the employee future benefit plan. Based on these measurement dates, the Bank reported a deficit of $177 million in its principal pension plans as disclosed in Note 20 to the Consolidated Financial Statements on pages 138 to 140. There has been a decline in the funded status of the plans since 2009 due to a sharp reduction in prescribed discount rates in most countries resulting in a higher benefit obligations. In addition, plan asset values are still below their pre-2008 levels.

The decline in the funded status of the plans will impact the benefit expense for fiscal year 2011 and possibly future years.

Actual experience that differs from assumptions made by management will result in a net actuarial gain or loss, consequently increasing or decreasing the benefit expense for future years. In accordance with GAAP, this difference is not recognized immediately as income or expense, but rather is amortized into income over future periods.

Management determines whether the unrecognized net actuarial gain or loss is more than 10% of the greater of the plan assets or benefit obligation at the beginning of each year. Any unrecognized net actuarial gain or loss above this 10% threshold is generally amortized into income over the estimated average remaining service period of active employees ranging from 10 to 20 years for the Bank’s principal pension plans, and 8 to 27 years for the Bank’s principal other benefit plans.

Note 20 on pages 138 to 140 of the 2010 Consolidated Financial Statements contains details of the Bank’s employee future benefit plans, such as the disclosure of pension and other future benefit amounts, management’s key assumptions, and a sensitivity analysis of changes in these assumptions on the employee future benefit obligation and expense.

Corporate income taxes

Management exercises judgement in determining the provision for income taxes and future 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 legislation for each jurisdiction in which the Bank operates and makes assumptions about the expected timing of the reversal of future 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 future assets and liabilities is not as anticipated, the provision for income taxes could increase or decrease in future periods. The Bank records a valuation allowance if management assesses it is likely that the future income tax assets will not be realized prior to expiration.

Total gross future tax assets related to subsidiaries’ unused income tax losses arising in prior years were $347 million as at October 31, 2010 (2009 — $376 million). These future tax assets have been reduced by a valuation allowance of $1 million (2009 — $3 million) due to uncertainty about the utilization of these losses. Furthermore, one of the Bank’s foreign subsidiaries has a valuation allowance of $316 million (2009 — $313 million) related to certain loan loss allowances available to be applied against future taxable earnings. If and when there is greater certainty of realizing these future tax assets, the Bank will adjust the valuation allowances. The Bank’s total net future income tax asset was $1,775 million as at October 31, 2010 (2009 — $2,240 million). Note 19 on page 137 of the 2010 Consolidated Financial Statements contains further details with respect to the Bank’s provisions for income taxes.

Variable interest entities

In the normal course of business, the Bank enters into arrangements with variable interest entities (VIEs) on behalf of its customers and for its own purposes. These VIEs can be generally categorized as multi-seller commercial paper conduits, funding vehicles, structured finance entities and collateralized debt obligation entities. Further details are provided on pages 46 to 49 in the off-balance sheet arrangements section.

Management is required to exercise judgement to determine whether a VIE should be consolidated. This evaluation involves understanding the arrangements, determining whether the entity is considered a VIE under the accounting rules, and determining the Bank’s variable interests in the VIE. These interests are then compared to those of the unrelated outside parties to identify the holder that is exposed to the majority of the variability in the VIE’s expected losses, expected residual returns, or both, to determine whether the Bank should consolidate the VIE. The comparison uses both qualitative and

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quantitative analytical techniques and use of models and involves the use of a number of assumptions about the business environment in which the VIE operates and the amount and timing of future cash flows.

Management is required to exercise judgement to determine if a primary beneficiary reconsideration event has occurred. In applying the guidance under Canadian GAAP, the Bank considers the following to be reconsideration events for VIEs where the Bank has a variable interest: changes to the VIE’s governing documents or contractual arrangements; the primary beneficiary disposing some or all of its variable interest to unrelated parties; or new variable interests issued to parties other than the primary beneficiary.

During 2010, there were no reconsideration events that would have required the Bank to re-assess the primary beneficiary of its multi-seller conduit VIEs.

As described in Note 6 to the Consolidated Financial Statements (on pages 125 to 126) and in the discussion on off-balance sheet arrangements (on pages 46 to 49), the Bank is not the primary beneficiary of the three multi-seller asset-backed commercial paper (ABCP) conduits that it sponsors and is not required to consolidate them on the Bank’s balance sheet.

In the future, if the Bank were to become the primary beneficiary of these three Bank-sponsored multi-seller ABCP conduits and consolidate them on the Bank’s balance sheet, based on the values as at October 31, 2010, it would result in an increase in the Bank’s reported assets of approximately $4 billion, and a reduction in capital ratios of approximately 10 to 15 basis points.

Goodwill

Under GAAP, goodwill is not amortized but assessed for impairment on an annual basis at the reporting unit level, or more frequently if an event or change in circumstances indicates the asset might be impaired. Goodwill is assessed for impairment by comparing the fair value of the reporting unit to its carrying amount. If the fair value of the reporting unit exceeds its carrying amount, no further testing is required. If the fair value is less than the carrying amount of the reporting unit, the amount of impairment loss is quantified by comparing the carrying value of goodwill to its fair value, calculated as the fair value of the reporting unit less the fair value of its assets and liabilities.

The Bank determines its reporting unit’s fair values from internally developed valuation models that consider factors such as normalized earnings, projected earnings, and price earnings multiples. Management judgement is required in estimating the fair value of reporting units and imprecision in any assumptions and estimates used in the fair value calculations could influence the determination of goodwill impairment. Management believes the assumptions and estimates used are reasonable and supportable in the current environment.

Based on the assessment approach described above, the Bank did not record any goodwill impairment losses for any of its six reporting units in 2010 or 2009.

Contingent liabilities

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 proceedings, including actions brought on behalf of claimants. According to GAAP, the Bank should accrue for a loss if, in management’s opinion, it is likely that a future event will confirm a liability existed at the balance sheet date and the amount of loss can be reasonably estimated.

In some cases, it may not be possible to determine whether a liability has been incurred or to reasonably estimate the amount of loss until the case is closer to resolution. In these instances, no accrual can be made until that time. If it can be determined that a liability existed as at the balance sheet date, but a reasonable estimate involves a range within which a particular amount appears to be a better estimate, that amount would be accrued. If no such better estimate within a range exists, the Bank is required to accrue the minimum amount in the range. On a regular basis, management and internal and external experts are involved in assessing the adequacy of the Bank’s contingent loss accrual. Changes in these assessments may lead to changes in litigation accruals.

While there is inherent difficulty in predicting the outcome of such matters, based on current knowledge, management does not believe that liabilities, if any, arising from pending litigation will have a material adverse effect on the Bank’s consolidated financial position, or results of operations.

Changes in accounting policies

Current year

There were no changes in accounting standards in 2010 that affected financial statement reporting.

Prior year

Classification and impairment of financial assets

In August 2009, the CICA amended Section 3855, Financial Instruments – Recognition and Measurement, to harmonize classification and related impairment accounting requirements of Canadian GAAP with International Financial Reporting Standards (IFRS). The amendments allow certain debt securities not quoted in an active market to be classified as loans and measured at amortized cost. The Bank still has the ability to classify these instruments as available-for-sale, in which case they are measured at fair value with unrealized gains and losses recorded through other comprehensive income. The amendments also allow the reversal of impairment charges for debt securities classified as available-for-sale on the occurrence of specific events. Impairment charges for debt securities classified as loans are recorded as provisions for credit losses. As a result of this change, the Bank reclassified certain securities not quoted in an active market with carrying value of $9,447 million to loans. This reclassification resulted in reduction of after-tax accumulated other comprehensive loss of $595 million. Details of this change in accounting policy are included in Note 1 to the Consolidated Financial Statements on page 115.

Financial instrument disclosures

In June 2009, the CICA issued amendments to its Financial Instruments Disclosure standard to expand disclosures of financial instruments consistent with new disclosure requirements made under International Financial Reporting Standards (IFRS). These amendments were effective for the Bank commencing November 1, 2008 and introduce a three-

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level fair value hierarchy that prioritizes the quality and reliability of information used in estimating the fair value of instruments. The fair values for the three levels are based on:

• Level 1 — unadjusted quoted prices in active markets for identical instruments

• Level 2 — models using inputs other than quoted prices that are observable for the instruments, or

• Level 3 — models using inputs that are not based on observable market data

Note 26 on pages 155 details the fair value hierarchy of the Bank’s financial instruments which are recorded at fair value.

Future accounting changes

Transition to International Financial Reporting Standards (IFRS)

Canadian publicly accountable enterprises must transition to IFRS for fiscal years beginning on or after January 1, 2011. For the Bank, IFRS will be effective for interim and annual periods commencing November 1, 2011 (adoption date), and will include the preparation and reporting of one year of comparative figures, including an opening balance sheet as at November 1, 2010 (transition date).

In order to prepare for the transition to IFRS, the Bank set up a significant project, implemented a project governance structure and developed an implementation plan which consists of three phases: (i) planning and governance; (ii) review and detailed assessment; and (iii) design, development and implementation. The second phase of review and assessment is now complete. The finalization of accounting decisions by management and their review and approval by the Audit & Conduct Review Committee is outstanding. The Bank has started the third phase for all critical areas and is focused on finalizing implementation decisions regarding first-time adoption and ongoing accounting policy choices.

The Bank actively monitors developments and changes in standards from the International Accounting Standards Board (“IASB”) and the Canadian AcSB, as well as regulatory requirements from the Canadian Securities Administrators and OSFI.

As interpretations of current accounting standards continue to change, the Bank will adjust its implementation plan accordingly.

Key elements of the Bank’s IFRS changeover plan

The following summarizes the Bank’s progress towards completion of selected key activities contained in its conversion plan, including significant milestones and anticipated timelines.

Financial statement presentation

KEY ELEMENTS AND MILESTONES

• Identify differences between Canadian GAAP and IFRS accounting policies.

• Select and approve the Bank’s IFRS 1 first-time adoption and ongoing accounting policy choices by Q4 2011.

• Assess requirements and develop model financial statements, including note disclosures under IFRS.

• Prepare an IFRS opening balance sheet by Q4 2011, with significant impacts confirmed by Q3 2011.

• Prepare fiscal 2011 quarterly comparative year information under IFRS for disclosure in 2012.

STATUS

• Detailed assessments of accounting differences applicable to the Bank have been identified.

• Preliminary assessments are completed for IFRS 1 exemptions and key accounting policy choices. Certain decisions will likely be finalized by Q3 2011.

• Preliminary model IFRS financial statements have been prepared. Recommended format of consolidated balance sheet and statement of income is expected to be completed by Q2 2011.

• Quantification of differences and preparation of opening balance sheet is underway and will likely be an ongoing and iterative process through to 2012, including tax impacts.

Training and communication

KEY ELEMENTS AND MILESTONES

• Develop the Bank’s training strategy by Q3 2010.

• Provide in-depth training to finance, key support areas, and IFRS governance members (including Board of Directors and senior management).

• Conduct a global learning needs assessment for all stakeholders.

• Determine communication requirements for external stakeholders.

STATUS

• Global training strategy has been finalized and approved.

• Training programs continue to be provided to finance and other key stakeholders, including senior management. Information seminars have been provided to the Board of Directors. Credit and banking personnel also continue to be trained to enable their review of customer financial information prepared on a different basis of accounting.

• Training programs will continue in fiscal 2011 and will be increasingly focused on specific subjects.

• Comprehensive learning needs assessment is underway and ongoing.

• External communication currently provided through the quarterly and annual reports. An industry-wide education session on the impact of IFRS for analysts is planned for Q1 2011.

Information technology systems

KEY ELEMENTS AND MILESTONES

• Implement a solution for the capture of fiscal 2011 comparative year financial statements by Q1 2011.

• Identify and address the need for modification to systems as a result of IFRS changes.

STATUS

• Solution for the capture of comparative year financial information has been designed. System development and testing are underway.

• The Bank has not identified the need for any significant modifications to its information technology systems.

Business and process activities

KEY ELEMENTS AND MILESTONES

• Identify the impact of financial reporting changes on business and process activities by Q4 2010.

• Identify the impact on processes outside of financial reporting, such as the Bank’s performance measurement processes, including planning and budgeting, and capital management processes.

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STATUS

• The Bank has completed its business impact assessment of the financial reporting changes and has not identified any significant changes required to business activities.

• Applicable hedging strategies have been reviewed to ensure they qualify for hedge accounting under IFRS.

• The Bank has analyzed the impacts of IFRS on processes outside of financial reporting.

Control environment

KEY ELEMENTS AND MILESTONES

• Identify and implement changes in internal controls over financial reporting (ICFR) and disclosure controls and procedures (DC&P) resulting from changes to policies, processes and systems.

• Evaluate the effectiveness of controls to ensure the integrity of financial reporting.

STATUS

• ICFR and DC&P will be appropriately addressed as process and system changes are made.

First-time adoption of IFRS

The Bank’s adoption of IFRS will require the application of IFRS 1,First-Time Adoption of International Financial Reporting Standards(“IFRS 1”), which provides guidance for an entity’s initial adoption of IFRS. IFRS 1 generally requires that an entity retrospectively apply all IFRS effective at the end of its first IFRS annual reporting period. However, IFRS 1 does include certain mandatory exceptions and limited optional exemptions from this general requirement of retrospective application. The Bank has not finalized these transition decisions.

SIGNIFICANT OPTIONAL EXEMPTIONS

The following are the more significant optional exemptions available under IFRS 1 which the Bank is currently considering. This is not an exhaustive list and does not encompass all exemptions which the Bank is considering; however the remaining first-time adoption elections under IFRS 1 are not significant to the Bank’s conversion and financial statements.

Business combinations

Entities can elect to not retrospectively restate any of the business combinations that occurred prior to the transition date.

If the Bank chooses to not restate any business combinations prior to November 1, 2010, certain adjustments will likely still be required upon transition to IFRS for items such as outstanding contingent consideration and acquisition-related costs. The offsetting amount would be recorded against opening retained earnings.

If the Bank were to restate its business combinations under IFRS, the key accounting differences (that are discussed on page 85) could potentially impact purchase price allocations and the amount of goodwill recorded on the consolidated balance sheet.

Employee benefits

Entities can elect to recognize all cumulative unamortized actuarial gains and losses for employee defined benefit plans at transition date instead of retrospective restatement, with an offsetting adjustment against opening retained earnings.

Based on the Bank’s latest actuarial valuation for Canadian GAAP reporting, if the Bank were to choose this accounting exemption, there would be a negative impact to opening retained earnings. The final impact under IFRS would differ from Canadian GAAP numbers due to adjustments for items such as using an October 31 measurement date for the actuarial valuation, and using fair values for determining the expected return on plan assets.

Cumulative translation differences

IFRS 1 allows cumulative translation differences for all foreign operations to be deemed zero at the date of transition to IFRS, instead of recalculating from inception. This would result in the reclassification of amounts in accumulated other comprehensive income to retained earnings on transition.

If the Bank were to choose this accounting exemption, certain adjustments may still be required if for example, the Bank assesses there are any changes to the functional currency of its reporting units under IFRS.

Designation of previously recognized financial instruments

Under IFRS and Canadian GAAP, a financial instrument is designated into a specific classification upon inception of the instrument. Classifications cannot be amended subsequently except under rare circumstances.

IFRS 1 permits the Bank to reclassify and redesignate financial instruments at the date of transition as long as certain criteria are met. In addition, the financial instruments of entities consolidated for the first time under IFRS are required to be specially designated on the transition date. These financial instrument classification decisions should be made by November 1, 2010 and appropriately documented at that date.

The Bank has documented its financial instrument classification decisions with regards to redesignations of certain financial instruments on the Bank’s balance sheet, as well as the classification of financial instruments of entities that will likely be consolidated for the first time under IFRS. The redesignations relate to financial instruments that would not meet the criteria for fair value option under IFRS. In addition, certain available-for-sale securities will be reclassified to the loans and receivables category under IFRS.

MANDATORY EXCEPTIONS

The IFRS 1 mandatory exceptions that are more relevant to the Bank include the following.

Derecognition of financial assets and liabilities

IFRS 1 requires that the derecognition guidance for financial assets and liabilities be applied to transactions on or after January 1, 2004.

The Bank’s insured residential mortgage securitizations through the Canadian Government’s Canada Mortgage Bond (“CMB”) Programs receive off-balance sheet treatment under Canadian GAAP. The Bank’s current view is that these mortgage securitization transactions will likely not meet the derecognition criteria under IFRS. This would result in an increase in total assets and liabilities on the Bank’s Consolidated Balance Sheet, with the offset to opening retained earnings.

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The impact to retained earnings represents the net effect of the unwinding of the mortgage sales previously recognized under Canadian GAAP and the re-recognition of the mortgages on-balance sheet, along with the related funding liability, under IFRS. The Bank will therefore, reverse the gain on sale previously recognized in earnings under Canadian GAAP, as well as any cumulative mark-to-market on financial instruments related to these transactions. The interest and fees earned on the mortgages, net of the yield paid to the investors in the securitization vehicles, would be recognized going forward.

Future changes in the standard

In November 2010, the IASB approved amendments to IFRS 1 to allow first-time adopters the option of applying the IFRS derecognition requirements to transactions occurring on or after an entity’s transition date, or another date of the entity’s choosing, instead of the current mandatory date of January 1, 2004. The Bank is currently assessing the impact of these amendments.

Hedge accounting

IFRS 1 requires an entity to recognize hedging relationships in its IFRS opening balance sheet if the hedging instrument is of a type that would qualify for hedge accounting under IFRS. However, hedge accounting can be applied to those hedging relationships subsequent to the transition date only if all IFRS hedge accounting criteria are met. If the criteria are not met, an entity would have to follow IFRS guidance for discontinuing hedge accounting until the criteria are met. Hedging relationships cannot be designated retrospectively and the supporting documentation cannot be created retrospectively.

The Bank’s applicable hedging strategies have been reviewed to ensure they qualify for hedge accounting under IFRS. Hedging documentation has been amended effective November 1, 2010 to ensure compliance with IFRS.

Key differences between current accounting policies and IFRS requirements

IFRS are premised on a conceptual framework similar to Canadian GAAP, although significant differences exist in certain matters of recognition, measurement and disclosure. The Bank has determined a number of key differences that have the potential to significantly affect the financial statements, operations or capital of the Bank. Net adjustments to the Bank’s opening balance sheet resulting from differences between Canadian GAAP and IFRS will be recorded against retained earnings on transition, or other component of equity. We are in the process of quantifying these adjustments; however, the impact of IFRS on the Bank’s consolidated financial results at the time of the transition is dependent upon prevailing business circumstances, market factors and economic conditions at that time, as well as the accounting elections that have not yet been made. As a result, the transition impact is not reasonably determinable at this time.

Derecognition

Canadian GAAP uses a control-based model to assess derecognition, while IFRS primarily focuses on whether risks and rewards have been substantively transferred. As a result of the differences in criteria, transfers of certain financial assets that previously qualified for derecognition under Canadian GAAP will likely no longer qualify for derecognition under IFRS. As noted above, this would impact the accounting treatment of mortgages sold into the CMB Programs.

Consolidation

Canadian GAAP determines consolidation of an entity using two different frameworks: the variable interest entity (“VIE”) and voting control models. The consolidation of a VIE under Canadian GAAP is based on whether the Bank is the primary beneficiary and is exposed to the majority of the VIE’s expected losses, or entitled to the majority of the VIE’s expected residual returns, or both. Furthermore, Canadian GAAP provides an exemption for the consolidation of qualifying special purpose entities (“QSPE”), eligible under certain conditions.

Under IFRS, an entity will be consolidated based solely on control, which is evidenced by the power to govern the financial and operating policies of an entity to obtain benefit. When assessing control under IFRS, all relevant factors are considered, including qualitative and quantitative aspects. Control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than one half of an entity’s voting power. Control can exist when the parent owns half or less of the voting power but has legal or contractual rights to control, or de facto control. Unlike Canadian GAAP, there is no concept of QSPEs under IFRS.

The Bank has not finalized its consolidation analysis. However, as a result of these accounting differences, the Bank expects to consolidate certain VIEs under IFRS that are not consolidated under Canadian GAAP, such as QSPEs. This would result in an increase in assets, liabilities, and non-controlling interests, with the offset to opening retained earnings. The Bank is still assessing the impact related to its multi-seller conduits.

Future changes in the standard

The IASB is expecting to issue a revised consolidation standard in late 2010. It is unlikely that the revised standard will be effective for the Bank’s conversion to IFRS in fiscal 2012.

Business combinations

The business combinations model under IFRS represents a fair value model of accounting which can result in a significant change in accounting compared to current Canadian GAAP. Most significantly, the differences between IFRS and Canadian GAAP relate to the following:

• Directly attributable transaction costs and certain restructuring costs are expensed under IFRS rather than included in the acquisition purchase price.

• Under IFRS, contingent consideration is measured at fair value on the acquisition date, with subsequent changes in the fair value generally being recorded through the income statement. Under Canadian GAAP, contingent consideration is recognized only when the contingency is resolved, and this is recorded against goodwill.

• IFRS allows non-controlling interests (“NCI”) to be recognized at fair value, while Canadian GAAP measures NCI at its carrying amount.

• Under Canadian GAAP, previously acquired interests are measured at the carrying amount, while IFRS requires that an existing ownership interest be remeasured to fair value once control is obtained. This remeasurement is recognized through the income statement.

• Shares issued as consideration in a business combination are measured at their market share price at the closing date under IFRS, rather than the announcement date under Canadian GAAP.

Going forward, these differences will result in more income volatility as fewer items are included in the purchase price equation.

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Financial instruments

Classification and measurement

For classification and measurement of financial instruments, there is significant alignment between Canadian GAAP and IFRS. However, a difference between IFRS and Canadian GAAP remains for the measurement of unlisted equity securities, which are measured at cost under Canadian GAAP. IFRS requires that all available-for-sale securities be measured at fair value.

Hedging

Hedge accounting requirements are substantially aligned between Canadian GAAP and IFRS.

Impairment

In the provisioning for impaired loans, IFRS and Canadian GAAP are aligned in principle, as they both require an incurred loss provisioning model. However, under IFRS, loan losses and allowances will be presented based on whether they are assessed individually or collectively. As a result, there may be changes in the classification of the Bank’s provisions between specific and general allowances versus individual and collective allowances.

Provisioning for loan losses must be based on the discounted values of estimated future cash flows. This amount is accreted over the period from the initial recognition of the provision to the eventual recovery of the present value of the loan, resulting in the recording of interest in the statement of income. IFRS requires that this accretion amount be presented in interest income. As permitted under Canadian GAAP, the Bank records this accretion amount in provision for credit losses.

Future changes in the standard

The IASB issued a new financial instruments standard which addresses the classification and measurement of financial instruments, and is also in the process of considering significant changes to impairment of financial assets and hedge accounting. These changes are not expected to impact the Bank prior to the adoption date.

Impairment of Goodwill

IFRS uses a one-step approach for impairment testing of non-financial assets by comparing the asset’s carrying value to its recoverable amount. The recoverable amount is the higher of fair value less costs to sell, and value in use (which uses discounted future cash flows). Canadian GAAP however, uses a two-step approach for impairment testing: first comparing an asset’s carrying value with undiscounted future cash flows to determine whether impairment exists; and then measuring any impairment by comparing the asset’s carrying value with its fair value.

IFRS requires that goodwill be allocated and tested for impairment at the level of cash generating unit (CGU) or group of CGUs. CGUs represent the lowest level of assets or groups of assets that generate largely independent cash inflows. Under IFRS, each CGU or group of CGUs to which goodwill is allocated should represent the lowest level within the entity for which information about goodwill is available and monitored for internal management purposes. This level of grouping is potentially more granular when compared to the Canadian GAAP reporting unit.

These differences in impairment testing could result in the identification of impairment more frequently under IFRS. The Bank is in the process of analyzing any potential changes to the assessment of impairment on goodwill.

Employee benefits

The key differences between Canadian GAAP and IFRS are reflected below.

Actuarial gains and losses

IFRS requires an entity to make an accounting policy choice regarding the treatment of actuarial gains and losses, subsequent to the transition date. Under IFRS, actuarial gains and losses may either be:

• deferred and amortized, subject to certain provisions (“corridor approach”);

• immediately recognized in profit or loss; or

• immediately recognized in other comprehensive income without subsequent recycling to income.

Under current Canadian GAAP, the Bank follows the corridor approach in recognizing actuarial gains and losses under its defined benefit plans. The Bank has not finalized its decision with respect to the accounting for actuarial gains and losses under IFRS.

Measurement date

IFRS requires that the defined benefit obligation and plan assets be measured at the balance sheet date while Canadian GAAP allows the measurement date of the defined benefit obligation and plan assets to be up to three months prior to the date of the financial statements. The Bank currently uses July 31 or August 31 as the measurement date, depending on the employee future benefit plan.

Expected return on assets

IFRS requires the use of fair value for determining the expected return on plan assets. Canadian GAAP allows the calculation of return on plan assets to be based on either fair value or a market-related value. The Bank’s current policy is to use a market-related value for determining the expected return on plan assets.

Future changes in the standard

The IASB is considering changes to its accounting for employee future benefits, which are not expected to be finalized until early 2011. It is likely that adoption of these changes would not be mandatory until after the Bank transitions to IFRS.

Customer loyalty programs

IFRS applies a revenue approach to accounting for customer loyalty programs. The principle being that customers are implicitly paying for the points they receive when they buy goods or services and therefore, a portion of the revenue earned at that time should be deferred. The deferred revenue is calculated based on the estimate of the fair value of the points and recognized when the customer has redeemed the points for an award. Canadian GAAP does not provide specific guidance on accounting for customer loyalty programs. The Bank follows a liability approach for its customer loyalty programs where a provision is recorded based on the cost to provide the award in future. The Bank is currently assessing the impact with respect to its customer loyalty programs. IFRS may affect the timing of revenue recognition; however, over the life of the award, the net income for customer loyalty programs will be the same as under Canadian GAAP.

Share-based payments

IFRS requires cash-settled share-based payments to employees to be measured (both initially and at each reporting date) at fair value of the awards, while Canadian GAAP requires that such payments be measured based on intrinsic value of the awards. This difference is

862010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS| CONTROLS AND ACCOUNTING POLICIES

expected to impact the Bank’s liability-based awards. Furthermore, under IFRS, forfeitures are required to be estimated on the grant date and included in the measurement of the liability. However, under Canadian GAAP, forfeitures may be recognized either as they occur, or estimated on initial recognition. The Bank currently recognizes forfeitures as they occur.

Although the expense relating to share-based payments is the same over the life of the award, it will likely be higher in earlier periods under IFRS as compared to Canadian GAAP as a result of these differences.

Investment in associates

Under Canadian GAAP and IFRS, the equity method is used where significant influence exists and the accounting is substantially the same under both standards. However, some key differences exist which are discussed below.

Accounting policies and reporting periods

IFRS explicitly requires that an associate’s accounting policies must be consistent with those of its investor, and the reporting dates may not differ by more than three months. Canadian GAAP does not specifically require uniformity in accounting policies and guidance on consistency of reporting periods is not provided. The Bank is currently assessing the impact of these differences.

Potential voting rights

Under IFRS, voting rights that are currently exercisable are considered in assessing significant influence. As a result, there may be more or less investments that require equity accounting under IFRS as potential voting rights are considered.

Regulatory developments

In March 2010, OSFI issued an advisory to federally regulated entities relating to the conversion to IFRS. OSFI requires that the net impact to retained earnings from conversion to IFRS be recognized in available capital. However, for regulatory capital purposes, OSFI has provided banks the option to phase in the impact of conversion to IFRS on retained earnings over a maximum of five quarters. This election must be made at the time of conversion and is irrevocable. OSFI has also made a concession on the calculation of the asset-to-capital multiple (“ACM”) with respect to certain securitized insured mortgages that will likely come back on balance sheet. The government insured mortgages securitized through the CMB Programs up until March 31, 2010, will be grandfathered and therefore, would not impact the ACM.

Related party transactions

The Bank provides regular banking services to its associated and other related corporations in the ordinary course of business. These services are on terms similar to those offered to non-related parties.

Loans granted to Directors and Officers in Canada are at market terms and conditions. Prior to March 1, 2001, the Bank granted loans to officers and employees at reduced rates in Canada. The loans granted prior to March 1, 2001, are grandfathered until maturity. In some of the Bank’s foreign subsidiaries and branches, in accordance with local practices and laws, loans may be made available to officers of those units at reduced rates or on preferred terms. Loans to executive officers of the Bank totaled $7.3 million as at October 31, 2010 (2009 — $6.8 million), and loans to directors $0.3 million (2009 — $0.1 million).

Directors can use some or all of their fees to buy common shares 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. Commencing in 2004, the Bank no longer grants stock options to non-officer directors (refer to Note 22 of the Consolidated Financial Statements on page 140).

The Bank may also provide banking services to companies affiliated with the Bank’s Directors. These commercial arrangements are conducted at the same market terms and conditions provided to all customers and follow the normal credit review processes within the Bank. The Bank’s committed credit exposure to companies controlled by Directors totaled $4.6 million as at October 31, 2010 (2009 — $3.6 million), while actual utilized amounts were $2.8 million (2009 — $1.1 million).

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 GAAP. In addition, the ACRC approves the terms and conditions of all transactions between the Bank and Bank-sponsored asset securitization special purpose vehicles to ensure that such transactions are at market terms and conditions. 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.

Scotiabank Annual Report2010     87

SUPPLEMENTARY DATA^*

Geographic information

T37 Net income by geographic segment

	2010												2009											2008
								Other											Other												Other
			United					Inter-							United				Inter-							United					Inter-
For the fiscal years ($ millions)	Canada		States			Mexico		national		Total			Canada		States		Mexico		national		Total			Canada		States			Mexico		national		Total
Net interest income	$	5,031	$	458		$	801	$	3,145	$	9,435		$	4,552	$	641	$	821	$	3,331	$	9,345		$	4,471	$	236		$	903	$	2,627	$	8,237
Provision for credit losses		709		(54	)		168		456		1,279			744		296		185		392		1,617			388		16			141		85		630
Other income		3,770		609			438		1,745		6,562			3,211		452		424		1,525		5,612			2,614		(202	)		478		1,137		4,027
Non-interest expenses		4,653		327			778		2,379		8,137			4,529		255		791		2,317		7,892			4,315		200			793		1,982		7,290
Provision for income taxes		738		330			76		558		1,702			513		222		69		380		1,184			344		(98	)		122		369		737
Non-controlling interest		1		—			6		93		100			—		—		6		108		114			—		—			9		110		119
Net income	$	2,700	$	464		$	211	$	1,404	$	4,779		$	1,977	$	320	$	194	$	1,659	$	4,150		$	2,038	$	(84	)	$	316	$	1,218	$	3,488
Preferred dividends paid											192											174												97
Corporate adjustments(1)											(549	)										(615	)											(358	)
Net income available to common shareholders										$	4,038										$	3,361											$	3,033

(1) Revenues and expenses which have not been allocated to specific operating business lines are reflected in corporate adjustments.

T38 Loans and acceptances by geography

Excludes reverse repos																	Percentage mix
As at September 30 ($ billions)		2010			2009			2008			2007			2006			2010			2006
Canada
Atlantic provinces		$	17.0		$	15.7		$	16.2		$	14.2		$	12.7			6.0	%		6.2	%
Quebec			17.7			16.0			16.7			14.2			13.1			6.3			6.4
Ontario			101.7			96.0			103.5			91.1			81.5			36.2			39.8
Manitoba and Saskatchewan			6.6			6.2			6.4			6.0			5.4			2.3			2.6
Alberta			21.7			20.3			22.4			19.9			17.1			7.7			8.4
British Columbia			21.1			18.8			21.2			18.8			16.4			7.5			8.0
			185.8			173.0			186.4			164.2			146.2			66.0			71.4
United States			21.1			22.0			20.6			14.9			14.3			7.5			7.0
Mexico			10.1			9.7			10.9			8.9			9.3			3.6			4.5
Other International
Latin America			23.4			21.5			22.6			11.6			9.2			8.3			4.5
Europe	��		6.5			12.9			18.4			10.2			8.1			2.4			3.9
Caribbean			18.8			15.6			14.8			12.2			11.6			6.7			5.7
Other			17.0			15.1			16.1			9.9			7.4			6.0			3.6
			65.7			65.1			71.9			43.9			36.3			23.4			17.7
General allowance(1)			(1.4	)		(1.4	)		(1.3	)		(1.3	)		(1.3	)		(0.5	)		(0.6	)
Total loans and acceptances		$	281.3		$	268.4		$	288.5		$	230.6		$	204.8			100.0	%		100.0	%

(1) As at October 31.

T39 Gross impaired loans by geographic segment

As at October 31 ($ millions)	2010		2009		2008		2007		2006
Canada	$	1,276	$	1,258	$	761	$	606	$	655
United States		179		408		107		11		119
Mexico		250		238		216		188		213
Other International		2,716		2,035		1,410		739		883
Total	$	4,421	$	3,939	$	2,494	$	1,544	$	1,870

* Certain comparative amounts in the Supplementary Data section have been reclassified to conform with current year presentation.

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MANAGEMENT’S DISCUSSION AND ANALYSIS| SUPPLEMENTARY DATA

T40 Specific provision for credit losses by geographic segment

For the fiscal years ($ millions)	2010			2009		2008		2007			2006
Canada	$	712		$	804	$	388	$	295		$	273
United States		(13	)		192		16		(91	)		(41	)
Mexico		168			185		141		68			27
Other International		456			392		85		23			17
Total	$	1,323		$	1,573	$	630	$	295		$	276

T41 Geographic distribution of earning assets

	2010
				% of
				earning
As at September 30 ($ billions)	Balance			assets			2009			2008			2007			2006
North America
Canada	$	295.2			62.0	%	$	277.9		$	263.0		$	247.5		$	218.4
United States		60.7			12.7			58.2			38.2			36.3			41.9
		355.9			74.7			336.1			301.2			283.8			260.3
Mexico		18.8			4.0			17.8			22.8			19.8			21.1
Europe
United Kingdom		12.8			2.7			8.6			11.0			6.4			6.4
Germany		2.4			0.5			3.7			4.1			3.8			3.5
Ireland		1.8			0.4			4.7			11.1			6.2			4.8
France		2.7			0.6			2.2			2.2			2.3			2.5
Netherlands		1.6			0.3			1.6			2.5			1.4			1.5
Other		5.0			1.0			6.6			7.5			5.5			3.4
		26.3			5.5			27.4			38.4			25.6			22.1
Caribbean
Jamaica		3.5			0.7			3.5			3.6			3.2			3.1
Puerto Rico		6.2			1.3			2.4			2.4			2.1			2.0
Bahamas		2.4			0.5			2.7			3.0			2.4			2.4
Trinidad & Tobago		2.4			0.5			2.6			2.1			1.7			1.5
Other		9.2			2.0			9.1			8.8			7.3			9.0
		23.7			5.0			20.3			19.9			16.7			18.0
Latin America
Chile		11.3			2.4			11.1			11.0			4.2			4.2
Peru		9.2			1.9			7.5			7.4			4.5			4.1
Other		8.7			1.8			8.0			9.1			7.0			4.3
		29.2			6.1			26.6			27.5			15.7			12.6
Asia
India		4.2			0.9			3.7			3.7			2.5			1.8
Malaysia		1.7			0.3			1.8			1.8			1.4			1.3
South Korea		3.1			0.6			2.6			2.0			1.8			1.6
Japan		1.3			0.3			1.2			1.9			1.8			1.1
China		3.9			0.8			1.5			2.1			0.9			0.5
Hong Kong		2.5			0.5			2.9			2.6			1.6			1.7
Other		4.2			1.0			4.7			3.9			2.7			2.4
		20.9			4.4			18.4			18.0			12.7			10.4
Middle East and Africa		2.9			0.6			3.4			3.1			1.8			1.8
General allowance(1)		(1.4	)		(0.3	)		(1.4	)		(1.3	)		(1.3	)		(1.3	)
Total	$	476.3			100.0	%	$	448.6			429.6		$	374.8		$	345.0

(1) As at October 31.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Credit Risk

T42 Cross-border exposure to select countries⁽¹⁾

									Investment in
As at October 31			Interbank				Government and		subsidiaries				2010		2009
($ millions)	Loans		deposits		Trade		other securities		and affiliates		Other		Total		Total
Mexico	$	1,383	$	183	$	765	$	227	$	2,336	$	51	$	4,945	$	4,445
Asia
China	$	1,664	$	1,974	$	249	$	391	$	—	$	26	$	4,304	$	2,065
India		1,707		974		32		196		—		34		2,943		2,840
South Korea		1,550		551		—		637		—		125		2,863		2,749
Thailand		196		8		—		62		1,367		—		1,633		817
Hong Kong		631		271		37		380		—		24		1,343		873
Malaysia		549		45		—		167		219		14		994		1,157
Japan		251		122		—		80		—		63		516		1,049
Other(2)		524		234		53		166		—		2		979		1,025
	$	7,072	$	4,179	$	371	$	2,079	$	1,586	$	288	$	15,575	$	12,575
Latin America
Chile	$	1,488	$	81	$	102	$	44	$	2,050	$	4	$	3,769	$	3,010
Peru		433		153		286		—		1,713		5		2,590		1,794
Brazil		431		1,392		102		241		—		1		2,167		1,883
Costa Rica		871		65		—		1		485		—		1,422		1,384
El Salvador		192		6		—		—		386		—		584		641
Colombia		238		22		4		—		66		—		330		88
Other(3)		1,389		35		23		22		104		18		1,591		1,293
	$	5,042	$	1,754	$	517	$	308	$	4,804	$	28	$	12,453	$	10,093

(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)	Includes Indonesia, the Philippines, Singapore and Taiwan.
(3)	Includes Panama, Uruguay and Venezuela.

T43 Loans and acceptances by type of borrower

	2010
As at October 31 ($ billions)	Balance			% of total			2009			2008
Loans to households
Residential mortgages	$	120.2			41.0	%	$	101.3		$	114.9
Credit cards		10.8			3.7			11.1			11.2
Personal loans		51.1			17.4			49.3			38.9
		182.1			62.1			161.7			165.0
Loans to businesses and governments
Financial services		19.3			6.6			18.8			18.7
Wholesale and retail		10.4			3.5			10.9			14.9
Real estate		10.7			3.6			11.7			13.5
Oil and gas		9.3			3.2			9.8			12.0
Transportation		7.0			2.4			7.8			8.5
Automotive		5.2			1.8			5.1			7.1
Agriculture		4.5			1.5			4.3			5.3
Government		4.2			1.4			3.3			3.4
Hotels and leisure		4.1			1.4			4.8			5.2
Mining and primary metals		5.3			1.8			5.7			8.1
Utilities		5.0			1.7			6.1			6.3
Health care		4.0			1.3			4.0			5.0
Telecommunications and cable		3.7			1.3			4.6			6.5
Media		1.9			0.7			2.7			4.7
Chemical		1.2			0.4			1.3			1.7
Food and beverage		2.8			1.0			3.8			3.1
Forest products		1.1			0.4			1.5			2.1
Other		11.4			3.9			9.5			10.9
		111.1			37.9			115.7			137.0
		293.2			100.0	%		277.4			302.0
General and sectoral allowances		(1.4	)					(1.5	)		(1.4	)
Total loans and acceptances	$	291.8					$	275.9		$	300.6

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MANAGEMENT’S DISCUSSION AND ANALYSIS| SUPPLEMENTARY DATA

T44 Off-balance sheet credit instruments

As at October 31 ($ billions)	2010		2009		2008		2007		2006
Commitments to extend credit(1)	$	103.6	$	104.5	$	130.2	$	114.3	$	105.9
Standby letters of credit and letters of guarantee		20.4		21.9		27.8		18.4		18.5
Securities lending, securities purchase commitments and other		14.0		12.7		12.8		13.8		13.0
Total	$	138.0	$	139.1	$	170.8	$	146.5	$	137.4

(1) Excludes commitments which are unconditionally cancellable at the Bank’s discretion at anytime.

T45 Changes in net impaired loans

For the fiscal years ($ millions)	2010			2009			2008			2007			2006
Gross impaired loans
Balance at beginning of year	$	3,939		$	2,494		$	1,544		$	1,870		$	1,820
Net additions
New additions		3,298			4,461			2,158			1,338			1,262
Declassifications, payments and loan sales		(1.772	)		(1,149	)		(846	)		(891	)		(956	)
		1,526			3,312			1,312			447			306
Acquisition of subsidiaries(1)		571			—			341			33			340
Writeoffs
Residential mortgages		(82	)		(64	)		(59	)		(5	)		(5	)
Personal loans		(804	)		(669	)		(424	)		(301	)		(214	)
Credit cards		(352	)		(470	)		(268	)		(183	)		(150	)
Business and government		(347	)		(457	)		(129	)		(209	)		(174	)
		(1,585	)		(1,660	)		(880	)		(698	)		(543	)
Foreign exchange and other		(30	)		(207	)		177			(108	)		(53	)
Balance at end of year		4,421			3,939			2,494			1,544			1,870
Specific allowance for credit losses
Balance at beginning of year		1,376			1,303			943			1,300			1,139
Acquisition of subsidiaries		14			9			232			38			323
Specific provision for credit losses		1,323			1,573			630			295			276
Writeoffs		(1,585	)		(1,660	)		(880	)		(698	)		(543	)
Recoveries by portfolio
Residential mortgages		18			27			34			4			3
Personal loans		122			94			73			73			71
Credit cards		56			47			45			35			37
Business and government		68			55			79			74			70
		264			223			231			186			181
Foreign exchange and other(2)		(15	)		(72	)		147			(178	)		(76	)
Balance at end of year		1,377			1,376			1,303			943			1,300
Net impaired loans
Balance at beginning of year		2,563			1,191			601			570			681
Net change in gross impaired loans		482			1,445			950			(326	)		50
Net change in specific allowance for credit losses		(1	)		(73	)		(360	)		357			(161	)
Balance at end of year		3,044			2,563			1,191			601			570
General allowance for credit losses		1,410			1,450			1,323			1,298			1,307
Sectoral allowance		—			44			—			—			—
Balance after deducting general and sectoral allowance	$	1,634		$	1,069		$	(132	)	$	(697	)	$	(737	)

(1)	Represents primarily $553 of impaired loans purchased as part of the acquisitions of R-G Premier Bank of Puerto Rico. These impaired loans are carried at fair value on date of aquisition and no allowance for credit losses is recorded at the acquisition date as credit losses are included in the determination of the fair value.
(2)	Includes $4 transferred to other liabilities in 2010, $3 transferred from other liabilities in 2009, $3 transferred from other liabilities in 2008, and $5 transferred to other liabilities in 2006.

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T46 Provisions for credit losses

For the fiscal years ($ millions)	2010			2009			2008			2007			2006
Specific provisions for credit losses
Gross specific provisions	$	1,708		$	1,969		$	1,084		$	720		$	746
Reversals		(121	)		(173	)		(223	)		(239	)		(289	)
Recoveries		(264	)		(223	)		(231	)		(186	)		(181	)
Net specific provisions for credit losses		1,323			1,573			630			295			276
General provision		(40	)		127			—			(25	)		(60	)
Sectoral provision		(44	)		44			—			—			—
Total net provisions for credit losses	$	1,239		$	1,744		$	630		$	270		$	216

T47 Specific provisions for credit losses by type of borrower

For the fiscal years ($ millions)	2010			2009			2008			2007			2006
Personal
Residential mortgages	$	104		$	25		$	—		$	(9	)	$	10
Other personal loans		972			1,042			636			449			283
		1,076			1,067			636			440			293
Businesses and governments
Financial services		6			199			7			(10	)		—
Wholesale and retail		51			101			—			(39	)		5
Real estate		16			59			(69	)		(11	)		(7	)
Oil and gas		2			34			43			(1	)		—
Transportation		44			(9	)		(15	)		(9	)		4
Automotive		(4	)		19			5			1			11
Agriculture		(4	)		19			5			(4	)		2
Government		1			(35	)		(18	)		2			(6	)
Hotels and leisure		81			10			(4	)		(5	)		(21	)
Mining and primary metals		(2	)		3			(16	)		(4	)		(10	)
Utilities		—			—			(2	)		(18	)		(21	)
Health care		8			4			2			(1	)		2
Telecommunications and cable		(4	)		6			(3	)		(5	)		(14	)
Media		(15	)		52			11			(13	)		(4	)
Chemical		(3	)		1			7			(22	)		13
Food and beverage		2			8			(17	)		(6	)		7
Forest products		2			5			3			—			(1	)
Other		66			30			55			—			23
		247			506			(6	)		(145	)		(17	)
Total specific provisions	$	1,323		$	1,573		$	630		$	295		$	276

92     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

T48 Impaired loans by type of borrower

	2010							2009
			Specific							Specific
			allowance for							allowance for
As at October 31 ($ millions)	Gross		credit losses			Net		Gross		credit losses			Net
Personal
Residential mortgages	$	1,694	$	(222	)	$	1,472	$	1,119	$	(241	)	$	878
Other personal loans		756		(666	)		90		881		(688	)		193
		2,450		(888	)		1,562		2,000		(929	)		1,071
Businesses and governments
Financial services		91		(38	)		53		225		(42	)		183
Wholesale and retail		225		(88	)		137		213		(73	)		140
Real estate		705		(88	)		617		487		(76	)		411
Oil and gas		8		(3	)		5		71		(6	)		65
Transportation		188		(51	)		137		76		(15	)		61
Automotive		15		(11	)		4		77		(22	)		55
Agriculture		78		(31	)		47		106		(40	)		66
Government		48		(10	)		38		63		(23	)		40
Hotels and leisure		331		(49	)		282		260		(13	)		247
Mining and primary metals		18		(11	)		7		21		(9	)		12
Utilities		2		—			2		1		(1	)		—
Health care		23		(10	)		13		21		(9	)		12
Telecommunications and cable		18		(5	)		13		36		(14	)		22
Media		4		(3	)		1		49		(9	)		40
Chemical		1		(1	)		—		3		(1	)		2
Food and beverage		35		(16	)		19		41		(15	)		26
Forest products		14		(5	)		9		19		(12	)		7
Other		167		(69	)		98		170		(67	)		103
		1,971		(489	)		1,482		1,939		(447	)		1,492
Total	$	4,421	$	(1,377	)	$	3,044	$	3,939	$	(1,376	)	$	2,563

T49 Total credit risk exposures by geography^(1,2)

	2010
	Non-Retail										2009
As at October 31 ($ millions)	Drawn		Undrawn		Other exposures(3)		Retail		Total		Total
Canada	$	51,245	$	23,896	$	22,418	$	183,425	$	280,984	$	279,868
United States		32,304		18,220		22,109		683		73,316		80,340
Mexico		6,495		225		792		5,146		12,658		12,379
Other International
Europe		16,259		5,311		5,583		—		27,153		27,691
Caribbean		14,737		1,276		2,052		12,425		30,490		27,743
Latin America		16,063		754		1,359		7,091		25,267		24,109
Other		22,711		1,982		2,029		147		26,869		22,970
Total	$	159,814	$	51,664	$	56,342	$	208,917	$	476,737	$	475,100

(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)	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.

T50 AIRB credit risk exposures by maturity^(1,2)

As at October 31 ($ millions)	2010									2009
Residual maturity	Drawn		Undrawn			Other exposures(3)		Total		Total
Non-retail
Less than 1 year	$	49,967	$	16,643		$	21,933	$	88,543	$	92,957
One to 5 years		32,662	��	30,261			27,504		90,427		108,831
Over 5 years		5,395		779			3,881		10,055		11,338
Total non-retail	$	88,024	$	47,683		$	53,318	$	189,025	$	213,126
Retail
Less than 1 year	$	14,025	$	8,357		$	—	$	22,382	$	22,411
One to 5 years		115,298		—			—		115,298		100,888
Over 5 years		2,866		—			—		2,866		2,536
Revolving credits(4)		33,190		5,948			—		39,138		38,101
Total retail	$	165,379	$	14,305	(2)	$	—	$	179,684	$	163,936
Total	$	253,403	$	61,988		$	53,318	$	368,709	$	377,062

(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.

Scotiabank Annual Report2010     93

MANAGEMENT’S DISCUSSION AND ANALYSIS

T51 Total credit risk exposures and risk-weighted assets

	2010								2009
							Total Risk-		Exposure		Total Risk-
	Exposure at Default(1)						weighted		at Default		weighted
As at October 31 ($ millions)	AIRB		Standardized(2)		Total		assets		Total(1)		assets
Non-retail
Corporate
Drawn	$	45,284	$	45,394	$	90,678	$	71,290	$	98,975	$	81,771
Undrawn		36,008		3,277		39,285		19,553		36,694		19,429
Other(3)		10,180		2,531		12,711		6,754		13,181		6,397
		91,472		51,202		142,674		97,597		148,850		107,597
Bank
Drawn		12,394		13,441		25,835		6,107		21,598		5,527
Undrawn		11,108		636		11,744		3,162		14,240		2,391
Other(3)		10,009		487		10,496		1,800		12,410		2,032
		33,511		14,564		48,075		11,069		48,248		9,950
Sovereign
Drawn		30,346		12,955		43,301		2,080		51,341		2,340
Undrawn		567		68		635		71		866		83
Other(3)		145		6		151		6		642		18
		31,058		13,029		44,087		2,157		52,849		2,441
Total Non-retail
Drawn		88,024		71,790		159,814		79,477		171,914		89,638
Undrawn		47,683		3,981		51,664		22,786		51,800		21,903
Other(3)		20,334		3,024		23,358		8,560		26,233		8,447
	$	156,041	$	78,795	$	234,836	$	110,823	$	249,947	$	119,988
Retail
Retail residential mortgages
Drawn	$	121,265	$	16,666	$	137,931	$	12,107	$	122,018	$	9,868
Undrawn		8,068		—		8,068		132		6,702		131
		129,333		16,666		145,999		12,239		128,720		9,999
Secured lines of credit
Drawn		18,066		—		18,066		967		18,112		747
Undrawn		78		—		78		1		—		—
		18,144		—		18,144		968		18,112		747
Qualifying retail revolving exposures (QRRE)
Drawn		13,835		—		13,835		6,967		13,142		5,406
Undrawn		5,948		—		5,948		926		5,594		797
		19,783		—		19,783		7,893		18,736		6,203
Other retail
Drawn		12,213		12,567		24,780		14,990		23,013		14,074
Undrawn		211		—		211		131		454		346
		12,424		12,567		24,991		15,121		23,467		14,420
Total retail
Drawn		165,379		29,233		194,612		35,031		176,285		30,095
Undrawn		14,305		—		14,305		1,190		12,750		1,274
	$	179,684	$	29,233	$	208,917	$	36,221	$	189,035	$	31,369
Securitization exposures		15,503		—		15,503		4,606		18,528		6,474
Trading derivatives		17,481		—		17,481		5,425		17,590		5,850
Subtotal	$	368,709	$	108,028	$	476,737	$	157,075	$	475,100	$	163,681
Equities		2,984		—		2,984		5,664		2,897		5,607
Other assets		—		28,404		28,404		12,127		26,275		12,418
Total credit risk, before scaling factor	$	371,693	$	136,432	$	508,125	$	174,866	$	504,272	$	181,706
Add-on for 6% scaling factor(4)								5,649		—		6,134
Total credit risk	$	371,693	$	136,432	$	508,125	$	180,515	$	504,272	$	187,840

(1)	Outstanding amount for on-balance sheet exposures and loan equivalent amount for off-balance sheet exposures, before credit risk mitigation.
(2)	Net of specific allowances for credit losses.
(3)	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.
(4)	Basel Committee imposed scaling factor (6%) on risk-weighted assets for Internal ratings-based credit risk portfolios.

94     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

Revenues and Expenses

T52 Volume/rate analysis of changes in net interest income

	2010 versus 2009									2009 versus 2008
	Increase (decrease) due to change in:									Increase (decrease) due to change in:
Taxable equivalent basis(1)	Average			Average			Net			Average			Average			Net
For the fiscal years ($ millions)	volume			rate			change			volume			rate			change
Net interest income
Total earning assets	$	652		$	(2,698	)	$	(2,046	)	$	1,804		$	(5,313	)	$	(3,509	)
Total interest-bearing liabilities		(299	)		2,636			2,337			(1,013	)		5,148			4,135
Change in net interest income	$	353		$	(62	)	$	291		$	791		$	(165	)	$	626

(1) Refer to the non-GAAP measures on page 27.

T53 Taxes

											2010
											versus
For the fiscal years ($ millions)	2010		2009		2008		2007		2006		2009
Income taxes
Provision for income taxes	$	1,745	$	1,133	$	691	$	1,063	$	872		54	%
Taxable equivalent adjustment(1)		286		288		416		531		440		(1	)
Provision for income taxes (TEB)(1)		2,031		1,421		1,107		1,594		1,312		43
Other taxes
Payroll taxes		197		184		177		164		152		7
Business and capital taxes		171		177		116		143		133		(4	)
Goods and services and other		133		136		129		143		128		(2	)
Total other taxes		501		497		422		450		413		1
Total income and other taxes(2)	$	2,532	$	1,918	$	1,529	$	2,044	$	1,725		32	%
Net income before income taxes	$	6,084	$	4,794	$	3,950	$	5,226	$	4,549		27	%
Effective income tax rate (%)		28.7		23.6		17.5		20.3		19.2		5.1
Effective income tax rate (TEB) (%)(3)		31.9		28.0		25.4		27.7		26.3		3.9
Total tax rate (%)(4)		34.1		30.8		25.5		26.7		25.9		3.3

(1)	Taxable equivalent basis. Refer to the non-GAAP measures on page 27.
(2)	Comprising $1,365 of Canadian taxes (2009 – $675; 2008 – $569; 2007 – $1,175; 2006 – $1,035) and $1,167 of foreign taxes (2009 – $1,243; 2008 – $960; 2007 – $869; 2006 – $690).
(3)	Provision for income tax, expressed on a taxable equivalent basis, as a percentage of net income before income taxes.
(4)	Total income and other taxes as a percentage of net income before income and other taxes.

Scotiabank Annual Report2010     95

MANAGEMENT’S DISCUSSION AND ANALYSIS

Other Information

T54 Components of net income as a percentage of average total assets⁽¹⁾

Taxable equivalent basis
For the fiscal years (%)	2010			2009			2008			2007			2006
Net interest income		1.73	%		1.68	%		1.75	%		1.89	%		1.95	%
Provision for credit losses		(0.24	)		(0.34	)		(0.14	)		(0.07	)		(0.06	)
Other income		1.33			1.19			0.95			1.34			1.37
Net interest and other income		2.82			2.53			2.56			3.16			3.26
Non-interest expenses		(1.59	)		(1.54	)		(1.60	)		(1.73	)		(1.84	)
Net income before the undernoted:		1.23			0.99			0.96			1.43			1.42
Provision for income taxes and non-controlling interest		(0.41	)		(0.30	)		(0.27	)		(0.43	)		(0.40	)
Net income		0.82	%		0.69	%		0.69	%		1.00	%		1.02	%
Average total assets ($ billions)	$	516.0		$	513.1		$	455.5		$	403.5		$	350.7

(1) Income from tax-exempt securities has been expressed on an equivalent before-tax basis. The provision for income taxes has been adjusted by a corresponding amount: 2010 – $286 million; 2009 – $288 million; 2008 – $416 million; 2007 – $531 million; 2006 – $440 million.

T55 Assets under administration and management⁽¹⁾

($ billions)	2010		2009		2008		2007		2006
Assets under administration
Personal
Retail brokerage	$	87.7	$	76.4	$	74.3	$	77.4	$	69.7
Investment management and trust		68.8		60.1		55.8		53.1		59.5
		156.5		136.5		130.1		130.5		129.2
Mutual funds		38.8		31.6		27.9		24.8		19.8
Institutional		48.5		47.0		45.1		39.8		42.9
Total	$	243.8	$	215.1	$	203.1	$	195.1	$	191.9
Assets under management
Personal	$	14.4	$	13.6	$	12.5	$	11.2	$	10.0
Mutual funds		28.0		22.8		19.6		15.9		13.2
Institutional		6.0		5.2		4.6		4.3		4.6
Total	$	48.4	$	41.6	$	36.7	$	31.4	$	27.8

(1) 2009 and 2010 data as at October 31; 2006 to 2008 data as at September 30.

T56 Fees paid to the shareholders’ auditors

For the fiscal years ($ millions)	2010		2009
Audit services	$	18.0	$	16.6
Audit-related services		0.6		0.6
Tax services outside of the audit scope		0.1		0.1
Other non-audit services		0.2		0.7
Total	$	18.9	$	18.0

96     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

T57Selected quarterly information

	2010								2009
As at and for the quarter ended	Q4		Q3		Q2		Q1		Q4		Q3		Q2		Q1
Operating results ($ millions)
Net interest income		2,243		2,173		2,058		2,147		2,099		2,176		2,087		1,966
Net interest income (TEB(1))		2,313		2,243		2,129		2,222		2,172		2,244		2,164		2,036
Total revenue		3,942		3,784		3,873		3,906		3,735		3,775		3,596		3,351
Total revenue (TEB(1))		4,012		3,854		3,944		3,981		3,808		3,843		3,673		3,421
Provision for credit losses		254		276		338		371		420		554		489		281
Non-interest expenses		2,183		2,023		1,967		2,009		2,064		1,959		1,886		2,010
Provision for income taxes		390		399		444		512		321		303		319		190
Provision for income taxes (TEB(1))		460		469		515		587		394		371		396		260
Net income		1,092		1,062		1,097		988		902		931		872		842
Net income available to common shareholders		1,040		1,011		1,048		939		853		882		821		805
Operating performance
Basic earnings per share ($)		1.00		0.98		1.02		0.92		0.84		0.87		0.81		0.80
Diluted earnings per share ($)		1.00		0.98		1.02		0.91		0.83		0.87		0.81		0.80
Diluted cash earnings per share ($)(1)		1.02		0.99		1.04		0.93		0.85		0.88		0.82		0.82
Return on equity (%)(1)		17.9		18.2		19.9		17.4		16.4		17.3		16.8		16.2
Productivity ratio (%)(TEB)(1)		54.4		52.5		49.9		50.5		54.2		51.0		51.4		58.7
Net interest margin on total average assets (%)(TEB)(1)		1.75		1.68		1.73		1.76		1.74		1.76		1.71		1.52
Balance sheet information ($ billions)
Cash resources and securities		162.6		167.4		181.4		173.5		160.6		148.3		137.5		123.7
Loans and acceptances		291.8		286.5		281.3		275.8		275.9		276.8		306.6		313.2
Total assets		526.7		523.4		526.1		507.6		496.5		486.5		514.5		510.6
Deposits		361.7		365.2		371.2		364.9		350.4		333.7		346.9		346.6
Preferred shares		4.0		4.0		4.0		3.7		3.7		3.7		3.7		3.7
Common shareholders’ equity		23.7		22.5		21.6		21.6		21.1		20.3		20.1		19.9
Assets under administration		243.8		229.3		231.0		226.3		215.1		207.9		196.8		191.8
Assets under management		48.4		44.9		45.4		43.6		41.6		39.8		35.4		34.3
Capital measures
Tier 1 capital ratio (%)		11.8		11.7		11.2		11.2		10.7		10.4		9.6		9.5
Total capital ratio (%)		13.8		13.8		13.3		13.5		12.9		12.7		11.8		11.4
Tangible common equity to risk-weighted assets (%)(1)		9.6		9.3		8.8		8.8		8.2		7.9		7.2		7.2
Asset-to-capital multiple		17.0		17.1		17.7		16.8		16.6		16.6		17.3		18.1
Risk-weighted assets ($ billions)		215.0		213.0		215.1		215.9		221.6		221.5		241.8		239.7
Credit quality
Net impaired loans(2) ($ millions)		3,044		2,598		2,475		2,677		2,563		2,509		2,179		1,602
General allowance for credit losses ($ millions)		1,410		1,450		1,450		1,450		1,450		1,450		1,350		1,323
Sectoral allowance ($ millions)		—		—		24		43		44		48		60		—
Net impaired loans as a % of loans and acceptances(2)		1.04		0.91		0.88		0.97		0.93		0.91		0.71		0.51
Specific provision for credit losses as a % of average loans and acceptances (annualized)		0.41		0.43		0.55		0.55		0.63		0.64		0.54		0.36
Common share information
Share price ($)
High		55.76		52.89		55.33		49.93		49.19		46.51		35.85		40.68
Low		49.00		47.71		44.39		44.12		42.95		33.75		23.99		27.35
Close		54.67		51.59		51.78		44.83		45.25		45.92		33.94		29.67
Shares outstanding (millions)
Average — Basic		1,039		1,034		1,030		1,025		1,021		1,017		1,014		1,001
Average — Diluted		1,040		1,036		1,031		1,028		1,024		1,020		1,016		1,003
End of period		1,043		1,038		1,034		1,029		1,025		1,020		1,017		1,012
Dividends per share ($)		0.49		0.49		0.49		0.49		0.49		0.49		0.49		0.49
Dividend yield (%)(3)		3.7		3.9		3.9		4.2		4.3		4.9		6.6		5.8
Market capitalization ($ billions)		57.0		53.6		53.5		46.1		46.4		46.9		34.5		30.0
Book value per common share ($)		22.68		21.67		20.87		21.04		20.55		19.89		19.80		19.67
Market value to book value multiple		2.4		2.4		2.5		2.1		2.2		2.3		1.7		1.5
Price to earnings multiple (trailing 4 quarters)		14.0		13.8		14.2		13.0		13.6		16.6		11.8		9.8

(1)	Non-GAAP measure. Refer to the non-GAAP measures on page 27.
(2)	Net impaired loans are impaired loans less the specific allowance for credit losses.
(3)	Based on the average of the high and low common share price for the year.

Scotiabank Annual Report2010     97

MANAGEMENT’S DISCUSSION AND ANALYSIS

Eleven-year Statistical Review

T58Consolidated Balance Sheet

As at October 31 ($ millions)	2010			2009			2008			2007
Assets
Cash resources	$	46,027		$	43,278		$	37,318		$	29,195
Securities
Trading		64,684			58,067			48,292			59,685
Available-for-sale		47,228			55,699			38,823			28,426
Investment		—			—			—			—
Equity accounted investments		4,651			3,528			920			724
		116,563			117,294			88,035			88,835
Securities purchased under resale agreements		27,920			17,773			19,451			22,542
Loans
Residential mortgages		120,482			101,604			115,084			102,154
Personal and credit cards		62,548			61,048			50,719			41,734
Business and government		103,981			106,520			125,503			85,500
		287,011			269,172			291,306			229,388
Allowance for credit losses		2,787			2,870			2,626			2,241
		284,224			266,302			288,680			227,147
Other
Customers’ liability under acceptances		7,616			9,583			11,969			11,538
Derivative instruments(1)		26,852			25,992			44,810			21,960
Land, buildings and equipment		2,450			2,372			2,449			2,061
Other assets(1)		15,005			13,922			14,913			8,232
		51,923			51,869			74,141			43,791
	$	526,657		$	496,516		$	507,625		$	411,510
Liabilities and shareholders’ equity
Deposits
Personal	$	128,850		$	123,762		$	118,919		$	100,823
Business and government		210,687			203,594			200,566			161,229
Banks		22,113			23,063			27,095			26,406
		361,650			350,419			346,580			288,458
Other
Acceptances		7,616			9,583			11,969			11,538
Obligations related to securities sold under repurchase agreements		40,286			36,568			36,506			28,137
Obligations related to securities sold short		21,519			14,688			11,700			16,039
Derivative instruments(1)		31,990			28,806			42,811			24,689
Other liabilities(1)		28,947			24,682			31,063			21,138
Non-controlling interest in subsidiaries		579			554			502			497
		130,937			114,881			134,551			102,038
Subordinated debentures		5,939			5,944			4,352			1,710
Capital instrument liabilities		500			500			500			500
Shareholders’ equity
Preferred shares		3,975			3,710			2,860			1,635
Common shareholders’ equity
Common shares and contributed surplus		5,775			4,946			3,829			3,566
Retained earnings		21,932			19,916			18,549			17,460
Accumulated other comprehensive income		(4,051	)		(3,800	)		(3,596	)		(3,857	)
Total common shareholders’ equity		23,656			21,062			18,782			17,169
		27,631			24,772			21,642			18,804
	$	526,657		$	496,516		$	507,625		$	411,510

(1) Amounts for years prior to 2004 have not been reclassified to conform with current period presentation for derivative accounting as the information is not readily available.

98     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

2006			2005			2004			2003			2002		2001		2000
$	23,376		$	20,505		$	17,155		$	20,581		$	20,273	$	20,160	$	18,744
	62,490			50,007			43,056			42,899			34,592		27,834		21,821
	—			—			—			—			—		—		—
	32,870			23,285			15,576			20,141			21,439		25,256		19,162
	142			167			141			152			163		194		403
	95,502			73,459			58,773			63,192			56,194		53,284		41,386
	25,705			20,578			17,880			22,648			32,262		27,500		23,559
	89,590			75,520			69,018			61,646			56,295		52,592		50,037
	39,058			34,695			30,182			26,277			23,363		20,116		17,988
	76,733			62,681			57,384			64,313			77,181		79,460		78,172
	205,381			172,896			156,584			152,236			156,839		152,168		146,197
	2,607			2,469			2,696			3,217			3,430		4,236		2,853
	202,774			170,427			153,888			149,019			153,409		147,932		143,344
	9,555			7,576			7,086			6,811			8,399		9,301		8,807
	12,098			12,867			15,488			15,308			15,821		15,886		8,244
	2,103			1,836			1,823			1,944			2,101		2,325		1,631
	7,893			6,777			7,119			6,389			7,921		8,037		7,456
	31,649			29,056			31,516			30,452			34,242		35,549		26,138
$	379,006		$	314,025		$	279,212		$	285,892		$	296,380	$	284,425	$	253,171
$	93,450		$	83,953		$	79,020		$	76,431		$	75,558	$	75,573	$	68,972
	141,072			109,389			94,125			93,541			93,830		80,810		76,980
	29,392			24,103			22,051			22,700			26,230		29,812		27,948
	263,914			217,445			195,196			192,672			195,618		186,195		173,900
	9,555			7,576			7,086			6,811			8,399		9,301		8,807
	33,470			26,032			19,428			28,686			31,881		30,627		23,792
	13,396			11,250			7,585			9,219			8,737		6,442		4,297
	12,869			13,004			16,002			14,758			15,500		15,453		8,715
	24,799			18,983			13,785			14,145			15,678		15,369		14,586
	435			306			280			326			662		586		229
	94,524			77,151			64,166			73,945			80,857		77,778		60,426
	2,271			2,597			2,615			2,661			3,878		5,344		5,370
	750			750			2,250			2,500			2,225		1,975		1,975
	600			600			300			300			300		300		300
	3,425			3,317			3,229			3,141			3,002		2,920		2,765
	15,843			14,126			13,239			11,747			10,398		9,674		8,275
	(2,321	)		(1,961	)		(1,783	)		(1,074	)		102		239		160
	16,947			15,482			14,685			13,814			13,502		12,833		11,200
	17,547			16,082			14,985			14,114			13,802		13,133		11,500
$	379,006		$	314,025		$	279,212		$	285,892		$	296,380	$	284,425	$	253,171

Scotiabank Annual Report2010     99

MANAGEMENT’S DISCUSSION AND ANALYSIS

T59Consolidated Statement of Income

For the year ended October 31 ($ millions)	2010		2009		2008		2007
Interest income
Loans	$	12,171	$	13,973	$	15,832	$	13,985
Securities		4,227		4,090		4,615		4,680
Securities purchased under resale agreements		201		390		786		1,258
Deposits with banks		292		482		1,083		1,112
		16,891		18,935		22,316		21,035
Interest expenses
Deposits		6,768		8,339		12,131		10,850
Subordinated debentures		289		285		166		116
Capital instrument liabilities		37		37		37		53
Other		1,176		1,946		2,408		2,918
		8,270		10,607		14,742		13,937
Net interest income		8,621		8,328		7,574		7,098
Provision for credit losses		1,239		1,744		630		270
Net interest income after provision for credit losses		7,382		6,584		6,944		6,828
Other income		6,884		6,129		4,302		5,392
Net interest and other income		14,266		12,713		11,246		12,220
Non-interest expenses
Salaries and employee benefits		4,647		4,344		4,109		3,983
Other(1)		3,535		3,575		3,187		3,011
Restructuring provisions following acquisitions		—		—		—		—
		8,182		7,919		7,296		6,994
Income before the undernoted		6,084		4,794		3,950		5,226
Provision for income taxes		1,745		1,133		691		1,063
Non-controlling interest in net income of subsidiaries		100		114		119		118
Net income	$	4,239	$	3,547	$	3,140	$	4,045
Preferred dividends paid and other		201		186		107		51
Net income available to common shareholders	$	4,038	$	3,361	$	3,033	$	3,994
Average number of common shares outstanding (millions):
Basic		1,032		1,013		987		989
Diluted		1,034		1,016		993		997
Earnings per common share (in dollars):
Basic	$	3.91	$	3.32	$	3.07	$	4.04
Diluted	$	3.91	$	3.31	$	3.05	$	4.01
Dividends per common share (in dollars)	$	1.96	$	1.96	$	1.92	$	1.74

(1) Other non-interest expenses include a loss on disposal of subsidiary operations in 2003 and 2002 of $31 and $237, respectively.

100     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

2006		2005		2004		2003		2002		2001		2000
$	11,575	$	9,236	$	8,480	$	9,073	$	9,635	$	11,530	$	11,044
	4,124		3,104		2,662		2,859		3,087		3,062		2,286
	1,102		817		594		872		1,073		1,519		1,085
	881		646		441		442		573		872		916
	17,682		13,803		12,177		13,246		14,368		16,983		15,331
	8,589		5,755		4,790		5,222		5,519		8,233		8,192
	130		134		112		139		203		303		324
	53		53		164		182		158		136		120
	2,502		1,990		1,410		1,735		1,971		2,247		1,616
	11,274		7,932		6,476		7,278		7,851		10,919		10,252
	6,408		5,871		5,701		5,968		6,517		6,064		5,079
	216		230		390		893		2,029		1,425		765
	6,192		5,641		5,311		5,075		4,488		4,639		4,314
	4,800		4,529		4,320		4,015		3,942		4,071		3,665
	10,992		10,170		9,631		9,090		8,430		8,710		7,979
	3,768		3,488		3,452		3,361		3,344		3,220		2,944
	2,675		2,555		2,410		2,370		2,630		2,442		2,209
	—		—		—		—		—		—		(34	)
	6,443		6,043		5,862		5,731		5,974		5,662		5,119
	4,549		4,127		3,769		3,359		2,456		3,048		2,860
	872		847		786		777		594		869		983
	98		71		75		160		154		102		43
$	3,579	$	3,209	$	2,908	$	2,422	$	1,708	$	2,077	$	1,834
	30		25		16		16		16		16		16
$	3,549	$	3,184	$	2,892	$	2,406	$	1,692	$	2,061	$	1,818
	988		998		1,010		1,010		1,009		1,001		991
	1,001		1,012		1,026		1,026		1,026		1,018		1,003
$	3.59	$	3.19	$	2.87	$	2.38	$	1.68	$	2.06	$	1.83
$	3.55	$	3.15	$	2.82	$	2.34	$	1.65	$	2.02	$	1.81
$	1.50	$	1.32	$	1.10	$	0.84	$	0.73	$	0.62	$	0.50

Scotiabank Annual Report2010     101

MANAGEMENT’S DISCUSSION AND ANALYSIS

T60 Consolidated Statement of Changes in Shareholders’ Equity

For the year ended October 31 ($ millions)	2010			2009			2008			2007
Preferred shares
Balance at beginning of year	$	3,710		$	2,860		$	1,635		$	600
Issued		265			850			1,225			1,035
Balance at end of year		3,975			3,710			2,860			1,635
Common shares and contributed surplus
Common shares:
Balance at beginning of year		4,946			3,829			3,566			3,425
Issued		804			1,117			266			184
Purchased for cancellation		—			—			(3	)		(43	)
Balance at end of year		5,750			4,946			3,829			3,566
Contributed surplus:
Balance at beginning of year		—			—			—			—
Stock option expense		25			—			—			—
Balance at end of year		25			—			—			—
Total		5,775			4,946			3,829			3,566
Retained earnings
Balance at beginning of year		19,916			18,549			17,460			15,843
Adjustments		—			—			—			(61	)(1)
Net income		4,239			3,547			3,140			4,045
Dividends: Preferred		(201	)		(186	)		(107	)		(51	)
Common		(2,023	)		(1,990	)		(1,896	)		(1,720	)
Purchase of shares and premium on redemption		—			—			(37	)		(586	)
Other		1			(4	)		(11	)		(10	)
Balance at end of year		21,932			19,916			18,549			17,460
Accumulated other comprehensive income (loss)
Balance at beginning of year		(3,800	)		(3,596	)		(3,857	)		(2,321	)
Cumulative effect of adopting new accounting policies		—			595	(5)		—			683
Other comprehensive income (loss)		(251	)		(799	)		261			(2,219	)
Balance at end of year		(4,051	)		(3,800	)		(3,596	)		(3,857	)
Total shareholders’ equity at end of year	$	27,631		$	24,772		$	21,642		$	18,804

T61 Consolidated Statement of Comprehensive Income

For the year ended October 31 ($ millions)	2010			2009			2008			2007
Net income	$	4,239		$	3,547		$	3,140		$	4,045
Other comprehensive income (loss), net of income taxes:
Net change in unrealized foreign currency translation gains (losses)		(591	)		(1,736	)		2,368			(2,228	)
Net change in unrealized gains (losses) on available-for-sale securities		278			894			(1,588	)		(67	)
Net change in gains (losses) on derivative instruments designated as cash flow hedges		62			43			(519	)		76
Other comprehensive income (loss)		(251	)		(799	)		261			(2,219	)
Comprehensive income	$	3,988		$	2,748		$	3,401		$	1,826

(1)	Results from the adoption of new financial instruments accounting standards.
(2)	Cumulative effect of adoption of new stock-based compensation accounting standard.
(3)	Cumulative effect of adoption of new goodwill accounting standard.
(4)	Cumulative effect of adoption of new corporate income taxes accounting standard.
(5)	Relates to the adoption of the new accounting standard for impairment and classification of financial instruments. Refer to Note 1 of the Consolidated Financial Statements for details.

102     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

2006			2005			2004			2003			2002			2001			2000
$	600		$	300		$	300		$	300		$	300		$	300		$	300
	—			300			—			—			—			—			—
	600			600			300			300			300			300			300
	3,316			3,228			3,140			3,002			2,920			2,765			2,678
	135			172			117			163			101			155			87
	(26	)		(84	)		(29	)		(25	)		(19	)		—			—
	3,425			3,316			3,228			3,140			3,002			2,920			2,765
	1			1			1			—			—			—			—
	(1	)		—			—			1			—			—			—
	—			1			1			1			—			—			—
	3,425			3,317			3,229			3,141			3,002			2,920			2,765
	14,126			13,239			11,747			10,398			9,674			8,275			6,956
	(25	)(2)		—			—			—			(76	)(3)		(39	)(4)		—
	3,579			3,209			2,908			2,422			1,708			2,077			1,834
	(30	)		(25	)		(16	)		(16	)		(16	)		(16	)		(16	)
	(1,483	)		(1,317	)		(1,110	)		(849	)		(732	)		(621	)		(496	)
	(324	)		(973	)		(290	)		(201	)		(154	)		—			—
	—			(7	)		—			(7	)		(6	)		(2	)		(3	)
	15,843			14,126			13,239			11,747			10,398			9,674			8,275
	(1,961	)		(1,783	)		(1,074	)		102			239			160			(3	)
	—			—			—			—			—			—			—
	(360	)		(178	)		(709	)		(1,176	)		(137	)		79			163
	(2,321	)		(1,961	)		(1,783	)		(1,074	)		102			239			160
$	17,547		$	16,082		$	14,985		$	14,114		$	13,802		$	13,133		$	11,500
	2006			2005			2004			2003			2002			2001			2000
$	3,579		$	3,209		$	2,908		$	2,422		$	1,708		$	2,077		$	1,834
	(360	)		(178	)		(709	)		(1,176	)		(137	)		79			163
	—			—			—			—			—			—			—
	—			—			—			—			—			—			—
	(360	)		(178	)		(709	)		(1,176	)		(137	)		79			163
$	3,219		$	3,031		$	2,199		$	1,246		$	1,571		$	2,156		$	1,997

Scotiabank Annual Report2010     103

MANAGEMENT’S DISCUSSION AND ANALYSIS

T62 Other statistics

For the year ended October 31	2010		2009		2008		2007
Operating performance
Basic earnings per share ($)		3.91		3.32		3.07		4.04
Diluted earnings per share ($)		3.91		3.31		3.05		4.01
Return on equity (%)(1)		18.3		16.7		16.7		22.0
Productivity ratio (%)(TEB(1))		51.8		53.7		59.4		53.7
Return on assets (%)		0.82		0.69		0.69		1.00
Net interest margin on total average assets (%)(TEB(1))		1.73		1.68		1.75		1.89
Capital measures(2)
Tier 1 capital ratio (%)		11.8		10.7		9.3		9.3
Total capital ratio (%)		13.8		12.9		11.1		10.5
Tangible common equity to risk-weighted assets(1) (%)		9.6		8.2		6.6		7.4
Assets-to-capital multiple		17.0		16.6		18.0		18.2
Common share information
Share price ($):
High		55.76		49.19		54.00		54.73
Low		44.12		23.99		35.25		46.70
Close		54.67		45.25		40.19		53.48
Number of shares outstanding (millions)		1,043		1,025		992		984
Dividends per share ($)		1.96		1.96		1.92		1.74
Dividend yield (%)(3)		3.9		5.4		4.3		3.4
Price to earnings multiple(4)		14.0		13.6		13.1		13.2
Book value per common share ($)		22.68		20.55		18.94		17.45
Other information
Average total assets ($ millions)		515,991		513,149		455,539		403,475
Number of branches and offices		2,784		2,686		2,672		2,331
Number of employees(5)		70,772		67,802		69,049		58,113
Number of automated banking machines		5,978		5,778		5,609		5,283

(1)	Non-GAAP measure. Refer to non-GAAP measures on page 27.
(2)	Effective November 1, 2007, regulatory capital ratios are determined in accordance with Basel II rules. Comparative amounts for prior periods are determined in accordance with Basel I rules.
(3)	Based on the average of the high and low common share price for the year.
(4)	Based on the closing common share price.
(5)	Includes all personnel (part-time stated on a full-time equivalent basis) of the Bank and all of its subsidiaries.

104     2010 Scotiabank Annual Report

MANAGEMENT’S DISCUSSION AND ANALYSIS | SUPPLEMENTARY DATA

2006		2005		2004		2003		2002		2001		2000
	3.59		3.19		2.87		2.38		1.68		2.06		1.83
	3.55		3.15		2.82		2.34		1.65		2.02		1.81
	22.1		20.9		19.9		17.6		13.0		17.3		17.6
	55.3		56.3		56.9		55.9		55.7		54.6		57.3
	1.02		1.04		1.02		0.84		0.58		0.76		0.77
	1.95		2.00		2.10		2.16		2.29		2.32		2.21
	10.2		11.1		11.5		10.8		9.9		9.3		8.6
	11.7		13.2		13.9		13.2		12.7		13.0		12.2
	8.3		9.3		9.7		8.9		8.3		7.8		7.0
	17.1		15.1		13.8		14.4		14.5		13.5		13.7
	49.80		44.22		40.00		33.70		28.10		25.25		22.83
	41.55		36.41		31.08		22.28		21.01		18.65		13.03
	49.30		42.99		39.60		32.74		22.94		21.93		21.75
	990		990		1,009		1,011		1,008		1,008		996
	1.50		1.32		1.10		0.84		0.73		0.62		0.50
	3.3		3.3		3.1		3.0		3.0		2.8		2.8
	13.7		13.5		13.8		13.8		13.7		10.6		11.9
	17.13		15.64		14.56		13.67		13.39		12.74		11.25
	350,709		309,374		283,986		288,513		296,852		271,843		238,664
	2,191		1,959		1,871		1,850		1,847		2,005		1,695
	54,199		46,631		43,928		43,986		44,633		46,804		40,946
	4,937		4,449		4,219		3,918		3,693		3,761		2,669

Scotiabank Annual Report2010     105