Government owned Kiwibank and global banking giant HSBC have been warned, and made payments to customers totalling NZ$689,000 and NZ$113,000 respectively, following a Commerce Commission investigation into mortgage break fees charged by banks when customers repay fixed-rate loans early.

The Commission said today it had concluded its investigation into these fees under the Credit Contracts and Consumer Finance Act. The consumer watchdog had decided to take no enforcement action against ANZ, Westpac and GE. It concluded that the prepayment fees based on the change in wholesale interest rates charged by Kiwibank, HSBC, Westpac, ANZ and GE was likely to produce a reasonable fee complying with the Act.

However, Kiwibank and HSBC were both issued with warnings because the formulae they used until mid-2009 had technical deficiencies meaning they were likely to have breached section 54 of the Act, the Commission said. During the investigation both banks changed their formula and Kiwibank made ex-gratia payments to its customers totalling about NZ$689,000 with HSBC making payments to customers worth about NZ$113,000.

"The Commission has determined that a warning is appropriate in the circumstances."

The consumer watchdog started investigating the break fees, also known as full prepayment fees, after complaints from bank customers about the fees following sharp interest rate falls in late 2008 and early 2009. The drop in interest rates led to banks imposing "significant" prepayment fees on customers' breaking fixed-rate mortgages, the Commission said.

The first stage of the investigation ended in April last year with no enforcement action taken when the Commission concluded four banks – ASB, SBS Bank, BNZ and National Bank – were likely to be charging reasonable fees.

Read the Commerce Commission's full statement below

The Commerce Commission has concluded its investigation under the Credit Contracts and Consumer Finance Act (CCCF Act) into the mortgage break fees charged by banks when customers repay their fixed-rate loans early.

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The Commission began investigating the break fees, also known as full prepayment fees, after a range of complaints from bank customers about the fees following sharp drops in interest rates in late 2008 and early 2009. The decrease in interest rates led to banks imposing significant prepayment fees on customers breaking fixed-rate mortgages.

The first stage of the investigation ended in April 2009 with no enforcement action taken when the Commission concluded that four banks – ASB, SBS Bank, BNZ and National Bank – were likely to be charging reasonable fees. These banks charged fees based on the change in retail interest rates, which is consistent with a formula set out in the CCCF Regulations (colloquially known as the safe harbour formula).

Since then the Commission has continued to investigate the fees charged by Kiwibank, HSBC, Westpac, ANZ and GE, who charge prepayment fees based on the change in wholesale interest rates. The Commission has concluded that this basis is likely to produce a fee which is reasonable and therefore complies with the CCCF Act.

In relation to ANZ, Westpac and GE the investigation has been closed with no enforcement action. Kiwibank and HSBC have each been issued with a warning on the basis that the formulae they were using until mid-2009 had technical deficiencies which meant that they were likely to have breached section 54 of the CCCF Act. During the investigation both banks changed their formula. In addition, Kiwibank made ex-gratia payments to its customers totalling approximately $689,000 while HSBC made ex-gratia payments to its customers totalling approximately $113,000. The Commission has determined that a warning is appropriate in the circumstances.

“The Commission recognised, given the variance in fees being charged, that this was a significant and important issue for many bank customers and accordingly we conducted a comprehensive investigation of the matter. There is a great deal of complexity in the formulae, the underlying banking arrangements, related legal issues and in the Act itself, and we needed to be thorough in considering every aspect,” said Graham Gill, Fair Trading Manager Auckland, for the Commerce Commission.

“Creditors are entitled to charge a reasonable estimate of their loss on prepayment of a loan. The Act gives creditors a wide ranging discretion in assessing its loss, and this investigation was focussed on the nature of the loss suffered by the banks. The key loss suffered by the banks relates to interest rate swap contracts, which banks enter into when customers enter into fixed rate loans,” said Mr Gill.

“Consumers entering into fixed-rate mortgage contracts need to ensure they fully understand the implications of the contract they are signing. If they choose to, or need to, exit the contract earlier than the agreed term they face legitimate bank charges. They should also be aware that, under the CCCF Act, banks can alter the basis of their prepayment fees at any time if they provide customers with appropriate notification of the change,” said Mr Gill.

The Commission notes that the Ministry of Consumer Affairs is currently reviewing the Credit Contracts and Consumer Finance Act. The results of this investigation, which may be helpful to that review, have been provided to the Ministry.

Background

The Credit Contracts and Consumer Finance Act 2003 (CCCF Act) governs consumer finance arrangements including mortgages, term loans and credit cards.

Section 50 of the CCCF Act gives debtors a right of full prepayment. Customers may repay their loans in full at any time.

Section 54 of the CCCF Act allows creditors to charge customers a reasonable estimate of their loss on full prepayment. Creditors can adopt the procedure set out in the CCCF Regulations, commonly known as the safe harbour formula, or they may use any other appropriate procedure that results in a reasonable estimate of their loss. If a creditor uses the safe harbour formula, it is assumed that its estimate of loss is reasonable. Other formulae must be considered on a case-by-case basis, and may ultimately be tested in Court.

In Commerce Commission v Avanti Finance Limited (2009) 9 NZBLC 102,662 the Court considered section 54 and whether Avanti Finance’s formula produced a reasonable estimate of loss Avanti Finance’s formula calculated a loss based on its lost margin (profit). The focus of the case was on whether creditors must re-lend repaid finds to reduce or mitigate their loss.

The type of loss suffered by the banks based on movements in wholesale interest rates (arising from broken interest rate swap arrangements) is a different type of loss, and accordingly the issue of re-lending does not arise in the same way.

Typically banks and mortgage financiers have a mis-match between their loan book and their funding book. They typically provide mortgages for customers at fixed-rates for periods of two to five years. However, they generally borrow funds in a series of short-term funding transactions which effectively results in funding being at floating rates. In order to manage the risk of these positions, banks and mortgage financiers enter into interest rate swaps. These swaps are transactions based on wholesale interest rates designed to ‘hedge’ the risk of changes in interest rates.

When a customer breaks a fixed-rate mortgage, the bank no longer has the income stream it expected from the customer to offset its obligations under the swap. While the banks’ swap positions are generally on a portfolio basis, and therefore much larger than any individual fixed-rate loan, their loss is calculated by assuming that there is an individual swap position and it is broken on the date that the fixed-rate loan is broken. This calculation is based on the change in wholesale interest rates.

The banks which were investigated by the Commission and which calculate fees based on changes in retail interest rates are:
       ASB Bank Limited;
       Bank of New Zealand Limited;
       SBS Bank; and
       The National Bank of New Zealand, part of ANZ National Bank Limited.

The banks and finance institutions which were investigated by the Commission and which calculate fee based on changes in wholesale interest rates are:
       ANZ Bank, part of ANZ National Bank Limited;
       GE Money Home Lending Business (including TEA Custodians (Pacific) Limited and GE Custodians);
       Kiwibank Limited;
       The Hong Kong and Shanghai Banking Corporation Limited; and
       Westpac New Zealand Limited.