With 2017 sales down at Ford Motor Company 4.8% year to date basis last year – outpacing new car sales, which fell 2.1% over the first six months of 2017 – company executives were faced with a challenge: how to improve sales amid a cash-strapped middle-income consumer not spending as much. To boost their flagging fortunes, the company isn’t creating a better product or expanding its target market. Rather, they have decided to use machine learning to append credit standards, Dow Jones Newswire reported. The decision comes as Ford’s own loan loss rate is rising and a Moody’s report points to auto loan delinquencies on the rise. What could go wrong?

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Auto loan delinquencies

The good news out of the auto industry: ABS loan product performance improves, used vehicle prices on the rise

The news out of the auto loan industry has many dichotomous factors. On one hand, the performance of auto loan asset backed securities (ABS) is improving, with Moody’s index of monthly auto lease ABS residual performance reversing from losses to gains on a quarter over quarter basis.

This good news comes as used vehicle prices, which had been dropping to worrisome levels, is also improving. The Manheim Used Vehicle Index increased to 127.4 from 124.5 on a quarter over quarter basis.  This is good news on several levels. Used vehicles increasingly take business away from new sales when the price drops and when an auto loan results in the repossession of the vehicle losses accrued to the ABS investment vehicle are lessened to various degrees.

But much like the auto picture in general, there is a downside. The increase in the general used vehicles index largely reflected higher sales prices of trucks and SUVs, not cars. Used cars actually fell in value and the overall picture could be changing as Moody’s anticipates “moderating demand and higher supply” to hit the used car market.

“Any sustained softening in demand will reduce prices, lowering recoveries on defaulted loans in auto loan ABS and reducing residual value realization in most auto lease ABS,” Moody’s analysts Keith Van Doren, Damiela Jayesuria and Anna Burns wrote in an August 24 report.

Auto loan delinquencies on the rise as Ford's loan losses increase

What good news there is in the car industry comes amid increasing Auto loan delinquencies and dropping credit scores of subprime loan holders.

Delinquencies of loans 60 days more past due rose to 0.66% from 0.58% and on loans 90 days or more past due rose to 3.9% from 3.5% on a quarter over quarter basis. The good news is the delinquency trend in 90 days past due loans are moderating. As well, the negative Auto loan delinquencies data is offset to various degrees by a decline in delinquencies of loans 30 days past due.

This comes as the average FICO for subprime ABS pools decreased to 573 year to date in 2017 from 579 in 2016.

Now enter Ford with their expanding of credit scores and this could have the impact of changing the ABS pool FICO score averages meaningful by simply increasing the pool of subprime loans. The stated goal of the new loan program, which is anticipated to be formally rolled out Friday, is to consider more than credit score, particularly among people with limited credit experiences. As an example, one area Ford is focusing on are those potential borrowers who have low credit scores because they have not taken loans from banks or mainstream lenders. While this represents enhanced risk, it does not involve borrowers with a history of delinquencies or defaults.

While credit standards are being altered for certain groups of people, it remains to be seen if delinquencies rise. If the firm can creatively identify those borrowers who have negative credit scores but do not reflect meaningful increased credit risk, the program would be profitable if Auto loan delinquencies don't rise to the point they offset profits from the associated sales gains.

But Ford’s track record at picking winning borrowers, particularly of late, has not been overwhelming. The auto maker wrote off $82 million in US consumer loans and leases in the second quarter, up 30% on a year over year basis. Ford's decision comes as analysts have been increasingly voicing concern about subprime auto lending standards.

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