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The potential problem with record U.S. auto sales

With U.S. auto sales barreling along at or near record levels just about every month lately, what could go wrong? Well, people could stop buying new vehicles. Or to some observers something even more worrying could happen: Americans might stop paying back their auto loans.

And here, the statistics are concerning. Fitch Ratings reports that the number of consumers who had fallen "seriously delinquent" -- 90 days or more behind -- on their car payments hit a 20-year high in February. But they fell in March. Good news, right?

Actually, Fitch warns that the reprieve won't last because of the growth in subprime auto lending, that is, loans made to buyers with the lowest credit quality. You remember what happened to all those subprime home loans several years ago? Well, that's why some on Wall Street are wondering if the auto sector is headed for "carmageddon."

Subprime auto loans on the rise

Fitch did an analysis of loans that were bundled into asset-backed securities (ABS) to be resold to investors and found that those serious delinquencies slipped to 4.15 percent last month from 5.16 percent in February. The ratings agency said the drop-off was due to several factors, including borrowers using tax refunds to pay off debts along with seasonal trends typically seen in Fitch's Auto ABS Indices.

"Pressure from weaker underwriting standards in 2013-2015 transactions will continue to negatively affect the indices in 2016 irrespective of seasonal trends," Fitch said. "Increased lending to borrowers with weak or limited credit history will move delinquency and loss frequency levels higher."

That's why subprime loans are so worrisome. According to data from Experian, 10.7 percent of all new car loans of went to subprime borrowers as of the fourth quarter of 2015, the latest data that's available. The rate in the year-earlier period was 10.08 percent.

Average credit scores for new loans are about 711, a decrease from their peak of 736 in 2009. Wells Fargo (WFC) estimates that the default rate rose to 12.3 percent in January, the highest since 2010, from 11.3 percent in December.

Will pent-up demand for cars spread to other retailers?

Even so, some auto industry analysts, such as Charles Chesbrough of IHS Auto, remain bullish on the sector. He expects to sales hit a record 17.8 million this year compared with 17.5 million last year.

"There is some concern that delinquencies are up," he said. "However, some of the increase may be explained by the fact there is more subprime lending, and these borrowers always have more delinquencies than higher-tiered buyers."

A robust job market, cheap gas and low interest rates will fuel demand for vehicles and negate concerns that the auto market might implode like housing did a few years ago in the run-up to the Great Recession, according to Chesbrough.

Still, lenders aren't only willing to make loans to less creditworthy borrowers, they're also extending loan payback periods far beyond the typical 48 months. J.D. Power & Associates shows in the most recent quarter that loans of 72 months or longer accounted for more than 33 percent of sales, continuing the growth seen over the past few years.

As of the most recent quarter, 31.3 percent of all car owners owe more on their cars than the cars are worth, also referred to as being underwater or having negative equity. This may make it difficult for consumers to trade in cars when they go back into the market in a few years. "It's something to be monitored," said Deidre Borrego, a senior vice president at J.D. Power.

And if they default on their current auto loan, good luck trying to get another one.