As winter approaches, banks brace for defaults on restaurant loans

Some banks that make loans to restaurants are bracing for a wave of delinquencies and defaults next year as federal stimulus funding runs dry and winter weather limits the outdoor dining options that kept many eateries’ revenue flowing during the coronavirus pandemic.

While lenders agree that quick-service eateries have largely rebounded from the plummet in sales caused by stay-at-home orders and returned to making regular payments, full-service restaurants have been slower to recover.

Exactly how much trouble lies ahead might be clearer by the end of December, said Bob Derrick, the chief credit officer of Synovus Financial in Columbus, Ga. The $53 billion-asset bank has a $1 billion restaurant portfolio, of which 45% are loans to full-service restaurants. Derrick said that while many full-service eateries have recovered as much as 85% of pre-pandemic revenues, he worries that revenue won’t return to 100% until those establishments are able to operate at full capacity, without restrictions.

“Absent another stimulus package and absent any kind of new [Paycheck Protection Program], there’s just not another lifeline available,” which sets the stage for defaults next year, Derrick said. “I think this quarter will be the telltale quarter…because all of the lifelines are starting to run out.”

Restaurants have been particularly hard hit by the pandemic as social distancing measures forced many to close their doors for weeks early on and to limit capacity even after stay-at-home orders were lifted.

Between March 15 and June 15, restaurants accounted for 12% of all U.S. business bankruptcies, the highest percentage of any industry during that period, according to global restaurant consultant Aaron Allen & Associates, a Chicago-based firm that advises the foodservice and hospitality industries. The firm estimates that 10% to 15% of all U.S restaurants — mainly casual dining, full-service restaurants and independents — will close for good by the end of the year. And if there is another nationwide surge of the virus and without additional aid from the federal government, the figure could rise to 20%.

Firm founder Aaron Allen said restaurants received $32 billion in the first round of PPP funding, or roughly 9% of the total funds allotted. While that money “helped keep many alive” it’s not enough to cover the losses, Allen said.

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“It’s going to be hard to recover, even once restaurants are back at full capacity — the timeline for which is still a long ways out at this pace,” he said in an email.

Quick-service restaurants have been able to transition more successfully than full service, in part by shifting to online ordering and ramping up curb-side, drive-through and delivery options. Full-service restaurants trimmed their costs by reducing their workforce, selling inventory and limiting their menus, but in many cases it has not been enough.

The upcoming winter season won’t help, said analyst Terry McEvoy of Stephens Inc.

“As cold weather hits, what will happen to those restaurants that relied heavily on outside dining to serve customers?” he said. “In New York, Chicago, the Northeast, are those diners going to be comfortable eating outside … and at limited capacity, can those restaurants operate profitably?”

At Cadence Bancorp. in Houston, loans to quick-service restaurants account for about 70% of its $1.1 billion restaurant book. Dan Holland, the executive vice president of restaurant banking, said that segment, which includes chains such as Taco Bell, KFC and Pizza Hut, “continues to perform and outperform the rest of the industry” but that its loans to casual-dining establishments are stressed. The $18.4 billion-asset Cadence reported net charge-offs of $19.9 million for the third quarter, 75% of which were tied to the restaurant portfolio.

“The not-so-rosy part is casual dining concepts that really saw a big shock,” Holland said. “They’re more challenged because of social distancing policies, so it’s taking those guys longer to recover.”

Revenues have rebounded since the spring, when they were down by as much as 85% year over year. In the third quarter, revenues at the casual-dining restaurants were down 15% to 30% year over year, he said.

“You can’t mask that all, but it’s certainly better than it was at the onset of this pandemic,” he said.

During the third quarter, the bank set aside $33 million for potential bad loans, down from $158.2 million in the prior quarter. The bank has been actively de-risking its loan book for several quarters, including paring down restaurant loans. That segment declined by $63.1 million during the quarter due to activity such as pay downs and charge-offs.

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Synovus is experiencing the same split when it comes to quick- and fast-service eateries. By the end of the third quarter, 5% of the bank’s full-service restaurant loans were in deferral, compared to zero in the quick service category. To avoid defaults, Synovus is working with owners to try to modify or restructure loans, but there is a realization that not all restaurants are going to make it, Derrick said.

“If there is some potential to get back to a level that’s acceptable in terms of revenue, if you’re working with guarantors and investors to come up with a plan, that’s a possibility” to help get back to profitability, he said. “But a number of them will not come back.”

Meanwhile the $37 billion-asset F.N.B Corp. in Pittsburgh is being cautious by setting aside nearly $23 million in the third quarter to cover potential losses on loans to hotels and restaurants. During the recent quarterly call, Chief Credit Officer Gary Guerrieri told investors that the bank “took aggressive risk rating actions against the COVID-impact portfolios,” including shifting 90% of the hotel portfolio and 25% of the restaurant portfolio into “classified” and “special mention” categories as a way to “prudently build reserves against” those pandemic-vulnerable industries.

Still, Guerrieri expressed optimism that restaurants and hotels will be able to “weather the storm.”

Webster Financial in Waterbury, Conn. is similarly optimistic. Sixteen percent of the bank’s $176 million restaurant of restaurant loans were in deferral as of Sept. 30, down from 28% in June. Chris Motl, the head of commercial banking at the $31.7 billion-asset bank, said the current environment has been challenging and will get even tougher with the colder weather and the loss of outdoor dining in some areas.

“But,” he said in an email, “we have seen consumers change their habits, and non-travel spending is at levels from a year ago. We are optimistic this trend continues, which may increase spending on food and beverage in the coming months.”

Restaurants as a whole are holding up better than some anticipated, said analyst Collyn Gilbert of Keefe Bruyette & Woods. Even so, because the second round of deferrals is starting to expire, there’s an assumption that net charge-offs across all industries will stay elevated for a few quarters, Gilbert said.

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Once the first quarter passes, there should be a better sense of the true loss rate, Gilbert said.

“We expect an extended restructure period for a lot of credits and that will carry people through,” she said. “But we do think as they migrate through, some businesses will just have to close their doors and file for bankruptcy, which means loss recognition is more likely to come in the back half of 2021.”

At the $145.2 billion-asset Regions Financial, management has identified full-service restaurants specifically as a trouble spot in its loan portfolio. At the end of September, 40% of the bank’s loans to full-service restaurants were classified as “criticized” while 4% of loans to full-service eateries were in deferral.

Charge-offs across the entire restaurant portfolio were $32.7 million year-to-date, compared to $21 million for all of 2019. Chief Financial Officer David Turner Jr. told analysts that it’s hard to predict the timing of charge-offs.

“We continue to refine our view of high-risk portfolios through ongoing conversations with customers and market observations,” he said and noted that the portion of the bank’s portfolio considered high-risk declined from $8.4 billion at the end of the second quarter to $6.6 billion at the end of September.

At Eagle Bancorp in Bethesda, Md., commercial lenders are working with restaurant customers to see if they will be able to pivot their business models in a way that brings back revenue and staves off defaults. Management offered an initial 90 days of payment deferrals, followed by a second 90 days for those who needed it. Now the second round of accommodations is coming to an end.

At the end of September, 42% of the bank’s outstanding restaurant loans were in deferral.

“The trick is how we work with clients to navigate these [challenges] as well as we can,” said Tony Marquez, the president of commercial banking at the $10.1 billion-asset bank. “We’re not going to sit here and say, ‘boo hoo.’ What we have to do is proactively find solutions that allow those who will succeed in this market to succeed. The others, regrettably, won’t be faring as well and we have to figure that out.”

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