This story is part of a series looking at how the coronavirus is impacting the tourism industry and the lenders exposed to it. Read more here.

A year ago, fast-food restaurants struggled to manage profit margin pressures as labor costs pushed expenses while online delivery competitors ate into market share. The COVID-19 pandemic has turned the tables, leaving full-service restaurants — and the finance companies that lend to them — most vulnerable.

As the virus swept through the country and government officials mandated the closure of public businesses, sit-down restaurants that depend on an intimate experience seem particularly exposed. On the other hand, fast-food operations have largely remained open with drive-thru windows conducive to social distancing.

For the financial sector, the dynamic could translate to relative strength for banks, which focus more on fast food, and losses for nonbanks with exposure to higher-end concepts that rely on full tables. Industry experts say losses for lenders will ultimately depend on each loan and the restaurant's market, concept and ability to execute.

"Restaurants are less capitalized by nature. When you're dealing with an undercapitalized industry with thin margins, you can't function profitably when your foot traffic drops 50%," said Benjamin Sabraw, a managing director for SMS Financial LLC, an investment firm that specializes in nonperforming loans. "Even at 35% [less traffic], you're not able to make a profit."

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Some markets have started to reopen, and consumers have shown eagerness to go out for a meal.

"Take Florida, for example. People were anxious to get out, and that in and of itself will create demand for restaurants," said Dan Holland, head of restaurant lending for Cadence Bancorp., adding that his Florida-based restaurant clients reported a bump in traffic over Memorial Day weekend. "I think it will be municipality-specific."

But demand remains far below normal levels in markets nationwide. Restaurant bookings in Hawaii were down more than 94% year over year on June 22, marking the nation's largest decline, according to online booking agent OpenTable. Rhode Island was the sole state with an increase, with bookings up 1%.

Opportunities in the new normal

For banks with exposure to restaurants, their general focus on "quick-service" or "limited service" restaurants, often known as fast-food or fast-casual establishments, should limit losses.

An S&P Global Market Intelligence analysis of first-quarter disclosures found Wells Fargo & Co. with the most restaurant loans outstanding at $5.8 billion. Of that total, $3.9 billion was in limited service restaurants.

Concentrations in limited or quick-service restaurants were similar at other banks. Cadence Bancorp. reported that quick-service accounted for 68% of its portfolio. The bank reported charge-offs in its restaurant portfolio in the 2019 second and fourth quarters. With just over $1 billion of restaurant loans as of the first quarter, or roughly 8% of gross loans, the bank has one of the largest concentrations in the industry.

But much of the bank's problem credits were driven by rising labor costs in the fast-food industry, such as new minimum wage laws and a competitive labor market, executives said. As the pandemic has required restaurants to close in-store dining, operators require less labor to run the business.

"Now, we're seeing operators with a drive-thru only business. It's a more efficient labor model," said Cadence Chairman and CEO Paul Murphy. "Some of the operators are making comments that in the future restaurants will be smaller and off-premise will be bigger."

Murphy said Cadence plans to continue pruning its restaurant exposure, targeting a book of $750 million. But the bank will still consider new loans and recently evaluated two deals in a week, Murphy said. With the economic uncertainty, the bank is focused on borrowers with moderate to low leverage, but underwriting on cash flow is a tall order considering the number of unknowns, Holland said.

"What does this look like on the other side?" he said. "That's where we're really digging deep and making sure we understand what the new normal looks like. In a lot of cases, it's just to-be-determined."

Many lenders are in the same boat, said Derek Ladgenski, a partner at law firm Katten Muchin Rosenman who advises companies, including restaurants, on debt financing. He said lenders have required less leverage, more equity contributions and fewer borrower-friendly legal provisions when considering new deals. For existing credits, lenders, and especially banks, have generally worked with borrowers to delay principal and interest payments.

"People who know the space are well-positioned to come out of this OK," he said. "They don't know when it's going to be OK or how long it'll take, but they know lending is a partnership."

Among full-service restaurants, where customers order from a server, financiers say owners are similarly changing operations to adjust for the pandemic. Distancing tables and relying on take-out orders might be sufficient for certain business types, but higher-end restaurants will struggle to turn a profit under those conditions, said Jason Ader, founder of SpringOwl Asset Management, a hedge fund that targets distressed companies.

Pandemic practices such as spreading out tables reduce restaurants' revenue while more stringent cleaning measures and the printing of single-use menus will push up costs.

"Fine dining will struggle because it's just critical to have two seatings, and it's critical to have density," Ader said. "It was a tough enough business to begin with. If these are the rules for a significant period of time, no restaurant can survive."

Alaskan wilderness

Lenders expect markets to recover at significantly different rates. While the quicker reopening for states such as Florida has jump-started business, there are also indications of a spike in COVID-19 cases, which could derail the recovery. Meanwhile, markets more reliant on seasonal tourism are already facing the prospect of a lost year.

One of the states taking a slower reopening path is home to markets particularly exposed to restaurants and hotels. Alaska has required out-of-state visitors quarantine for 14 days, a policy that was lifted June 5. The state is particularly reliant on the cruise industry, which brings thousands of tourists who visit port towns and take land excursions to see the state's natural beauty. Among U.S. counties, the Denali borough in Alaska is the most exposed to accommodation and food services industry.

Prospects for Alaska's hospitality industry are particularly strained by its latitude. The tourist season typically runs from May 15 to Sept. 15, so the loss of two or three months — many operators have delayed opening until July 1 — represents the loss of nearly half their prime money-making season, said Vanessa Jusczak, director of the Denali Chamber of Commerce.

Still, most small businesses in Denali are planning to open and are hopeful they can survive the pandemic, Jusczak said. While the short money-making season amplifies the loss of business, it also increases the value of funds received via the government's Paycheck Protection Program, which covers eight weeks of expenses in the form of a forgivable loan with conditions.

"I'd say there's a 50-50 split between worry and optimism," Jusczak said in an interview, adding that in-state travel has seen a surge as Alaskans take advantage of empty campgrounds that are usually chock full of out-of-towners. "Everyone is banking on other Alaskans taking staycations."

But Jusczak said it seems clear that in-state travel will not be sufficient to replace cruises, which an industry group projects brings 1.4 million visitors a year. Several smaller lodges and businesses in remote areas have already closed down for the year, she said. More than one major cruise line has canceled Alaska trips for the season. Cruise companies tend to partner with local businesses, tour operators and restaurants in port cities to offer visitors activities while docked, said Alicia Maltby, executive director of the Alaska Hotel & Lodging Association.

"It's going to be tough," she said. "I think everyone is focused on 2021 at this point."