Evergrande Creditors Left With Few Options As Beijing Sets The Agenda

China Evergrande Group’s creditors are now facing even dimmer prospects of ever getting their money back, as the country’s real estate crisis spreads and claims on the developer’s assets continue to pile up.

The deeply indebted company failed to meet its own deadline to unveil a restructuring plan by the end of July. In a late Friday evening filing to the Hong Kong Stock Exchange, Evergrande said it now hopes to formalize a plan to specifically restructure offshore borrowings before the end of the year, and the company’s stake in its electric vehicle and property management units can be offered as supplement “credit enhancement” packages.

But the Shenzhen-based property developer and its founder Hui Ka Yan will most likely have limited say in how this happens, as the government-supervised restructuring process has a new priority to take into account. Cash-strapped property firms, including Evergrande, Kaisa, Sunac and others, had suspended construction on pre-sold homes across more than 90 Chinese cities. Fearing that their homes may never be completed, many homebuyers have been boycotting their mortgage payments—which has put as much as 2.4 trillion yuan ($356 billion) of bank loans at risk.

Problems building in the country’s real estate sector run the risk of spilling into the financial system at a time when President Xi Jinping is widely expected to seek an unprecedented third-term at China’s national party congress to be held later this year. Although Evergrande is a commercial venture, Beijing will oversee it restructuring to ensure it conforms with the government’s top priority of maintaining financial and social stability.

“The current must-do for the Chinese government is making sure Evergrande delivers its already sold projects,” said Shen Chen, a partner at Shanghai Maoliang Investment Management. “The company is expected to put its limited resources on this first, and payment for the rest can wait.”

Creditors are likely to take a divided stance on this, said Shen Meng, director of Beijing-based boutique investment firm Chanson & Co. He said the company—and perhaps even Hui himself—is expected to contribute to funds that will be set aside for the construction of unfinished homes. Last week, Reuters reported that Beijing is considering setting up a fund of roughly $44 billion to help the distressed sector. The city of Zhengzhou, in the meantime, has already established a separate bailout fund aimed at resuming construction.

While onshore creditors are likely to conform with the government’s priorities and give Evergrande even more time, international debtors have a high probability of launching more legal proceedings—including lawsuits and winding-up petitions—against the firm to protect their interests, Chanson’s Shen said.

For them, recovery prospects are getting even weaker. China’s slumping property market has made project sales increasingly difficult, while the “misuse of cash under the property service arm has further hurt the recovery value of offshore bonds,” said Nomura credit analyst Iris Chen.

An investigation in July found that the unit in question—the Hong Kong-listed Evergrande Property Services—had used nearly $2 billion worth of its bank deposits as collateral to secure loans for unnamed third parties, and the borrowed amount was subsequently diverted back to the parent company and used for “general operations.” The collateral was later seized by the banks after the third-party borrowers failed to pay up, leaving Evergrande with less cash to satisfy the claims from creditors.

Several executives at the parent company–including its longtime Chief Executive Xia Haijun and Chief Financial Officer Pan Darong—had to step down, but that did little to quell the anger of international investors. Creditors holding debts backed by assets at Evergrande Property Services were demanding an explanation as to how the funds could have been pledged without disclosing this information to investors.

Nomura’s Chen predicted that international investors could now face a haircut of as much as 85%, up from the 75% estimate she first gave about a year ago. And the tangled net of debt doesn’t end here. On Sunday, Evergrande said in another filing that a subsidiary based in the southeastern city of Nanchang had been ordered to pay a guarantor almost $1.1 billion as compensation, and it will need to sell shares owned in the Shengjing Bank in northeastern China to cover that amount. Shu Hui Woon, credit analyst at Singapore-based research firm Lucror Analytics, said there is a good chance that more claims are on the way.

“It is unclear what assets the company still has as Evergrande might have provided guarantees that are still undisclosed or unclaimed at the moment,” she said in an emailed note. “The company will likely seek to negotiate with creditors to deter them from resorting to court, else the restructuring progress might be further delayed.”