Who really owns Providence Place?

And will taxpayers get what they were promised?

by Richard P. Morin

Just who is the owner of Providence Place? It's hard to get a simple answer from anyone, but in sifting through the written testimony in what has turned out to be a contentious and somewhat lengthy legal battle between two of the mall's partners, one fact emerges: Nomura Asset

Capital Corp., the mall's biggest investor and a New York real-estate firm with the backing of one of the world's largest banks, based in Japan, may, if not now then in the near future, be one of the owners.

Even if Nomura is merely a financier, as Providence Place developers maintain, as a lender it enjoys all the privileges of an owner, including the potential to share in as much as 75 percent of the mall's profits as well as the right to force a sale of the retailing behemoth once it is built. And these privileges should give all Rhode Islanders pause, because instead of Fleet Bank, once a regional and now a national lending institution with longstanding ties to the Ocean State, financing Providence Place as originally planned, we have a giant international bank with no emotional connection to Rhode Island whatsoever holding the strings to our future economic growth.

As most people know, in addition to the $114.5 million Commonwealth Development Corporation initially borrowed from Nomura for start-up costs, last November Providence Place developers replaced a $260 million construction loan from Fleet with a $280 million one from Nomura -- a deal that was sealed just last Wednesday, with the total loan amount being slightly altered to reflect construction costs higher than initially anticipated. For Nomura, a company known for taking risks, the deal was akin to investing in a Third World country -- their only interest was to make money.

Fleet, of course, is also an international player, whose headquarters are now in Boston. Still, the company certainly has proved to be a supporter of Rhode Island over the years, with offices and jobs here and hundreds of thousands of dollars invested in local charities and causes. As a result, Commonwealth's decision to switch banks has caused a ripple of concern among some mall observers. But, oddly enough, city and state officials, including Governor Lincoln Almond, don't seem disturbed by it. Almond's spokesperson, Eric Cote, says, "The bottom line is the mall is being built."

That's not the way Alexius C. Conroy, a Connecticut-based mall developer with a ten-percent interest in Providence Place, sees it, however. Last fall, he sued lead developer J. Daniel Lugosch III and his partner, Peter Steingraber, in US District Court, claiming that their buyout of fellow mall partner Robert J. Congel with a loan from Nomura violated a 1989 agreement signed between the partners.

It was during the court battle between the two estranged mall partners that the details of what some consider Providence Place's speculative financing and ownership arrangement came to light. According to the sworn written testimony of several real-estate experts (including the former head of the Prudential Realty Group), Nomura, as a result of their providing the funds to buy out Congel, is now an owner of Providence Place and not just a lender. As proof, the experts pointed to the profit-sharing arrangements between Nomura and Commonwealth and to several other provisions in the loan agreements not normally associated with lenders.

As part of the loan agreement, Nomura, a subsidiary of Japan's largest investment bank with well over $100 billion in assets, stands to share in 55 to 75 percent of the mall's net profits starting on December 31, 2000 -- four months after Providence Place is scheduled to open. And this profit-sharing is a "highly unusual right, and certainly one not normally possessed by a true lender," says William Hecht, a partner in the New York City-based accounting firm of M.R. Weiser & Co., in court documents. "Lenders are simply not in the business of taking over successful borrowers."

In an interview with the Phoenix earlier this month, Doyle described the Nomura loans as a form of "hybrid financing" common on Wall Street. He added that it is not uncommon for lenders that provide the majority of financing in a real-estate development to receive a portion of the profits in return. In Nomura's case, the company is providing developers with 98 percent of the roughly $350 million in developers' costs -- further evidence, according to Hecht and other real-estate experts, that Nomura is an owner. (An additional $100 million will be paid by Providence Place's individual retailers to build the interiors of their own stores in the mall.)

In particular, what makes Nomura's loan different from others, says Doyle, is that it gives the real-estate company the right to exercise warrants that would give it a "special class of ownership" once the mall is stabilized in 2001.

The state, which must approve of any lenders and new partners in the project, has already approved of Nomura as both a lender and a partner in Providence Place. And it seems that Nomura is now getting its affairs in order to become an owner (if it already isn't one) in the near future. "Currently, the state considers Nomura a lender," says Mary Talbot, spokesperson for the Economic Development Commission. But in the next few weeks, she expects documents to be signed that will offer Nomura the opportunity to "convert from a lender to a minority partner in the project."

Doyle defends Nomura's right to become an owner of Providence Place by saying, "Nomura is clearly not entering in this deal to just make nine percent interest [on their loan]. They have put up an enormous amount of money, and they expect to see a return on that investment." Still, he insists that although Nomura will share in profits and have the opportunity to become a minority owner, Lugosch and his partners in the Commonwealth Development Corp. will maintain control over the day-to-day operations of Providence Place.

But even if this is true, Nomura still has ultimate control, as they can force a sale of Providence Place. According to the written testimony of Mark L. Kaplan, a partner in the accounting firm of David Berdon & Co. in New York, a memorandum from Nomura executives dated January 8, 1997 says Providence Place will be up for sale in January 2001. The memo goes on to say that Nomura expects to make a profit of $90 million to $150 million off this sale.

Although both city and state officials say they are unaware of Nomura's right to force a sale, they contend that they are protected in such an event. In fact, agreements signed between mall developers and the state actually allow for the sale after Providence Place is built. But they also require that any new owners have extensive experience in running large malls. "Nobody intended Dan Lugosch to own the mall for 30 years," says Joseph Larissa, Almond's executive counsel. "And if Nomura decides to exercise their option to become a part owner in the mall, the state will welcome them with open arms."

To protect the taxpayers of Rhode Island, both the city and state have written into their agreements with Commonwealth that any new owner of Providence Place must abide by all the conditions of the present, signed contracts. These include the sales-tax agreement between the mall's owner and the state and Providence's 30-year payment plan in lieu of taxes. (If the city's tax treaty is realized, the plan is worth some $141 million to Providence.) Also, if the new owners do not provide a written statement attesting to how they will abide by all present terms, city officials can reject the sale of Providence Place, says deputy city solicitor Patricia McGlaughlin.

On the other hand, if this project has proved anything, it is that no agreement is set in stone, as documents between the state/city and mall developers already have been rewritten once and agreements between mall owners themselves have been contested in court. What's more, if Providence Place is sold, the contracts could fall by the wayside altogether, says radio talk-show host and political consultant Michael Vallante.

"If Nomura sells the mall, the people they sell it to are going to walk in and say you [the state] are going to have to do X, Y, and Z to keep the mall open. Rhode Island politicians will say, `Our hands are tied,' and they'll jump through every hoop and deliver just what they [the new owners] want."

Over the last year, Nomura has quietly increased its role and stake in the building of Providence Place. (Company officials have not publicly commented about their participation in Providence Place, while Nomura's spokesperson, P.J. Johnson, declined to talk to the Phoenix.) And there may be a very calculated reason for their behind-the-scenes approach -- Nomura officials may not want to draw attention to the fact that their Japanese parent company, Nomura Securities Co. Ltd., has allowed itself to be extorted by the Japanese Mafia over the years and has developed ties to criminal figures in Japan.

Mall developers have taken great pains to point out that Nomura Asset is far removed from its parent company's troubles in Japan. And, in fact, Nomura Asset is spinning off into another company that would be based in San Francisco. But Providence Place's New York-based financier, which has rapidly become a major player on Wall Street and the nation's largest lender of construction projects, also is not without critics.

Nomura Asset has been highly successful in the high-stakes game of packaging and trading collateralized mortgage obligations. That means that Nomura lends money, often hundreds of millions of dollars to developers, and then packages and sells the mortgage loans, reaping enormous profits in the process.

Nomura has been criticized the most for the speed at which they make these loans. Indeed, Ethan Penner, the highly successful head of the company, is a 30-something wunderkind who counts junk-bond kingpin Michael Milken among his heroes. In a profile of himself in Business Week, Penner boasted, "We take more risks than anyone else on Wall Street."

While traditional banks, such as Fleet, take months to deliberate on loans to builders, making sure projects are viable and developers financially sound, Nomura traditionally advances funds in mere weeks. Although this has made Nomura quite popular among real-estate developers, particularly cash-starved ones, the company also has made even fellow risk-takers on Wall Street nervous.

Financiers quoted in a Wall Street Journal article last August said that, in their rush to cobble together loans for sale, Nomura officials probably were not scrutinizing them as carefully as they should have been. Some even worried that the overzealous nature of this new type of gung-ho financier would lead to disaster, with Nomura-backed projects collapsing. And, in fact, at least two multi-million-dollar construction loans from Nomura have gone sour over the last three years. One involved a nursing home in Arizona; the other, a shopping center in Virginia.

Critics maintain that Nomura also has made a number of risky loans that rating agencies have refused to rate, forcing Nomura to hold on to the loans rather than sell them, as is the firm's practice.

Just how closely Nomura officials studied their loans to Lugosch and his partners in Providence Place is unclear.

What is certain, though, is that in the process of loaning the money, Nomura inherited all of the city and state tax breaks and public subsidies originally intended to make the project financially feasible for developers. These include tens of millions of dollars in sales-tax exemptions (some estimates place the tax breaks value at over $112 million); $42 million in new highway ramps and pedestrian walkways paid for by the state; and a piece of property the state purchased for $11.1 million.

State Representative Bruce Long (R-Middletown) says he is not so sure that his colleagues, as well as the state's residents, would have supported such aspects of the project had they known that one of the world's biggest banks would benefit from them. The original tax deals struck between the city and state and mall developers were intended to help Lugosch and his partners pay their debts on Providence Place. But since Nomura is -- or stands to be -- an owner of Providence Place and, in either event, collects upwards of 75 percent of the mall's net profits, the state has inadvertently increased Nomura's bottom line.

But even though the state never intended to endow Nomura with its subsidies for mall owners, Cote, Almond's spokesperson, says it is "naive" to think that one of the world's largest banks doesn't deserve state and city subsidies and that concessions shouldn't be made to banks like Nomura to convince them to do business in Rhode Island. Joseph Larissa, Almond's executive counsel, agrees.

"So what if they received a tax subsidy," he says. "We've been getting nothing [in way of taxes] from that parcel of land prior to this agreement. The most important thing for the city and the state was to get this mall built."

With an economy that has traditionally trailed most states, Rhode Island needs the new upscale mall and the potential growth it represents for downtown Providence to help offset the loss of the state's long-departed manufacturing base. Already, Providence Place is reaping economic benefits for the state. Since its groundbreaking, at least six multi-million-dollar development projects in downtown Providence have been unveiled, including the building of at least three new major hotels.

The mall project also has put hundreds of Rhode Islanders to work constructing Providence Place, thus increasing the state's income-tax revenues, while anticipated development downtown and permanent jobs at Providence Place will further boost the state's income-tax collections. More important, the mall will hopefully help fill the largely unused Convention Center and attract an influx of out-of-state visitors whose retailing dollars will generate an estimated $8 million a year in new sales-tax revenues. And this is why Rhode Island politicians and business leaders are so desperate to get Providence Place built.

Indeed, the state did more than offer Nomura a few perks to lure them to Rhode Island -- legislators actually cleared the way for the real-estate company to make more money than what was allowed under state law. Last June, the General Assembly approved an exemption to a Rhode Island statute that protects consumers from high-interest rates on loans and, in the process, allowed Nomura to exceed the state's 21-percent maximum on loans to mall developers.

To be fair, legislators may have had little choice but to pass the bill if they wanted Providence Place to be built. At the time, Fleet, which had originally agreed to fund construction, had decided to postpone its loan until the conclusion of Conroy's lawsuit against Lugosch. But Lugosch needed at least $49.5 million right way to lock up a steel fabrication bid. Otherwise, the project would have veered off course once again, resulting in yet another financial setback.

As a result, Nomura offered to loan the money, as long as they were granted an exemption that would allow them to include profit-sharing as part of the "additional interest" on the loans. In other words, it was now or never for the state and mall developers.

When the House leadership hastily called for a vote on the exemption, the lone voice of opposition was Long, who requested that the bill be sent to the House Corporations Committee for review and approval. Because of his vote (one is all it takes to send a bill to committee), the proposed legislation was delayed and hearings were held. But when it was sent back to the floor a week later, Long says that he was literally encircled by his colleagues. Facing intense pressure, he ignored his gut feeling and voted for the project.

Many others apparently succumbed to pressure from the House leadership as well, says Long. Overall, the General Assembly "was not privy to the details of this agreement. And I think many members . . . still don't understand what this [the bill] means," he says. "What's extraordinary is that it took a court case for the public and much of the General Assembly to find out the details of our own legislation."

Like the rest of Rhode Island, state officials also seem to be in the dark as to when, exactly, the mall will open. Gilbane Building Co., Providence Place's initial general contractor, left the project last December when they couldn't come to an agreement with Lugosch on the construction cost or completion date. (Gilbane had yet to sign a contract with Commonwealth.)

Gilbane was quickly replaced by the New York-based Morse Diesel, which is now under contract to complete Providence Place by August 1999. Although the parting with Commonwealth was amicable, Barbara Payne, director of corporate communications for Gilbane, says that Gilbane officials do not believe that Providence Place can be completed by that date. It also remains to be seen whether the increase in construction budget (to $181 million) will be enough to build Providence Place, she says.

If Providence Place doesn't open on time, Lugosch and his partners may be in serious trouble. Lease agreements with anchor tenants Filene's, Lord & Taylor, and Nordstrom can be voided if Providence Place falls behind schedule. And if even one anchor tenant pulls out, mall owners will not be able to make their loan payments and Providence Place will fail, according to Lugosch's own court testimony. Lugosch also has other reasons for needing Providence Place to open on time -- in court documents, experts say that a portion of his multi-million-dollar loans is already collecting interest, so the clock is ticking.

Overall, the parameters of success are getting tighter and tighter, as the price tag for Lugosch's dream project continues to rise (from $330 million to the present $455 million) along with his debt obligation to Nomura. Much of this cost increase is a direct result of the delays in bringing the project to completion. And, according to Doyle, the court battle between Lugosch and Conroy also has cost the project millions of dollars beyond anticipated legal fees.

What's more, Rhode Island officials may have pushed Lugosch further into the hole two years ago, when they insisted that he land Nordstrom, the pricey Seattle retail giant known for its impeccable service and upscale clientele, as Providence Place's main attraction.

Nordstrom is the nation's largest independently owned fashion specialty retailer. In 1996 alone, they did more than $4.5 billion in sales. As a result, wherever the "Rolls Royce of retailers" has opened a store, a buzz of shoppers and ringing cash registers have followed. For the last two years, though, Nordstrom has been in an economic slump, and these setbacks have left analysts and company officials wondering when the retailer will rebound and post numbers that once again will make Nordstrom the envy of the retailing world.

In the last few weeks, Nordstrom's stock has dramatically plummeted by some 20 percent. And company co-president Pete Nordstrom has said publicly that the retailer has had difficulty adapting to new retailing trends. Perhaps Lugosch recognized this when he ended his attempts to land the Seattle retailer after Nordstrom officials initially resisted his invitation to Providence Place. But then the .state made it clear to Lugosch that "it would help them [developers] tremendously if they could get Nordstrom," says Doyle. So Lugosch sweetened the pot and tried again.

"The administration, frankly, refocused Dan's attention," says Doyle, "and although he thought many times he didn't have a chance, he redoubled his efforts and brought in Nordstrom."

But by bringing in the Seattle retailer's store, Lugosch may have paid a heavy price. So desperate was Lugosch to make city and state officials happy by making Nordstrom Providence Place's crown jewel, he agreed to pay the cost of building the store. Although Providence Place developers will not say how much they will pay to do this, the price tag has been estimated at around $23 million.

Nordstrom's lease terms also are particularly favorable to the retailer. Asked if Nordstrom received a lease agreement with below-market value, Doyle says that the Seattle retailer was "unquestionably" treated differently than other Providence Place tenants.

These additional and unanticipated building costs and legal battles may be pushing Lugosch to his financial limits. Even his own spokesperson says that things are getting tight. "The margins [the amount of money developers must raise in order to pay back loans and keep the mall open] got tighter by the end of the dealings with the state legislature, the city, and the court battle with Conroy," says Doyle.

Unlike other mall developers, though, Lugosch has stayed in this project at times when it did not make any financial sense, says Doyle. "Sometimes you are so far down the path, you have no choice but to continue down the path."

Richard Morin can be reached at rmorin[a]phx.com.

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