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DALLAS-Comerica Inc., doing a show-and-tell presentation, told analysts its gravest exposure lies in its Western residential market, specifically California where it has $700 million invested in 150 commercial loans with 85% on a watch list. To ease the risk, some properties are being sold and others have been turned over to brokers to be sold.

“Our capital position remains strong,” Ralph W. Babb Jr., chairman and CEO of Dallas-based Comerica, repeatedly emphasized to analysts at the Lehman Brothers Global Financial Services Conference, which wrapped up yesterday at the Hilton New York Hotel in New York City. Babb says a capital optimization strategy is in place and working. It includes reducing the number of new branch openings this year to 29 and staff cuts, where possible.

Ironically, Comerica started this week by declaring it is opening three centers in the San Diego area: Fenton Marketplace in Mission Valley, Hillcrest neighborhood and Carlsbad. Mission Valley is open and the other two will come on line in early 2009, taking the financial giant to 12 offices in San Diego County. Additional banks will open in Oakland, Los Angeles and Phoenix. In the past four years, Comerica has gone from 41 banks to 85 in the state and more on the way. Comerica, with 416 banking centers, will add four more locations this year in Phoenix, 10 in Texas, one in Florida and none in its former port, Michigan, where it operates 234 locations.

“We have the size, scale and market position to be an increasingly important market player in some significant markets,” said Babb, who heads up the largest bank headquartered in Texas. Last year’s headquarters move to Downtown Dallas from Detroit has helped “advance our strategy” to expand into high-growth markets, he added.

But, its California lending push has caused some reservations, based on comments during the Lehman call. Comerica took $73 million of its $112 million of Q2 charge-offs thanks to its commercial portfolio “primarily due to ongoing weakness in the California residential sector,” Babb said. The Western region accounts for $16.9 billion or 32% of the bank’s $52.4 billion of outstanding loans at the second-quarter close and $58 million of commercial charge-offs. Its largest market is the Midwest, which represents $19.3 billion or 37% of the total.

To put the financial picture into perspective, though, CRE loans are just $7.1 billion or 14% of Comerica’s full stack of outstanding loans. The financial team reported non-performing loans, excluding commercial, rose 61 bps, driving the watch list total to 9.3%. “This will increase as we provide excess net charge-offs,” Babb said.

Non-accrual loan write-downs averaged 28%, according to the executive team. Babb squarely put the blame on the doorstep of commercial developers of residential product in the California market, where 85% of the 150 projects are on a watch list–virtually all rolling onto the roster in the past six months.

In comparison to its peers, Babb said the non-performing portfolio and watch list are “manageable” tallies. The plan is to limit exposure by reducing the business that it books in California and focusing on the middle market. “Outside of commercial real estate, all the business lines were displaying good credit in the second quarter,” Babb said.

Babb admitted Comerica’s team “missed” the mark in California’s valuation drop. “It was overpriced and we didn’t see it coming that it would stop,” he told analysts. The outcome is Comerica has implemented “tougher stress factors,” he said. “The good news is it’s contained and we’ll move forward.” New appraisals are underway for the California properties as part of the repositioning plan.

To cope with Freddie Mac and Fannie Mae, Babb said Comerica plans to “selectively reduce its outstanding loans” by $2 billion to $3 billion in 2009. The staff too will be consolidated and cut, where possible. “This plans does not hinder our ability to grow new relationships,” he stressed. “We are working hard to leverage technology and maximum productivity to execute on our growth strategy. And, we are working hard to stay ahead of the credit issues in a continued weak economic environment.”

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