DBRS Confirms Sky Financial Group, Inc. at BBB (high)

Dominion Bond Rating Service (DBRS) has today confirmed its ratings on Sky Financial Group, Inc. (Sky or the Company) and its bank subsidiary, Sky Bank, as indicated above. DBRS also assigned a rating of BBB to Sky’s Trust Preferred Securities. In addition, DBRS also assigned ratings to Sky’s other banking subsidiary, Sky Trust, N.A., of A (low) to Deposits & Senior Debt and R-1 (low) to Short-Term Instruments. The rating action follows a detailed review of the Company’s operating results and financial fundamentals. The trends on all ratings remain Stable.

Sky’s ratings reflect an Ohio-based, five-state community banking franchise with recurrent core earnings, strong asset growth, an entrenched core deposit franchise and a granular commercially-based loan book. The Company’s below-peer credit quality, elevated concentration in commercial real estate, less robust liquidity and high-cost deposit mix are also embedded in the assigned ratings.

In 2005 and H1 2006, Sky’s revenues continued to strengthen from balance sheet expansion and fee income growth. However earnings contracted due to higher credit provisions of $52 million in 2005 and the absence of the one time $20 million after-tax gain on the sale of its dental finance business in 2004. The 2005 Belmont Bancorp and Falls Bank acquisitions increased revenues and expenses while loan growth exceeded deposit growth, increasing non-core funding reliance for the year.

In February 2006, the Company announced the acquisition of Union Federal Bank of Indianapolis (Union Federal), which is expected to close in the third quarter of 2006. DBRS notes that the Union Federal transaction will give Sky instant scale with 43 branches and a $1.8 billion fourth ranked deposit share in the Indianapolis metropolitan area that has more favorable demographics than much of the Midwest. This transaction is also consistent with the Company’s strategy to shift its focus to metropolitan markets. DBRS believes that Sky will be challenged, however, in reducing Union Federal’s reliance on wholesale funding while rebuilding Sky’s capital ratios and reducing its double leverage.

Sky has built its $16 billion multi-state community banking franchise from a $600 million bank by acquiring 19 banks or thrifts and 11 insurance brokers since 1990. The Company has grown primarily due to these successful acquisitions and has a dedicated and experienced integration team that proactively manages the merger process and has considerable technical expertise.

Sky’s profitability is sound, recurrent and at peer average levels. The Company’s net interest margin is in line with its regional peers and has remained stable over the past few years in contrast to the declines experienced by many banks. Sky’s deposit mix has a relatively high amount of certificate of deposit (CD) funding and a low amount of non-interest-bearing deposits, which elevates its funding costs above peers. DBRS believes that Sky’s profitability would significantly benefit from transforming this deposit mix by increasing low-cost business deposits and lowering the proportion of CDs. Fee income levels are above peer average at 30% of revenues and the Company has successfully replaced declining mortgage revenues with increased insurance commissions, trust fees and deposit service charges. A competitive advantage for Sky is its strong operating leverage as its level of efficiency far exceeds its peers.

Liquidity is a challenge for the Company, which is only about 85% core-deposit-funded and therefore has a higher-than-average reliance on wholesale funding. In addition, Sky’s coverage of its obligations at the parent holding company without upstreamed dividends was 69% at June 30, 2006, and elevated rollover risk was also noted.

The loan portfolio, which is 69% commercially based, is highly granular and nearly entirely collateralized. Sky has an outsized core commercial real estate (CRE) portfolio currently representing an elevated 3.2 times tangible common equity (TCE). Additionally, over 70% of the Company’s largest commitments are CRE-related. Growth in the CRE portfolio would not be viewed favorably from a ratings perspective. This exposure is mitigated by the granularity of the portfolio, along with property type and geographic diversification within the Company’s Midwest footprint. Furthermore, the Company has experienced minimal level of losses in the CRE portfolio over the past three years, a period that included a number of acquisitions. Given the level of exposure and portfolio composition, however, DBRS believes that the Company’s earnings and capital would be pressured in the event of a regional CRE downturn. DBRS notes that given Sky’s geographic location, exposure to the automobile industry is nominal at less than 2% of loans.

Credit quality improved in 2005 and through H1 2006 after declining for several years; however, metrics including reserve levels continue to lag similarly rated peers as the Company works through its portfolio of acquired credits. While asset quality is lagging, credit costs are readily absorbed by Sky’s solid core earnings. Given the Company’s disciplined underwriting standards and vigorous credit review process, DBRS expects credit quality to improve over the medium term.

Sky Financial Group, Inc., the sixth largest public bank holding company headquartered in Ohio, is a community financial services company with approximately $16 billion in assets and 297 branches operating two banking subsidiaries, Sky Bank and Sky Trust, N.A., as of March 31, 2006.

The A (low) Deposits & Senior Debt ratings of Sky Bank and Sky Trust, N.A. are equivalent to DBRS’s intrinsic assessment (IA) of the Bank’s SA-3 support assessment (SA). For more detail on the IA and SA methodology, please see the related DRBS press release issued on June 1, 2006. At the date of this publication, DRBS is in the process of adjusting its existing bank ratings to this new IA and SA methodology.

Notes:
All figures in U.S. dollars unless otherwise noted.
The Trust Preferred Securities for Sky Financial Group, Inc. contain certain unique covenants that give them some equity-like characteristics.