Suncorp Metway looks like being the first major Australian financial group to slash dividends to preserve capital as questions are raised about how it has managed to fund more than half its $3 billion 2009 wholesale funding requirements by accessing its insurance operations. Investment analysts this morning forecast a cut of between 12% to 33% in the company’s 2009 payout.

The group yesterday “flagged” a dividend cut, and then media reports suggested that management then backed away from such a move. It paid $1.07 a share in 2008, unchanged from the previous year, and had been pushing the line that it would keep the payment steady this year. That would require earnings of more than $1.02 billion, which won’t happen.

“Suncorp has flagged the possibility of reducing the quantum of dividends payable to shareholders for the current financial year to provide appropriate capital buffers to withstand a variety of possible exceptional circumstances,” the company said in yesterday’s update.

The market spotted that for a bit of ‘rubbery guidance’ and sold the shares down, and this morning analysts at Goldman Sachs JBWere suggested the dividend could be cut by a third, from $1.07 paid for the 2008 year, to around 70 cents a share: “It now seems even more likely than before that the company will need to cut its dividend. We have assumed a one-third cut to 70cps.”

Analysts at Merrill Lynch said: “SUN expects to address its tight capital position through dividends, which we cut a further 12% in FY09F and around 2% there-out. We continue to believe the risk to dividends could be much more material, particularly if SUN wants to put the capital issues fully to rest. In our view SUN needs to move quite decisively on this front.”

The analysts both expressed concern though at another part of the update that only emerged in a conference call with investors. In its update, Suncorp said it had finished raising its 2009 wholesale funding which was $3 billion, down from the original estimate of $4.5 billion. That was because loan growth had slowed sharply, from a range of 8%-10% growth to 5%.

But in the conference it emerged that Suncorp had raised $1.8 billion of that $3 billion from its insurance subsidiaries.

Goldman Sachs commented:

The revised requirement was recently completed through a number of term private placement transactions...However, it later revealed that $1.8bn of this has actually been placed to the general insurer. This at least explains how so much “private funding” was put away in such a short space of time – but we are not entirely happy with the “in house” nature of this risk transfer.

And Merrill Lynch said:

Given the lower growth expectation, management indicated that its term funding requirement for the bank had reduced from $4.5bn to $3.0bn and that the funding was now entirely in place. On the call management indicated that SUN’s general insurance operations had provided $1.8bn of the funding. The argument was that there is significant margin in AAA rated RMBS paper so why wouldn’t SUN take it on its own book. While we lack comfort with such a transaction, we understand that APRA and the credit rating agencies were fine with it. Management assured that the transaction was done on arms length terms. Medium term, ex the Government’s current backing, we continue to believe SUN’s credit rating will be a key constraint to its competitiveness in the post credit crisis world.

No matter what APRA and the credit rating agencies think (they helped give us the credit freeze and APRA allowed some of the big banks to have off balance sheet vehicles), the fact that it took questions from analysts to prise this out of Suncorp stinks. Let’s hope there’s not another bad insurance event, such as an earthquake somewhere that would strain the insurance arm.

The insurance and banking businesses are separate and rated separately so there’s no double counting, but this deal could only have been done because of the Federal Government’s guarantee on deposits and wholesale funding. And how could it be done at arms length? Both the insurance business and Metway bank are in the same group: does the insurance business have a clear majority of independent directors on its board capable of making this decision?

UBS called yesterday’s update a “disguised downgrade”. Let’s hope that’s as far as it goes at Suncorp this year.