According to New York Times and Wall Street Journal reports, the government is expected to announce Thursday that the Charlotte, N.C.-based bank needs $34 billion in capital based on the results of its “stress tests” on 19 of the nation’s largest financial firms. The New York Times quoted a bank executive, while the Journal report cited unnamed people familiar with the situation.

The stress tests are being used to determine how banks would fare if economic conditions worsened. Any banks that are deemed to need more capital based on potential future losses will be required to address the capital situation immediately, to ensure they have the necessary protection if the economy worsens.

Banks will have an opportunity to raise the funds on their own before the government steps in to help support them.

For Bank of America, the $34 billion shortfall could be covered in multiple ways, including converting into common stock a portion of a $45 billion investment it received from the government as part of the Troubled Asset Relief Program. Bank of America has been among the hardest hit banks by the credit crisis and ongoing recession.

via Bank Of America Needs $34B In Capital ~ The Huffington Post.

Just like Citigroup last week, B of A’s earnings are made up almost entirely of either one-time items, or items no sane investor would consider actual income. Particularly:

• A $2.2 billion mark-to-market gain due to Merrill Lynch’s credit spreads blowing out. Yes, this is indeed a sign that the company could be heading for big trouble, but accounting rules allow companies to book widening spreads as income, since they could theoretically buy back debt at a discount.
• A $1.9 billion pre-tax gain on the sale of shares of China Construction Bank.

Add the two up, and there’s your net income in its entirety. In other words, looking at earnings on any normalized — or rational — basis, B of A barely broke even. That isn’t too surprising when you look at how quickly credit quality fell off a cliff:

• Provisions for credit losses more than doubled to $13.4 billion.
• Net charge-offs surged to 2.85%, from 1.25% a year ago.
• Nonperforming assets exploded to 2.65%, up from 0.90% a year ago.
• Credit card losses as a percentage of receivables jumped to 8.62%, from 5.19% a year ago.  

A fallout in credit quality — particularly on the consumer side — is to be expected. Problem is, B of A is knee-deep in all the wrong places right now, and doesn’t have the balance sheet strength to pull off this kind of deterioration without raising capital. That’ll likely have to come from converting government-issued preferred shares into common equity, diluting the pants off of existing investors.