Signs of improvement in the U.S. economy and gains from asset sales helped Bank of America Corp post a quarterly profit, sending its shares higher, but the second-largest U.S. bank still needs more capital and with little left to sell, it is becoming creative.

Bank of America said on Thursday it was considering issuing $1 billion (646 million pounds) in common stock to certain employees in lieu of a portion of their year-end cash bonuses next month.

The move, a large stock issue to effectively captive investors -- its employees -- could further pad the bank's capital levels, but at the same time dilute shareholders' interest and may stir discontent among some bankers.

In a move that will conserve capital, Chief Financial Officer Bruce Thompson also told reporters that the bank did not ask the Federal Reserve for permission to increase its dividend or buy back its own stock as part of this year's ongoing stress tests. Other banks have said they are eager to return more capital to shareholders as part of the process.

Last year, Bank of America asked the Fed for a modest increase from its quarterly dividend of a penny per share but was rejected. After the denial, the bank turned its attention to meeting new international standards by building more capital, a measure closely watched by investors, Thompson said.

If you look at where we are relative to our peers, we made enormous progress this quarter in closing the gap, he said.

Better capital measures, a fourth-quarter profit after a year-ago loss and improving loan demand all helped buoy Bank of America's shares, which rose as much as 7 percent on Thursday morning.

Bank of America looks like it's making good progress on the capital build-up, said Derek Pilecki of Gator Capital Management in Tampa, Florida. It's a work in progress with expense cuts continuing. They have to issue stock to make capital targets, but the dilution isn't overwhelming.

Bank of America is still trying to recover fully from the aftermath of the 2008 financial crisis and a disastrous acquisition of mortgage lender Countrywide Financial that has saddled the company with losses.

Chief Executive Brian Moynihan is working to show Bank of America has enough capital to absorb these mortgage-related losses and to meet new international capital standards. Over the past two years, he has been shedding noncore businesses to boost capital levels and streamline the company.

Last spring, Bank of America launched a wide-ranging efficiency program called Project New BAC, which is expected to eliminate 30,000 jobs in its first phase over the next few years.

On a conference call with analysts on Thursday, Thompson said the bank should start to see the benefits of job cuts in first-quarter expenses.

Bank of America said its Tier 1 common equity ratio, a key measure of capital against risk-weighted assets, reached 9.86 percent at the end of December.

That was up from 8.65 percent at the end of September and higher than the 9.25 percent minimum the bank had projected.

By issuing more shares to its employees next month, Bank of America effectively is asking them to underwrite a stock sale, said Richard Lipstein, a managing director at Boyden Global Executive Search.

Rather than sell more shares to the public, they are going to be selling them to their employees, Lipstein said.

But with Wall Street shrinking, few may gripe. So many people feel fortunate to have a job, they are not going to complain about their compensation, said Lipstein.

There is a significant upside potential if Bank of America can turn itself around, so not everybody is going to go out and sell their shares, said Lipstein.

ONE-TIME GAINS

Bank of America said net income applicable to common shareholders was $1.58 billion, or 15 cents per share, in the fourth quarter, compared with a loss of $1.6 billion or 16 cents per share a year earlier.

The Charlotte, North Carolina-based bank benefited from pretax gains of $5.3 billion from the sale of China Construction Bank Corp <0939.HK> shares, and gains from the exchange of trust preferred securities and the sale of debt securities.

Various accounting charges and litigation expenses reduced earnings by $3.7 billion. The legal expenses include charges related to a Countrywide fair lending settlement and the bank's latest expectations for a pact with state attorneys general and federal officials over alleged foreclosure abuses, Thompson said.

The bank set aside $2.9 billion in the quarter for loan losses, down from $5.1 billion a year ago. Bank of America, which is working to shed risky assets, also said total loans decreased to $926 billion from $932 billion in the third quarter.

Like rivals Wells Fargo & Co , JPMorgan Chase & Co and some regional banks, Bank of America reported loan growth in the fourth quarter, potentially boding well for the U.S. economy.

In its corporate bank, average loans and leases increased 29 percent to $107.5 billion, with growth in both U.S. and international commercial loans.

But also like other banks with large investment banking operations, such as Citigroup Inc , JPMorgan, Goldman Sachs Group Inc and Morgan Stanley , Bank of America was hurt by lacklustre trading and investment banking revenue in the fourth quarter as clients roiled by the European debt crisis shunned capital markets and put off deals.

Sales and trading revenue in Bank of America's banking and markets unit increased to $1.9 billion, excluding an accounting charge, from $1.1 billion in the third quarter but was down from $2.4 billion a year ago.

Investment banking fees were flat from the third quarter at $1 billion but down from $1.6 billion a year ago.

Bank of America bulked up its investment banking business with the 2009 purchase of Merrill Lynch.

In December, Moynihan said the bank had seen better results in this business in the fourth quarter after a weak third quarter.

The bank also continued to struggle to show revenue growth at a time of low interest rates and regulatory restrictions on fees earned from debit card transactions.

Total revenue declined to $24.9 billion from $28.5 billion in the third quarter but was up from $22.4 billion a year ago.

The bank said the Durbin amendment, the provision in the Dodd-Frank financial reform bill that curbed debit-card swipe fees, decreased card services revenue by $430 million.

Bank of America had a solid quarter, but not quite enough to make you pop the champagne said Allerton Smith, senior director at Moody's Analytics.

Capital ratios are up, liquidity is stronger and there is a noticeable decline in problem loans, Smith said.

Bank of America shares were up 4.7 percent at $7.12 in late morning on the New York Stock Exchange, off an earlier high at $7.28.

(Reporting By Rick Rothacker in Charlotte, N.C.; Additional reporting by Ben Berkowitz in Boston and Jed Horowitz and David Henry in New York; editing by Paritosh Bansal, Maureen Bavdek, John Wallace and Matthew Lewis)