He said the largest U.S. bank's 32 cents-per-share quarterly dividend is "not safe," and that the bank may have to issue common stock or sell assets to raise capital because regulators may forbid it from issuing more preferred or convertible securities.
"We see multiple headwinds for Citigroup including additional write-downs, higher consumer provisions as a result of rapidly deteriorating consumer credit trends, and the potential for additional capital raises, dividend cuts, or asset sales," the analyst said.
Citigroup did not immediately return a call seeking comment.
Tanona also downgraded the U.S. brokerage sector to "neutral" from "attractive," saying deteriorating fundamentals will likely prolong any recovery from the year-long credit market tightening.
European financials fell in early trade on Thursday following the report. Citigroup shares, meanwhile, fell 61 cents to $18.24 in pre-market trading. If they fall below $18.00, they would touch their lowest level since October 1998, the month Citicorp and Travelers Group merged to form Citigroup, Reuters data show.
In Europe, Citigroup shares were more than 6 percent down.
Merrill shares fell 83 cents to $34.63 in pre-market trading.
Capital, Dividend Concerns
Though Citigroup in January cut its quarterly dividend 41 percent, Tanona said another cut may be warranted by the bank's lack of current earnings power.
He said halving the current dividend could preserve $3.5 billion of capital annually.
"Given the firm's current level of earnings power, we do not believe the dividend is safe." On June 17, Goldman analysts led by Richard Ramsden said U.S. banks may need to raise $65 billion of additional capital to cope with mounting losses from a global credit crisis that will not peak until 2009.
As of May, Citigroup had raised $42 billion, including capital injections from sovereign wealth fund Government of Singapore Investment Corp, data compiled by Reuters News show.
The bank has also suffered more than $46 billion of write-downs and credit losses in the last three quarters.
Tanona now expects Citigroup to post a second-quarter loss of 75 cents a share compared with his earlier forecast of a profit of 25 cents.
He changed his 2008 forecast for the bank to a loss of $1.20 a share from his prior view of a profit of 30 cents.
For Merrill, the world's biggest brokerage, Tanona now expects a quarterly loss of $2 a share, compared with his earlier estimate of a profit of 25 cents.
For 2008, he sees a loss of $3.55, compared with his prior forecast of a profit of 8 cents.
Citigroup could be more exposed than Merrill Lynch and JPMorgan Chase to hedges on its leveraged loan and commercial mortgage-backed securities portfolios, Tanona said.
It will be a challenging quarter once again in fixed income, currency and commodities, impacted by a number of write-downs and trading losses, he said.
"We expect write-downs for Citigroup and Merrill to outpace what we saw from Morgan Stanley and Lehman Brothers Holdings recently, due to Citigroup's and Merrill's large exposures to ABS CDOs (asset-backed security collateralized debt obligation) and associated hedges with the monolines (insurers)," Tanona said.
Earlier this week, Merrill Lynch analyst Guy Moszkowski projected a second-quarter loss and $8 billion of new write-downs for Citigroup.
Last week, Citigroup Chief Financial Officer Gary Crittenden said on a Deutsche Bank conference call that the bank could take substantial write-downs this quarter.