* BP needs further cuts to support dividend, U.S. bank says
* M&A needed to offset production decline
* BAML cuts rating on BP shares to underperform from neutral
By Ron Bousso
LONDON, Sept 4 (Reuters) - BP will need to buy oiland gas fields to offset falling production, which could lead itto issue equity to raise funds, Bank of America Merrill Lynch(BAML) said on Friday, cutting its rating on the oil major'sshares to underperform from neutral.
As oil prices are expected to recover only slowly over thenext two years, the British oil and gas company will have tosell more assets, cut spending by an additional $5 billion andincrease borrowing to maintain dividends, the U.S. bank said.
With lower in-house growth, BP will need to acquirecompanies or assets. All this could result in BP issuing sharesto raise funds, it said.
"We warn of increasing M&A (merger and acquisition) risk: BPis in our view likely to replace organic with inorganicinvestment opportunities -- including the risk of valuedestruction as well as further dilution from at least partiallyequity-funded M&A," BAML said.
"Should project sanctioning see further delays as we facepersistently low oil prices, we believe the temptation to engagein more M&A and external reserve replacement will only grow," itadded in the report published on Friday.
BP declined to comment.
Barclays last month rated BP's shares "overweight", notingprogress in cost saving. "We continue to see BP as having adifferentiated opportunity to reduce costs relative to the widerpeer group and anticipate further progress throughout the restof 2015 and into 2016," Barclays said.
Like most peers, BP has slashed spending in the face of anextended period of low oil prices.
It has also sold more than $50 billion of assets over thepast year to boost its balance sheet and to finance the costsand fines of the deadly 2010 Gulf of Mexico oil spill.
BP, for years the subject of speculation that it could be anacquisition target, is expected to maintain its dividend payoutthrough increased borrowing, BAML said.
Assuming benchmark Brent crude oil prices recover to $70 abarrel by 2017, BP will still need $4 billion in additional cashsavings to cover dividends, BAML said.
"Given the industry's patchy track record on creating valuefrom M&A, we believe investors will be rewarded for patience. Inother words, we believe it pays to stand on the sidelines andevaluate any M&A proposition after it is announced," BAML said.
It cut its price target for BP shares to 330 pence from 420pence. At 1352 GMT, the stock was trading around 338 pence. (Editing by Mark Potter)