S&P, Moody's eye $17.3 bln in subprime rating cuts

(Recasts lead, adds Moody's in 2nd paragraph, updates market reaction)

By Walden Siew

NEW YORK, July 10 (Reuters) - Two leading rating agencies on Tuesday started to slash ratings for more than $17.3 billion of mortgage-related debt, rattling global financial markets amid fears that growing problems in the risky subprime market could spread to the wider economy.

Standard & Poor's said it may cut ratings on $12.1 billion of mortgage-related debt as soon as this week on expectations for an 8 percent drop in U.S. home prices and more mortgage defaults.

Rival Moody's Investors Service said it cut ratings of 399 mortgage-backed securities and may cut ratings of another 32, affecting a total of $5.2 billion in debt. For details, click on [nWNA2449]

"This subprime situation is being underestimated and is worse than many people had expected," said Thomas Metzold, a portfolio manager at Eaton Vance in Boston. "Investment managers' exposure to this is greater than they say and they will get less recovery than they expect."

S&P conceded that it failed to see the extent of losses when originally rating the debt, which include 612 residential mortgage securities. The agency said it is overhauling its methodology and reviewing its ratings of the $1 trillion market for debt structures known as collateralized debt obligations, or CDOs.

The changes by S&P, the credit-rating unit of McGraw-Hill Cos. (MHP.N), comes on the heels of increasing troubles in the subprime mortgage market that caters to borrowers with spotty credit histories.

The news spooked investors, driving them away from financial stocks and other riskier investments and into the safety of U.S. government bonds. S&P's index of financial shares .GSPF fell more than 2 percent, its lowest level in almost three months.

The Dow Jones industrial average .DJI closed down 148.3 points at 13,501.70. Benchmark Treasury yields dropped to their lowest levels in a week. The dollar weakened to a record low against the euro EUR=, while a benchmark subprime index dipped to another record low.

"Beginning in the next few days, we expect that the majority of the ratings on the classes that have been placed on CreditWatch negative will be downgraded," S&P said in a statement.

S&P's projected fall in home prices would exceed the record 6.5 percent drop between 1991 and 1992, making subprime loans issued last year particularly vulnerable, David Wyss, chief economist at Standard & Poor's in New York, said in a conference call.

Because most subprime loans carry adjustable interest rates, more borrowers face trouble making payments as loans reset at higher rates. And declining home prices mean that borrowers unable to pay loans cannot solve their problems by selling their homes.

The $12.1 billion in affected debt represents 2.13 percent of the $565.3 billion U.S. subprime market.

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