REFILE-US STOCKS-Wall St falls as financials lead decline

(Refiles to fix final paragraph to read 'declining stocks outnumbered advancing ones ... ')

* Financial stocks tumble as credit worries swirl

* Merrill, Lehman, Citigroup among biggest drags

* Dow off 2.1 pct, S&P off 1.9 pct, Nasdaq off 2 pct (Updates to close)

By Steven C. Johnson

NEW YORK, July 28 (Reuters) - U.S. stocks tumbled on Monday as fear of more credit and housing market turmoil battered financial shares and a mixed bag of quarterly results added to uncertainty the outlook for corporate profits.

Oil prices rose more than 1 percent on supply concerns, further unnerving investors and renewing some worries about inflation and consumer spending.

But it was news that federal regulators seized two more failed U.S. banks late last week that triggered Monday's sharp sell-off in financial shares and sent major indexes down more than 2 percent.

Among the hardest-hit shares were Merrill Lynch MER.N, down more than 11 percent; Citigroup (C.N), off over 7 percent and Lehman Brothers LEH.N, down more than 10 percent.

Lehman Brothers Holdings Inc LEH.N, the fourth-largest U.S. investment bank, stumbled after a Merrill analyst said the firm may post a third-quarter loss and face a round of fresh write-downs on its residential mortgage portfolio. For more, see [ID:nBNG307228].

The S&P financial index .GSPF shed 4.6 percent. The sell-off came after a rally last week that lifted many banks' shares 40 percent or more.

"It's all about financials right now. We saw a couple of small banks go 'belly up' over the weekend. Now people are wondering what's going to happen next and when," said Paul Nolte, director of investments at Hinsdale Associates, in Hinsdale, Illinois.

The Dow Jones industrial average .DJI sank 239.61 points, or 2.11 percent, to 11,131.08. The Standard & Poor's 500 Index .SPX shed 23.39 points, or 1.86 percent, to 1,234.37. The Nasdaq Composite Index .IXIC lost 46.31 points, or 2.00 percent, to 2,264.22.

Two weeks after the Federal Deposit Insurance Corp seized IndyMac Bancorp Inc IDMC.PK, the Office of the Comptroller of the Currency said late on Friday it closed First National Bank of Nevada and First Heritage Bank NA of California.

"This is a reality check," said Jim Awad, chairman of W.P. Stewart Asset Management in New York. "There are going to be other shoes that drop."

Merrill Lynch was a major drag on the S&P 500, falling 11.6 percent to $24.33, while Citigroup shares fell 7.5 percent to $17.43; Bank of America shares declined 5.1 percent to $28.06 and Lehman shares lost 10.4 percent to $15.27.

Another major loser in the financial sector was insurer American International Group (AIG.N), down 12 percent at $23.96.

Shares of mortgage finance companies Fannie Mae (FNM.N) and Freddie Mac (FRE.N) also plunged, reversing gains seen after Congress, over the weekend, approved a rescue plan for the U.S. housing market. Fannie Mae's stock slid 10.7 percent to $10.31, off its intraday high at $12.96. Freddie Mac's stock lost 6.7 percent to $7.72, off its intraday high at $9.10.

"There won't be much good news for the financials until we see a firming in housing, and the odds are we won't see that before the end of the year," said Gail Dudack, chief investment strategist at the Dudack Research Group in New York.

Verizon Communications (VZ.N) declined 2.5 percent to $33.60 after its second-quarter results showed further weakness in its landline telephone business.

On the Nasdaq, shares of iPod and iPhone maker Apple (AAPL.O) were the biggest drag, falling 4.8 percent to $154.40.

U.S. oil for September delivery CLc1 gained $1.47 to settle at $124.73 a barrel, lifted by supply concerns following attacks by militants in Nigeria on two major crude oil pipelines there.

Kraft Foods Inc (KFT.N) was a bright spot, with its shares gaining 4.9 percent to $30.83 after the maker of Oreo cookies posted a stronger-than-expected quarterly profit. [ID:nN28461563]

Trading volume was light on the New York Stock Exchange, with about 1.17 billion shares changing hands, below last year's estimated daily average of roughly 1.90 billion, while on Nasdaq, about 1.96 billion shares traded, also below last year's daily average of 2.17 billion.

Declining stocks outnumbered advancing ones on the NYSE by a ratio of more than 2 to 1 on the NYSE and by about 3 to 1 on the Nasdaq.

(Additional reporting by Walter Brandimarte and Ellis Mnyandu; Editing by Jan Paschal)