The shares of U.S. commercial and investment banks fell on Tuesday after two bond rating agencies started to downgrade billions of dollars of securities backed by subprime bonds, triggering concerns that bond sales and lending businesses could slow.

Declines were led by banks perceived to have high exposure to mortgages and other fixed income businesses, including Lehman Brothers Holdings Inc. (NYSE:LEH - BSC - news), which fell as much as 4.1 percent.

Lenders specializing in mortgages dropped as well. Countrywide Financial Corp. (NYSE:CFC - NFI - news) fell 8.7 percent.

These declines helped drag down financial indexes. The Amex Securities Broker Dealer index (^XBD - ^BKX - ^KRX - news) fell 2.3 percent to 91.13.

"Sentiment on financial stocks is pretty negative," said Blake Howells, director of research at Becker Capital Management in Portland, Oregon. "We've been looking at whether it makes sense to buy regional bank shares, but we think there could be another drop before they hit bottom."

Tuesday's declines came after Standard & Poor's said subprime mortgages were performing worse than expected and that the situation may get worse. The rating agency said it could cut some $12 billion of bonds linked to subprime mortgages, and expects to start cutting them in the next few days.

Later in the session, Moody's Investors Service cut ratings of 399 mortgage-backeds, and said it may cut another 32, in a move that affected a total of $5.2 billion of debt.

U.S. homeowners entered the foreclosure process at a record pace in the first quarter and sales of new and existing homes are slowing.

That turmoil is cutting into the performance of some bonds that were essentially repackaged home loans to people with weak credit and has seeped into collateralized debt obligations, or bonds backed by portfolios of subprime bonds or other debt.

Regional banks that make or invest in home loans have also been hit -- Huntington Bancshares Inc. (Nasdaq:HBAN - news) said on Monday the soft housing market would cut into second quarter earnings as it set aside more money for bad loans.

TROUBLE IN JUNKLAND

But equally worrisome to equity investors is trouble in the junk bond markets, where a slew of recent issuers have had to cancel, delay or sweeten sales.

"It will be more difficult to get junk bond deals done in future, and banks and brokers have really profited from junk bond sales and private equity deals," said Marshall Front, who oversees $700 million as chairman of Front Barnett Associates LLC in Chicago.

Front wants to buy more financial stocks, but is waiting for valuations to fall before doing so.

Add it all up and underwriting and lending profits could be squeezed, said Becker's Howells.

But all is not lost for brokers and banks. The economy is still relatively strong, and as markets fluctuate more, trading profits increase. Rene Canezin, Lehman's junk bond head, said last month that credit trading volumes were at record levels.

Lehman shares fell $3.76 to $71.10, their biggest one-day decline in percentage terms since March. Bear's shares fell 4.12 percent to $137.96, also their biggest one-day decline since March.

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