Aug. 22 (Bloomberg) -- Two European mortgage-backed securities funds had their ratings slashed to junk from AAA by Standard & Poor's after investors refused to provide short-term financing as the fallout from the U.S. subprime slump spreads.

S&P cut the rankings on $3.2 billion debt issued by funds of London-based Solent Capital Partners LLP and Avendis Group in Geneva by as much as 17 levels to CCC. The credit ratings may be cut further, S&P said today in a statement.

The rout in subprime mortgages has roiled the $1.1 trillion market for asset-backed commercial paper, short-term IOUs secured by home and car loans. Investors including Bill Gross, chief investment officer at Pacific Investment Management Co., have criticized ratings firms for failing to accurately value collateral backing the debt and waiting too long to cut rankings.

``With the benefit of hindsight, the agencies clearly got it significantly wrong,'' said Mark Bowles, who oversees $10 billion of asset-backed securities at UniCredit SpA in London. ``But we are in market conditions that nobody could have foreseen.''

Solent's $4.5 billion Mainsail II Ltd. fund and Avendis's $5 billion Golden Key Ltd. unit were forced to sell assets after they couldn't find buyers for their short-term debt, causing ``an erosion of capital,'' S&P said.

Steepest Downgrades

Golden Key's commercial paper rating was cut to B, one step below investment grade, from the highest level of A-1+. Ratings on parts of Mainsail II fell by 16 steps to CCC+ from the highest grade, and its commercial paper rating dropped three steps to A- 3, the lowest short-term investment grade ranking.

About $254 million of securities were cut to CCC or CCC+ from AAA, according to S&P.

The downgrades are among the steepest in Europe since February 2001 when S&P cut ratings on debt sold by U.K. film company Flashpoint Ltd. by 18 levels in one day. The notes were sold through Hollywood Funding to finance films and were supposed to repay investors with proceeds from the movies.

Solent spokeswoman Sally Moore in London declined to comment. A representative for Avendis was unavailable to comment.

Pimco's Gross, manager of the world's biggest bond fund, in June said S&P and Moody's were fooled by the ``six-inch hooker heels'' of collateralized debt obligations awarded investment- grade ratings. CDOs pool other debt, including mortgage-backed bonds, and slice them into portions with rankings as high as AAA.

The U.S. Securities and Exchange Commission yesterday said it will probe the ratings companies' response to the subprime fallout, while French President Nicolas Sarkozy and Europe's financial regulator last week called for a review of the firms.

Market Turmoil

The credit market turmoil, sparked by the highest levels of defaults on U.S. subprime mortgages in a decade, prompted investors to refuse to buy short-term debt backed by home loans. Yields on asset-backed commercial paper soared to 6.09 percent yesterday, the highest since January 2001.

More than 20 companies including Thornburg Mortgage Co. in Santa Fe, New Mexico have been unable to roll over asset-backed commercial paper. Thornburg said on Aug. 20 that it sold $20.5 billion of securities at about 95 cents on the dollar to pay down commercial paper it couldn't refinance.

HBOS Plc, the U.K.'s largest mortgage lender, yesterday was forced to step in to repay commercial paper owed by its Grampian Funding LLC unit.

S&P doesn't expect the downgrades of Mainsail II and Golden Key to affect ratings on other European or U.S. sellers of asset- backed commercial paper, the ratings company said in a separate statement today.

Moody's Downgrade

Moody's Investors Service today cut Mainsail II's commercial paper rating to ``not prime,'' its short-term non-investment grade, from its highest ranking of Prime 1. Moody's last week reduced Golden Key's ratings to not prime.

Ratings on similar funds operated by London-based Cairn Capital Ltd. and Sachsen LB Europe, may also be cut, S&P said.

Cairn Capital is proposing a restructuring of its Cairn High Grade Funding I Ltd. unit, which has not breached any tests, S&P said. Sachsen's $7 billion Sachsen Funding I Ltd. has failed liquidity tests but not yet started selling assets, the credit rating firm said.

The four funds are known as SIV-Lites, a form of structured investment vehicle. SIVs aim to make money by borrowing in the commercial paper markets and investing in longer-dated bonds, usually asset-backed securities.

SIV-Lites differ from SIVs because they have a fixed maturity date, and tend to invest more heavily in mortgage-backed securities. The funds are similar to CDOs that pool bonds, loans and other debt and use their income to pay investors.

To contact the reporter on this story: Laura Cochrane in Melbourne at lcochrane3bloomberg.net; Neil Unmack in London at nunmack@bloomberg.net

Last Updated: August 22, 2007 12:44 EDT