UPDATE 2- Merrill Lynch cuts KeyCorp, Regions to sell

(Recasts; adds details, share movement)

May 16 (Reuters) - Merrill Lynch downgraded two large regional U.S. banks, KeyCorp (KEY.N: Quote, Profile, Research) and Regions Financial Corp (RF.N: Quote, Profile, Research), to "sell" from "neutral," citing a bleak outlook for such banks as credit conditions deteriorate and reserves for bad loans grow.

Analyst Edward Najarian said a larger-than-expected fall in housing prices in recent months would lead to higher residential and real-estate losses for Cleveland-based KeyCorp.

He also expressed concern about Birmingham, Alabama-based Regions' $6.2 billion residential construction portfolio.

Regions shares fell 5.53 percent to $20.14 and KeyCorp shares slid 5.82 percent to $23.63 in mid-day trading on the New York Stock Exchange.

A crisis in the financial markets triggered by a slump in housing prices has eaten into earnings at many U.S. banks, especially those with heavy exposure to problem loans.

KeyCorp had posted a 38 percent fall in first-quarter earnings, hurt by losses from loan sales and write-downs.

Operating profit at Regions fell 24 percent, as problem loans to homebuilders soared.

Najarian also cut his 2008 profit-per-share estimates by 15 cents to $1.90 for Regions and 10 cents to $1.85 for KeyCorp.