NEW YORK (Reuters) - Wachovia cut its investment rating and earnings outlook for American International Group (AIG.N: Quote, Profile, Research) on Tuesday, saying it believed the world's largest insurer could post up to $7 billion in second-quarter losses on assets linked to subprime mortgages.

Wachovia downgraded AIG to "market perform" from "outperform," saying the investment losses could offset operating earnings and "put a dent into the company's recent capital raise."

AIG shares fell nearly 10 percent to $20.37 in morning New York Stock Exchange trade. The stock was the biggest percentage loser in the Dow Jones Industrial Average.

Because the market value of derivatives continued to fall in the second quarter, Wachovia said it expected AIG to post as much as $7 billion in losses on investments held by a financial products unit.

The investments, which are linked to subprime mortgages, have already triggered $20 billion in unrealized write-downs for AIG over the past two quarters, leading to record net losses.

AIG had no comment on the note or estimates of the potential second-quarter investment loss.

Wachovia cut its operating profit estimates for AIG to $1.15 a share from $1.90 for 2008 and to $5.40 from $6.49 for 2009.

"We believe the world's largest insurer will continue to be plagued by its exposure to the U.S. residential real estate market and its general exposure to the credit markets over the next year," Wachovia said in a note to clients.

In addition, Wachovia said its lower earnings view reflected slowing of AIG's main insurance business and expectations that claims received by its mortgage insurance unit would continue to be high.

(Reporting by Lilla Zuill; Editing by Lisa Von Ahn)