* ISM's factory activity index drops to 49.4 in August
* Jobless claims rise to 263,000 last week vs est. 265,000
* Banks among top drags on S&P, Dow
* Indexes down: Dow 0.43 pct, S&P 0.5 pct, Nasdaq 0.33 pct (Adds details, comments, updates prices)
By Yashaswini Swamynathan and Mamidipudi Soumithri
Sept 1 (Reuters) - Wall Street fell on Thursday, starting September on a dour note after a steeper-than-expected decline in monthly factory activity raised doubts about growth and the ability of the economy to withstand an interest rate hike.
A report from the Institute of Supply Management showed U.S. factory activity contracted for the first time in six months in August as new orders and production tumbled.
"It's an under 50 ISM number. Given that the Fed is so data-dependent, the market is worrying about how that will affect the Fed's decision," said Ernie Cecilia, chief investment officer of Bryn Mawr Trust in Pennsylvania.
The report precedes Friday's monthly nonfarm payrolls numbers which are likely to set the tone for the Fed policy meeting regarding the timing of the next rate hike.
Fed Chair Janet Yellen said last week the solid performance in the labor market has strengthened the case for an interest rate hike.
Traders have priced in a 24 percent chance of a hike in September, down from 30 percent before the ISM data was released. The odds for a hike in December fell to 53.6 percent from 57.2 percent, according to the CME Group's FedWatch tool.
At 10:56 a.m. ET, the Dow Jones industrial average was down 79.17 points, or 0.43 percent, at 18,321.71.
The S&P 500 was down 10.94 points, or 0.5 percent, at 2,160.01.
The Nasdaq Composite was down 17.45 points, or 0.33 percent, at 5,195.77.
The S&P 500's financial index saw its biggest decline in nearly two months after the ISM data raised doubts of a rate hike as early as this month.
"The financials have had a good run in the past few weeks, so there maybe some profit taking coming into the release of the employment numbers tomorrow," Cecilia said.
Shares of Bank of America, JPMorgan, Wells Fargo and Citigroup fell between 1-2 percent and were among the top drags on the S&P.
Goldman Sachs fell 1.1 percent and pulled down the Dow the most.
A more than 2 percent drop in oil prices weighed down energy companies. Exxon was off 0.9 percent and Chevron fell 0.6 percent.
Charter Communications rose 3 percent after the S&P Dow Jones Indices said the cable services company is set to join the S&P 500 index. The stock provided the biggest boost to the Nasdaq.
Wynn Resorts was the top percentage gainer on the S&P, gaining 5.5 percent after Macau, the world's biggest casino hub, posted a 1.1 percent rise in gambling revenue in August.
Declining issues outnumbered advancing ones on the NYSE by 1,984 to 820. On the Nasdaq, 1,720 issues fell and 881 advanced.
The S&P 500 index showed 13 new 52-week highs and one new low, while the Nasdaq recorded 72 new highs and 15 new lows. (Reporting by Yashaswini Swamynathan in Bengaluru; Editing by Don Sebastian)