By Michael Flaherty and David Dolan

Shares in Morgan Stanley fell below their low for the year at about $8.70 in premarket trading. Worries around Morgan also dragged down its closest rival, Goldman Sachs Group Inc , which slid more than 6 percent to $95 in premarket trading.

Shares of Morgan Stanley have lost about one-half of their value in the last three days on worries that Mitsubishi UFJ may back out of injecting much-needed capital. The plunge came despite assurances from both banks that the deal was expected to close on Tuesday.

"Until the deal is finalized, there's uncertainty in the market," said Marco Mak, head of research, at Tai Fook Securities. "There are so many rumors. It's basically a loss of confidence."

The two analyst reports, one by brokerage Ladenburg Thalman and the other by ratings agency Moody's, came at a delicate time for Morgan Stanley as its stock tumbled into single-digit territory.

The Ladenburg Thalmann report, by veteran bank analyst Dick Bove, cited potential exposure to Lehman Brothers Holdings Inc.

But Morgan Stanley spokesman Mark Lake said the bank has immaterial exposure to Lehman Brothers as of now.

'EXTENDED DOWNTURN'

Separately, Moody's warned Friday it might cut the long-term debt ratings of Morgan Stanley and Goldman, which would increase their cost of borrowing.

"Moody's review is based upon its expectation that an extended downturn in global capital market activity will reduce Morgan Stanley's revenue and profit potential in 2009, and perhaps beyond this period," the note said.

Still, Moody's noted that Morgan Stanley has moved quickly to reduce risk on its balance sheet and decrease leverage, and said the firm has a "good liquidity profile."

Morgan Stanley shares lost one-quarter of their value on Thursday alone, although some traders attributed the decline to the end of a temporary ban on short-selling.

The cost to insure its debt against default rose on Friday, indicating investor concern about its financial stability. The bank's five-year credit default swaps rose to an upfront payment of 28 percent of the sum insured plus 500 basis points a year from 19 percent on Thursday, according to Phoenix Partners Group.

That means it would cost $2.8 million to insure $10 million of debt plus $500,000 a year.

A spokesman for the Japanese bank, Tomohiro Kato, said it had no plans to change its investment plans.

That echoed a statement released by MUFG on Wednesday, in which the bank dismissed the speculation it could pull out as rumors with "no basis."

"If Mitsubishi pulls out, the US government will step in as they would not like to see them fail," said Mak of Tai Fook Securities.

Shares of Mitsubishi UFJ fell 8.5 percent to 710 yen, in line with a 9 percent drop in Tokyo's index of bank stocks<.IBNKS.T>.

"MUFG seems adamant that the deal is going ahead and will close on the 14th. The market seems determined to test their will," said David Threadgold, banking analyst at Fox-Pitt Kelton Cochran Caronia Waller in Tokyo.

"I very much doubt MUFG will pull out, and (they) probably hope that if they go ahead, that alone would add some stability to Morgan Stanley's share price."

(Additional reporting by Sachi Izumi, Tony Munroe and Elinor Comlay; editing by Anshuman Daga, Sue Thomas and Jeffrey Benkoe)