Oct. 9 (Bloomberg) -- Morgan Stanley dropped 26 percent, its biggest one-day decline in more than a decade, as a short-selling ban expired and concern escalated that the company may be unable to weather the credit crisis.

The stock fell $4.35 to $12.45 in New York Stock Exchange composite trading after dropping as low as $11.95 earlier in the day. The New York-based company has lost 77 percent of its value this year. Goldman Sachs Group Inc., the firm's larger rival, dropped $11.65, or 10 percent, to $101.35.

Morgan Stanley transformed itself into the fifth-biggest bank-holding company and agreed to sell more than 20 percent to Japan's Mitsubishi UFJ Financial Group Inc. for $9 billion in an effort to win the confidence of investors, counterparties and clients. The bankruptcy of Lehman Brothers Holdings Inc. last month and the emergency sales of Merrill Lynch & Co. and Bear Stearns Cos. sparked concern that companies like Morgan Stanley that depend on debt markets will run out of financing.

``The stock has been under pressure because the problems that affect other brokerage firms may also impact Morgan Stanley,'' said Frederic Ruffy, senior options strategist at WhatsTrading.com, a New York-based provider of options market analysis. ``After the lift of the short-selling ban, the shorts are focused on this stock again.''

Mark Lake, a spokesman in New York, declined to comment.

John Mack, Morgan Stanley's chief executive officer, last month lobbied the U.S. Securities and Exchange Commission to ban short-selling, arguing that it was driving down the company's stock. Short sellers borrow stock and sell it, hoping to buy it back at a lower price. The SEC's temporary ban ended last night.

Mitsubishi's Investment

Some disputed the idea that short sellers were responsible for the decline in Morgan Stanley's stock, noting that the shares fell 30 percent this week while the ban was in place.

``Poor fundamentals are driving decisions in these stocks,'' said Russell Kamp, chief executive officer of Invesco Quantitative Strategies in New York. ``The fact that there are fewer buyers should be quite telling.''

Mitsubishi UFJ, Japan's biggest bank, said yesterday it won't pull out of its agreement with Morgan Stanley and expects the transaction to close on Oct. 14. Concern the deal might fall through pushed Morgan Stanley's shares lower earlier this week. Morgan Stanley's Lake said that ``nothing has changed'' in regard to the agreement.

``As we disclosed earlier, we are expecting to close the deal as planned on Oct. 14,'' Mitsubishi UFJ spokesman Takashi Takeuchi said by phone in Tokyo. ``Nothing has changed in the plan.''

Morgan Stanley doesn't need to borrow new money in the bond market until the third quarter of 2009, according to analysts at UBS AG and Sanford C. Bernstein & Co.

Egan-Jones Rating

Egan-Jones Ratings Co. estimated today that Morgan Stanley ``probably needs $30 billion of new equity to address concerns'' about its financial strength. The company has about $900 billion of assets and an equity market value of $15.9 billion.

``Most units are likely to continue to be depressed over the next couple of quarters,'' Egan-Jones wrote today, cutting its rating on Morgan Stanley to BBB from BBB+. The firm ``took on significant principal risk in an effort to boost returns but is now paying the price.''

The Egan-Jones rating of BBB compares with an A+ rating from Standard & Poor's and an A1 rating from Moody's Investors Service.

Investors paid higher prices for options insurance against declines in Morgan Stanley shares. Implied volatility for at-the- money contracts expiring in 30 days increased 17 percent to 235.9. The record figure of 299 was set Sept. 18. More than 300,000 Morgan Stanley puts traded, 2.8 times the 20-day average.

Bond Protection

The cost to protect against a Morgan Stanley default rose. Credit-default swaps on the company's bonds rose to 19.5 percentage points upfront, according to CMA Datavision. That's in addition to 5 percentage points a year and means it would cost $1.95 million initially and $500,000 annually to protect $10 million for five years. The upfront cost was $1.9 million yesterday. Goldman's credit-default swap costs rose 0.22 percentage point to 4.65 percentage points, or $465,000 a year for protection on $10 million of debt for five years.

The price of Morgan Stanley's $4.5 billion of senior unsecured bonds that mature in April 2018 fell to 63 cents on the dollar from 66 cents yesterday.

To contact the reporters on this story: Christine Harper in New York at charper@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net

Last Updated: October 9, 2008 20:50 EDT