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Morgan Stanley takes another jab at costs as revenue remains elusive

By Olivia Oran

NEW YORK (Reuters) - Having searched high and low for revenue growth with little success, Morgan Stanley (MS.N) is taking a hatchet to costs.

The bank cut total expenses by 14 percent last quarter, results released on Monday showed. This followed an even sharper decline the prior period when it announced a sweeping plan to shed more of its bond-trading business.

Much of the cost reduction has come from paying fewer employees less money, and the bank plans to do more of that. Morgan Stanley cut 3 percent of its staff during the first quarter, and compensation-related expenses fell 19 percent compared with the year-ago period.

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But even with those steps, analysts grilled Morgan Stanley executives about whether they will be able to hit Chief Executive James Gorman's target of a 9 to 11 percent return-on-equity by 2017. That measure of how profitably the bank is using shareholder capital was just 6.2 percent during the first quarter.

"If Morgan Stanley doesn't get to this target, investors will want to think about the next alternative," CLSA banking analyst Mike Mayo said, referring to more drastic changes in its business mix. "We're not there yet, but we need to see evidence they're on track for 2017."

Gorman suggested the bank may, in fact, have to do more to hit his goal. Absent a revenue revival which seems unlikely this year, that means more cost cutting ahead.

"If these markets were to continue as is, our goals would be extremely difficult to achieve," Gorman said. He later added, “If indeed the environment continued as is, we would be much more aggressive on the cost front.”

The extent of Morgan Stanley's cost-cutting is leading some analysts and investors to wonder whether the bank is going too far.

Wall Street has a tendency to cut through fat into muscle, and sometimes bone, when markets are rough for extended periods as they have now been for more than five years. When conditions improve, banks that cut too much miss out on opportunities to grow revenue and gain market share in key businesses, because they no longer have the staff and resources to be nimble.

Banks "need to be careful," said Tyler Ventura, a research analyst with investment management firm Diamond Hill in Columbus, Ohio. "As the entire industry cuts, some are going to cut more than others and you want to make sure you can still maintain your business."

In January, Morgan Stanley announced an initiative to cut up to $1 billion in costs by 2017 in an initiative called Project Streamline. The plan included shifting operations to low-cost cities, outsourcing more and using technology to become more efficient.

Morgan Stanley Chief Financial Officer Jonathan Pruzan told Reuters in an interview on Monday most of the cost-cutting last quarter came from “tightening up discretionary spending.” More cost cuts are on the way, but it will take time for them to be reflected in earnings, he said.

The bank is also moving more staff to cities where salaries and overhead cost less than in New York or London. Around 40 percent of Morgan Stanley's bank-office staff sit in cheaper cities like Mumbai and Glasgow today, Pruzan said on a call with analysts. The bank wants to boost that to 50 to 55 percent.

MOVING TO THE CLOUD

Technology is another big part of Morgan Stanley’s cost-cutting drive.

The bank is relying more on cloud computing, which is storing and processing data through a shared, centralized system offered by large tech firms.

Using “the cloud” tends to be cheaper and more efficient for companies than buying and maintaining their own servers. But it takes time to transition, and for costs related to old technology to fade away.

As it stands, Morgan Stanley has few other options than to focus on costs, analysts say.

"As market activity improves, some of the cost-cutting questions at Morgan will probably go away," said Brian Kleinhanzl, a banking analyst with KBW. "But as of now, it’s the only lever that banks can really pull in this type of environment."

(Reporting by Olivia Oran in New York; Editing by Lauren Tara LaCapra and Cynthia Osterman)