The sky is not falling for the world of large law firms. But could Biglaw be a frog in boiling water? We can’t rule that possibility out just yet.

The latest report on law firm performance, focused on the first six months of this year, shows some signs of weakness. The numbers aren’t awful, but if Biglaw continues to travel down this path, it won’t wind up in a good place….

The information comes to us from our friends at Citi Private Bank, a leading law firm lender. Here’s what Gretta Rusanow, senior client advisor at Citi, wrote in a post for Am Law Daily (via Morning Docket):

First-half 2013 results suggest that the legal industry faces an uphill battle to match 2012’s low-single–digit profit growth. Expense growth outpaced very modest revenue growth, causing margin pressure. That modest revenue growth was due more to rate increases than any improvement in demand. In fact, demand declined. Yet despite declining demand, head count grew, leading to a worsening of the excess capacity we have witnessed in recent years — a major contributor to industry pricing pressure.

Given the current demand environment and the likelihood of ongoing pricing pressure, it will be a challenge for the industry to achieve enough revenue growth during the second half of 2013 to ease the margin pressure we saw during the first half. Rather than seeing a repeat of last year’s result, we think it’s more likely that we will see a flat year.

And maybe that’s not so bad. To quote the increasingly popular saying, “Flat is the new up.”

Here are the specific numbers from the Citi report:

  • Revenue: up 0.5 percent (“tepid, relative to the six-month growth in recent years”).
  • Billing rates: up 3.7 percent.
  • Demand: down 1.3 percent (“an improvement over the 3.3 percent decline seen during the first quarter,” but “a decline of 1.3 percent is still a decline”).
  • Expense growth: up 2.4 percent (better than the 3.4 percent growth rate in the first quarter, but still outpacing revenue growth, and driven by an increase in compensation costs).
  • Lawyer head count: up 0.4 percent (“The increase in lawyer head count, coupled with a decline in demand, resulted in lower lawyer productivity during the first half.”).

These numbers aren’t a huge surprise. As managing partner turned law firm consultant Edwin Reeser pointed out to me, the bottom line “is pretty much the same as the Wells Fargo Report. But with 81 of the Am Law 100 firms participating, and 45 of the Second Hundred, it is a strong sampling — which means overall, it is tough out there for all but a lucky few.”

Because of what has already happened year to date, 2013 will have a tough time topping 2012, as Gretta Rusanow explains:

Even if expense growth moderates during the latter half of 2013 from its first-half growth rate of 2.4 percent, the industry would still have to see a strong acceleration in revenue growth from the 0.5 percent seen so far, to ease the margin pressure experienced during the first half. It’s the combination of these challenges that has caused us to revisit our 2013 forecast of low single-digit profit growth. We think it is more likely that firms will see a flat year.

The last quarter of 2012 was boosted by a flurry of transactional activity driven by tax code changes and fiscal-cliff concerns. It seems unlikely that the final quarter of 2013 will be as busy — or as profitable.

And flat for the year could actually be optimistic. As Ed Reeser commented, “While ‘flat is the new up’ may be the general description for firm-wide performance, the prospect is more likely to be ‘down is the new reality.’ We have in fact already started to see the steps being taken by management to adjust to that reality, the preservation and increase of compensation for a few to ensure that ‘Your down is my up.”

Partners should keep their expectations for profits modest, and associates should do the same regarding bonuses. If you expect the worst, like the sky to fall, you might be pleasantly surprised.

Citi First-Half Report Finds Firms Facing Flat 2013 [American Lawyer via Morning Docket]

Earlier: Law Firm Performance In 2013 So Far — Plus Disturbing Data On Partner Productivity
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