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Bankers Still See Law Firms as Good Credit Risks
Citi Private Bank official says firm loans are up 25 percent, probably to fill the cash gap from clients not paying promptly
Fulton County Daily Report
October 09, 2008
While businesses around the country struggle to adjust to the tightening of the credit markets, law firms needing to borrow money are -- at least for now -- still experiencing relatively easy access to cash.
That doesn't mean, however, that all looks rosy for firm finances.
Some banks are increasing their scrutiny of law firm loans, attaching more covenants and conditions and looking ahead to how well firms can collect their receivables in the coming year. According to some bankers and consultants who focus on law firm lending, a lag in collection time is pushing firms not just to borrow more money but also to increase holdbacks on partner compensation and, perhaps, decrease overall profit distributions.
Dan DiPietro, client head of the law firm group at Citi Private Bank, said his employer still views lawyers as a good credit risk -- despite the crisis coursing through the markets and the collapse or merger of clients that supply billable hours to many of the nation's law firms.
"Our underwriting criteria have not changed; our appetite for lending has not changed," said DiPietro, speaking via cell phone while on a business trip to London. "What has changed is our focus and discipline on pricing and making sure that we're pricing with the view that this is not a standalone credit facility but is generating other revenue."
In other words, he explained, this is the opposite of a time when there is a lot of liquidity in the market, when banks price aggressively with thin spreads and are not as focused on returns. "In this market," he said, "there's a huge focus on overall returns."
Because Citi wants to be compensated for more than the cost of the loan, it encourages law firms to deposit their money with Citi and use other bank services that produce additional revenue streams.
DiPietro estimated that this year the dollar volume of loans his bank has granted to firms is up 25 percent. He attributes that figure to firms' need to fill the cash gap created by clients who aren't paying their bills as promptly as in the past.
Like many banks, Citi looks at firms' cash flow, receivables and work in progress when assessing their creditworthiness and how much cash to advance on revolving or long-term lines of credit. DiPietro noted that this examination is done informally rather than in a strict asset-based lending context.
DiPietro said Citi is giving existing loans a higher level of scrutiny and is looking more closely at firms on an individual basis to assess how the economic turmoil might affect their receivables.
Although defaults have not increased, he added, "We certainly have seen our level of classified loans increase." A classified loan is one issued in accordance with a bank's lending standards but later deemed by bank examiners to be substandard as a result of repayment problems or other issues.
WAITING FOR YEAR-END RESULTS
Lisa R. Smith, vice president at Hildebrandt International, a legal consulting firm that works with many of the Am Law 100 and 200 firms, said she, too, is seeing firms becoming more dependent on their lines of credit and seeking more cash because of slow collections. But, she said, because collections tend to be concentrated at the end of the year, only time will tell what proportion of those receivables actually is collectible. Both DiPietro and Smith said they're not aware of banks cutting off firms' access to credit at this point, though Smith said she did know of a few firms that were acting in anticipation of that possibility.
"I've heard a couple of firms worry about their line [of credit] and a few that have tried to drain some of the cash out to have it ready," she said. "They're borrowing as a hedge to have it when they need it."
Unlike Smith and DiPietro, Steve Allen, senior vice president and manager of the legal specialty group at SunTrust in Atlanta, said he has not seen demand for loans increase -- even though collection time for the firms with which his bank has relationships has stretched by between 15 and 30 days.
"There's usually a pretty large amount of receivables covering the borrowing that they've done, so there is lots of room for shrinkage ... before they have to come back and ask for additional credit," he said. Also, he added, "I think a lot of our clients, given the nature of their businesses, are very attuned to what is going on in the marketplace. Many law firms are choosing to deleverage, and we've advised them to do so."
One way firms afford to deleverage is by decreasing expenses. Allen said that he's seen firms lay off lawyers or staff and delay or reduce equity partner distributions before asking for more credit.
One reason for the difference between his perspective and DiPietro's may be the population to which they lend. Citi has relationships with some 650 U.S. and British law firms, many of them in the Am Law 100 and 200. SunTrust has relationships with about 250 firms and individual lawyers, the vast majority of them in the Southeast.
As Allen puts it, his perception -- in an anecdotal sense, at least -- is that firms in the Southeast may be more insulated from the current economic woes because their practices are not as dependant on the transactions and other Wall Street-type deals that are the bread-and-butter of New York firms. He also thinks that the Southeastern economy continues to remain diverse and attract new workers.
"Maybe the partner distributions will be a little bit lower this year than they have in prior years," he said, assessing the overall health of the Southeast's legal community, "but there certainly will not be the wholesale closing of law firms that you've seen and read about in New York City."
PARTNER PROFITS AMID WEAK REVENUE
How the economy will affect partner profits is something DiPietro and Citi have spent a fair amount of time considering.
In an analysis produced for The American Lawyer, a sibling publication of the Daily Report, DiPietro wrote that starting in the second half of 2007 and continuing through the first half of 2008, law firms' finances began to undergo some significant shifts.
Specifically, the study found that while expenses have stayed high -- primarily because of attorney hiring -- revenue growth is the weakest it has been in the past seven years, as is demand for legal services.
The Citi Private Bank Law Firm Group, which has done a confidential survey of the Am Law 100 and 200 and other firms for the past 28 years, found that demand, measured by gross billable hours, declined by 0.3 percent, as compared with the compound annual growth rate over the past seven years of 3.9 percent.
The result: profits per equity partner fell 9.1 percent in the first six months of this year, according to the study. The study also found that the 63 most profitable firms -- defined as those with profit per equity partner above $650,000 in 2000 -- have been the hardest hit so far in 2008.
Growth in profit per partner for most of those top-tier firms was up 11.7 percent in 2007, but down 11.8 percent in the first half of 2008. Less profitable firms, the survey found, saw only a 5.3 percent drop.
Why? According to DiPietro, top-tier firms focus on certain types of transactional work such as equity deals, securitization and structured finance and tend to have more clients in the financial services sector. To state the obvious, those are the types of transactions and businesses hit hardest in the unprecedented market upheaval of the past few weeks.
Still, he said in an interview that overall, he views the legal sector as a strong one with some weak players. Hildebrandt's Smith said much the same, though she added that she expects firms' 2008 revenue to be flat or down. "Being down 10 percent will not be out of line," she said. "I'd say 5 to 10 percent will not be at all unusual."
SunTrust's Allen also said that although firms' revenue and partner profits may slip, his bank still is offering both secured and unsecured loans, though it is looking more closely at firms' assets, receivables and collection times. But he calls that closer look -- which also involves an assessment of compliance with loan covenants covering issues such as a firm's write-offs, revenue per partner, revenue per lawyer and the number of lawyers who joined or left in a given year -- more of a tweak than a change.
His most telling assessment of the bank's perspective on law firm lending, he said, is this: "We're still out aggressively recruiting new clients."
