Sooner or later, it was bound to happen. After six years of keeping expenses down-largely through eschewing the associate salary wars of the late 1990s and dramatic ramp-ups in head count-law firms unloosened the purse strings. First-year associate salaries rose sharply, especially among Am Law 100 firms. So did hiring numbers. Both moves were made in anticipation of a law firm economy that would continue to produce the roughly double-digit increases in profits and gross revenues the industry has enjoyed over the last six years.
It certainly seemed like a reasonable assumption, given the strength of the legal economy in recent years. That strong revenue growth continued through the first six months of the year, according to data reported by the Law Firm Group at Citi Private Bank in our latest flash report. But for the first time since 2001, expense growth actually outpaced that of revenue from January through June, depressing profit margins. This could be the first sign that firms face rough seas ahead. The first half of 2007 did provide firms with enough momentum to produce what we believe will be respectable profit growth for the year, if not the gaudy increases firms have become accustomed to since 2001. However, in the second half of 2007, expenses will almost certainly continue their climb, propelled by the costs of associate salary increases and rising attorney numbers, along with escalating real estate and technology costs. On the revenue side, transactional work has dropped off sharply as the mortgage lending credit crisis continues to play out. And those old stalwarts of an economic slowdown-litigation and bankruptcy-have yet to fill in the gap created by the absence of transactional work. Unless business picks up, firms could find themselves struggling a bit in 2008.
