There was a ray of sunshine for the law firm industry during the first quarter of 2012, as demand grew modestly, reversing the decline seen in the fourth quarter of 2011.

But there were also some dark clouds. Expense growth outpaced revenue growth even more than in 2011. And while demand growth is good news, a similar growth rate in head count meant that there was no change in the industry’s productivity numbers, which have been historically low since the recession.

Overall, revenue growth of 1.2 percent was driven by a 1.5 percent increase in demand and a moderate increase in rates. However, there were notable differences across market segments. While revenue growth was strong for Am Law 51–100 firms and firms outside The Am Law 200, Am Law 1–50 and Second Hundred firms saw virtually no growth. Demand growth was also patchy. Am Law 51–100 and Second Hundred firms saw solid demand growth, while smaller firms saw demand continue to decline. Am Law 1–50 firms saw just a 0.6 percent increase. Rate increases continued to grow at a similar rate to 2011, and more than in the two years prior, but still lag behind historical averages.

These results are based on a sample of 176 firms (81 Am Law 100 firms, 44 Second Hundred firms, and 51 additional firms). Citi Private Bank provides financial services to more than 600 U.S. and U.K. law firms and more than 35,000 individual lawyers. Each quarter, the Law Firm Group confidentially surveys firms in The Am Law 100 and Second Hundred, along with smaller firms. In addition, we conduct a more detailed annual survey. These reports, together with extensive discussions with law firm management conducted on an ongoing basis, provide a comprehensive overview of financial trends in the industry and insight into where it is headed.

For our sample, the expense increase was a hefty 5.9 percent. Part of this was due to a modest increase in head count (1.6 percent). A larger driver was a rise in operating expenses, which, at 6.7 percent during the quarter, are increasing at almost double the rate of the first quarter of 2011. We continue to hear about increased infrastructure costs, and we may also be seeing the impact of firms changing their behavior regarding prepaying expenses. Many firms managed their expenses in the first quarter of 2011 by prepaying expenses at the end of 2010, when the outlook was brighter. It’s less likely, given the challenging demand environment that firms faced at the end of 2011, and the already high expense growth they were experiencing, that firms similarly prepaid 2012 expenses during the fourth quarter of 2011. So it’s possible that the growth in expenses we saw during the first quarter of 2012 is partially due to the lower expense base created by prepayment occurring at the end of 2010 but not at the end of 2011.

Head count increased across all segments, and most for the Second Hundred, where we saw some merger activity. That would explain some of the increase in equity partner head count for this segment—its increase was 1.5 percent, compared to the overall increase of 0.7 percent. The Am Law 1–50 segment did not increase equity partner head count at all, continuing the trend of careful equity partner head count management we have been seeing in recent years.

The changes in head count also resulted in a modest increase in leverage, and while it’s positive to see law firms increasing head count, we’re concerned about firms’ continuing low productivity levels. At a gap of 100 hours below historical productivity levels, firms continue to experience significant excess capacity.

Looking ahead, solid increases in overall inventory levels should augur well for collections in the second quarter. The real concern is how to control expense growth, if demand and revenue increases continue to remain modest.

Dan DiPietro and Gretta Rusanow are chairman and senior client adviser, respectively, at Citi Private Bank’s Law Firm.