Citibank’s Law Firm Group has recently issued its mid-year financial assessment of the legal industry and it is not a pretty sight.  But that bad news is based on results as of June 30, 2008, well before the takeover of Freddie and Fannie, the bailout of AIG, the disappearance of WaMu and Wachovia and Merrill, and the bankruptcy of Lehman, not to mention the failure of the Congressional rescue plan, all of which portends even worse carnage to come.

The first half of 2008 looks very different from the previous six years.  Revenue growth was the weakest it’s been in seven years–averaging 4.8% compared to the 10.6% 7-year average. With law firms continuing to add lawyers to their ranks (up 5.6%), a slowdown in productivity comparable to mid-2001 is taking hold, with expenses (up 10.1%) increasing faster than revenue.  Compensation costs are up 15%, well above the 7-year 10.1% average increase.

Practice areas like restructuring and bankruptcy that have been anti-cyclical in the past have not yet helped cushion the fall. 

Profits per Equity Partner dropped 9.1% during the first half of 2008 even though the 1.8% increase in the number of equity partners is substantially down from the 2.9% seven-year average.  Top tier firms suffered the most, falling from a 11.7% increase in PPEP in 2007 to a 11.8% drop, victims of the languishing deal/financings markets and an inability to be nimble in changed circumstances–the big firm head count increase doubled that of smaller rivals, which is in part why smaller firms had only half the drop in PPEP (5.3%) for the first half of 2008.

Interestingly, "international firms," those who have 10-15% of their lawyers overseas, have been subject to the same downturn, while "global firms," with 25% or more of lawyers overseas, have fared much better.  However, it may just be a matter of time before the global economy starts to throw out the same challenges to those firms.

Projections as of June 30 of PPEP for the year 2008 are flat to down 10%, indicating top-tier firms risk up to a 15% decrease, putting 2008 on track for the worse year since at least 2001 and maybe earlier.

Unfortunately, those numbers are likely to be rosy.  They do not take into account the recent paralysis in the credit markets, the enormous financial burden the government (and ultimately taxpayers) has taken on and the disappearance of several major banking clients.  Word of mouth indicates that many firms are holding back distributions to a level as much as 30-40% below last year’s. Given the fall of Heller Ehrman and the teetering of a number of other law firms, those who register a 15% decrease in profits this year may be the winners. 

How to make the best of a difficult situation?  Tying associate bonuses to their and/or the firm’s profitability may help motivate young lawyers and limit expenses.  Attrition has recently dropped dramatically so firms can winnow out unproductive lawyers and cherry-pick lateral hires that are consistent with their strategic plan, making sure they really know why those lawyers are leaving their old firms.   Making sure collections are current is also critical.  And this is the time to clamp down on administrative and other non-essential expenses. Finally, robust business development is more important than ever.