While their expenses have grown and a potential economic downturn looms, large New York law firms in 2018 saw, on average, their best revenue growth since the recession, according to surveys of New York-based law firms by banks.

The firms are also sitting on extraordinarily high levels of billed and unbilled time this quarter, meaning this month and the first quarter of 2019 may be especially rewarding.

While the past few years for New York firms have been healthy, 2018 appears to be an even better year due to an increase in both billing rates and demand, according to results from Wells Fargo Legal Specialty Group and Citi Private Bank Law Firm Group. In past years, billing rate increases mostly drove revenue growth.

“The story this year is that it's been a balance” of rate increases and demand growth, said David Altuna, a senior vice president at Citi's law firm group. “This is going to be the strongest year in the post-recession period from the top line perspective.”

According to Citi's figures, gross revenue for New York firms grew on average by 7.1 percent in the first nine months of 2018 compared with the same period last year. That beats the industry average of 6.3 percent, Altuna said. Citi's regional breakdown includes 39 New York-headquartered firms out of its industry survey of 190 firms.

New York firms in Citi's survey saw demand increase on average by 2.5 percent, matching the industry overall, Altuna said. That's compared with a post-recession average of just a 1 percent rise in demand, he said.

Citi projects, Altuna said, that the legal industry may have revenue growth in the mid-7 percent range by the end of the year. New York firms could see growth of more than 8 percent. That would be nearly double the revenue growth of New York firms last year, which was 4.5 percent.

Wells Fargo's survey data of New York firms showed even more glowing results. New York firms, in that survey, saw gross revenue rise on average about 8.9 percent in the first nine months of 2018. Wells Fargo's New York breakdown includes 25 firms in the region, including about 14 firms in the Am Law 100 and the rest in the Second Hundred or just outside it.

Robert Tolan, senior director of banking for the Wells Fargo group, said the performances of New York firms mirror the upbeat performance in the industry.

“It's not every firm, but on average their revenue growth is the highest it has been in a number of years, driven by a combination of increased rates, but also higher demand” and higher attorney head count, Tolan said.

The bank officials attribute the rising revenue and demand growth to robust deal activity and still relatively low interest rates. Demand and revenue growth is still driven by transactions, Altuna said, “but we're hearing very good things about litigation picking up.”

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Strong Start in 2019

With such demand growth, it's perhaps no surprise inventory—the amount of money from work in progress and accounts receivable—has skyrocketed. ALM reported that New York firms were sitting on high levels of cash at the end of 2017 too, but they have even more to collect this quarter.

Wells Fargo said the inventory of New York firms in the Am Law 100 spiked 10.3 percent by the end of the third quarter and 9.3 percent for all New York firms. “Inventory levels are putting firms in a position to finish very strongly,” Tolan said. ”It will ensure a strong fourth quarter but it will also tee firms up for 2019.”

Inventory for New York firms in Citi's survey grew on average 7 percent so far in 2018. “Not only do we expect 2018 to end well, but we expect 2019 to start fast,” Altuna said.

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Correction Ahead?

Still, concerns loom on the horizon, including a potential market downturn. Altuna said Citi is projecting a downturn but not until 2020. “It's an unprecedented period of growth that will correct at some point,” Altuna said.

Citi and Wells Fargo bank officials said they didn't see any data to reflect that firms are slowing down their hiring or planning in any way to prepare for a market correction.

While their top line figure is growing, expenses are tempering profit margins.

New York firms saw higher expense growth, 6.1 percent so far in 2018, compared with the industry's at 5.9, according to Citi's data. One concern, Altuna said, is an upcoming expense acceleration due to the associate compensation increases that were implemented in the middle of the year. The growth in expenses only accounts for three months of higher associate wages, Altuna noted.

Of those total expenses, New York operating expenses rose 4.9 percent in the first nine months of 2018. Such expenses could include rent, technology and cybersecurity upgrades and professional staff costs. In past years, firms tightened their belts on operating expenses to balance out compensation increases, but it's not happening to the same extent this year, Altuna said.

“We will have a strong year by the end of the year, but you may not see the profit growth that would be commensurate with the strength of the year,” Altuna said.

Of course, the glowing results overall reflect averages among many firms, and the bank officials said there's plenty of dispersion in the numbers. In Citi's survey, 24 New York firms saw growth in demand while 11 saw a decline in 2018.

Tolan pointed to a “pretty big bifurcation in the performance” between those New York firms in the Am Law 100 and those outside it. “There's more variance” in the Second Hundred group, with a few firms that are down year over year, Tolan said.

For the Second Hundred group, there's less demand and firms are keeping head count fairly flat and potentially reducing equity partner ranks, Tolan said, calling it a “different model of profitability” for those firms.

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