California Economy 2012: Turning the Corner?

California Economy 2012: Turning the Corner?

To understand California’s legal market, we must understand the economy as a whole.

California's economy is the ninth largest in the world, compared with other countries.  As of 2010, the gross state product (GSP) was about $1.9 trillion, comprising 13% of the national gross domestic product (GDP).  But California was hard-hit by the Great Recession with its economic growth rate slowing to 0.4% in 2008, compared to 3.1% in 2006 and 1.8% in 2007.  Now, along with the upswing in the national economy, California’s fortunes also appear to be improving with its strongest growth in five years.  Standard & Poor's upgraded its outlook on California's ability to repay its debts to "positive" from "stable."

Construction spending, often a barometer of economic health, rose at a rate of 7.3% in the fourth quarter of 2011 from a rate of 1.4% during the previous quarter.  California commercial real estate developers and their bankers are growing optimistic about their industry’s prospects.  The state’s markets for office and industrial space have made progress, driven by the steady employment gains in coastal California, including San Francisco and Silicon Valley, where the tech industry is strong.

In Southern California, office landlords also are beginning to see evidence of recovery.  In recent months, dozens of Internet startups and media companies have opened in “Silicon Beach” along Los Angeles’ western edge and Santa Monica.   A bigger influx of tech and media-related real estate deals over the next few years is expected as word spreads about the region’s appeal for the industry. Orange County was the first in Southern California to return to economic growth in 2010, fostered by its universities, high-tech industries and tourist attractions.  Residential real estate in Orange County, particularly for lower-priced condominiums, could begin to turn around.  Stronger job growth in San Diego suggests nonresidential construction will return there, as well.

International trade through the ports of Los Angeles and Long Beach and Los Angeles International Airport jumped late last year and is ready to expand along with the national economy.  But that projection would be negatively impacted by international political or economic crises in Europe, the Middle East, or elsewhere.

California's jobless rate, which was 10.9% in February 2012, is expected to fall to 7.7% by the end of 2014, slightly above the U.S. average, according to the UCLA Anderson Forecast. Growth in the San Francisco Bay Area continues to outpace the nation, led by the technology sector. Even hard-hit areas such as the Central Valley and the Inland Empire are seeing job gains.  In contrast to other parts of the country, California's labor force is expanding, thus keeping the state's unemployment rate high even as the employers are adding jobs.  Therefore, labor markets are not as bad in California as the unemployment rate suggests.

Although California’s economy is slowly improving, primarily in coastal areas, it still faces serious challenges, including:  slower growth in Asia and a stronger dollar hurting California exports and tech demand; a foreclosure and distressed sales backlog and continued weak demand for housing; and deep budget cuts at the state government level.

Los Angeles County

Barring an international meltdown, the job picture for Los Angeles County should brighten somewhat this year with the expected creation of about 22,700 jobs.  But, conditions remain difficult.  The county created more than ten times that many jobs in 2006, the year before the recession started.  LA County’s unemployment rate dipped to 11.8% in January 2012 from a revised 12% in December and 12.5% in January 2011.  This still was worse than the statewide average of 10.9%, and much worse than the national average of 8.3%. The county’s two largest cities, Los Angeles and Long Beach, saw their rates remain stubbornly high, at 13.3% and 13.2% respectively.

LA County lost 85,000 jobs in January as ten of the eleven local industry sectors showed declines in employment.  The hardest hit was the motion picture industry, which shed nearly 24,000 jobs. The retail sector lost 14,700 jobs, mostly due to layoffs of temporary holiday workers.  Professional and business services downsized by 13,000 jobs and private education lost nearly 7,000 jobs. Moreover, the county is home to virtually no major corporations.

Another problem facing Los Angeles is its sizable low-skill job sector.   About 13% of Los Angeles residents have less than a ninth-grade education, in a global economy where workers increasingly need specialized skills.  Industries which employ most of these workers, including hospitality, retail and construction, cut thousands of jobs as a result of the housing bust and drop in consumer spending during the recession.

2011 Law Firm Performance

Even with the economy languishing, a few California-based firms saw large gains in revenues or profits, especially those heavy with technology clients. But preliminary results from other firms in the annual Am Law survey showed revenues and profits hurt by financial market turmoil and worries that Europe's debt problems could slide the global economy into another recession. Law firm leaders described an uneven 2011 that started out promising but faltered by summer. By August, IPO work pretty much dried up.

Not surprisingly, law firms continued to manage costs and headcount carefully. Total attorney numbers dropped at many California firms and remained relatively flat at many others. Twenty-six of the state’s largest 50 firms posted modest increases in headcount in 2011, while 22 saw a net decrease.  These numbers are slightly better than in 2010, when 20 of the largest firms boosted their ranks while 26 shrank.  One exception was Quinn Emanuel, which added 190 lawyers, increasing headcount by 42% over 2010. Their profits per partner also were the highest of any California firm, topping $4 million, as a result of contingent and other alternative fee arrangements.

Most gains were not as a result of a surge in demand for legal services. Litigation was the single bright spot in 2010.  Therefore, law firms with a heavy litigation emphasis saw some of the biggest increases in profits and revenue, though not near Quinn’s record levels.  There was a modest uptick in demand from most practice areas, especially for firms with clients in life sciences, technology and financial services.  Law firms with proportionately fewer lawyers in New York did better as the turbulence in the capital markets tended to disrupt them less.

The continuing trend toward consolidation was particularly strong in California.  Los Angeles led all other cities with six law firm mergers.   In each of those, a local boutique was acquired by a larger firm, generally from outside California and with a bigger national presence.  The spike in mergers is a sign that the overall industry has recovered enough so that larger firms aren’t afraid to make moves, and there are no signs of the trend slowing down.  So far, the number of mergers has been almost double what they were at the same time last year.

Los Angeles legal market

Although many California-based firms had strong years in 2011, the Los Angeles legal market has been losing ground to other markets, including the Bay Area, New York, and Asia.  The primary reason is the disappearance of Fortune 500 companies.  The only major industry remaining is entertainment, but those companies are relying less on outside counsel.  Furthermore, many of the large local firms have been striving to become national and international players, with either no home office or a New York focus.  As a result, growing a Los Angeles office is less important than boosting a national or even international presence.

Finally, law firms have gotten used to the cost cutting measures they employed during the height of the Great Recession, including less leverage, elevating fewer attorneys to equity status, partners billing more hours, and the use of technology.  Therefore, even though revenues have picked up, the need for more associates has not kept pace.

Valerie Fontaine
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