Weaver: Remarkable resilience
Mid-sized law firms have improved their margins this year for the first time since 2021 while also reducing their exposure to client interest income, according to NatWest.
The bank’s annual legal report also suggested that the difficulties of attracting and retaining talent are easing.
Authored by Andrew Allen, a partner and head of PKF Francis Clark’s national legal sector team, the report drew on the detailed analysis of 110 law firms’ finances, with a median turnover of £17m.
Median fee income growth in 2025 was 12%, although two-thirds expect it to be less than 5% next year. Private client and residential conveyancing were cited as the most buoyant teams, with litigation and family the least.
A key metric of people costs as a percentage of fees – adjusting for notional partner salaries – was 64%, a point lower than last year.
“In the last two NatWest Bank surveys we have been reporting a gradual decline in core profitability (increase in people costs relative to income), so 2025 is the first year we have seen some improvement since 2021,” it said.
“This improvement in margin seems to have arisen from firms focusing on productivity; looking to increase average chargeable hours and recovered time.
“Many firms have been investing in improvements in time capture, scoping and general matter management to achieve this. This issue remains pivotal to many firms as we move into 2026.”
The majority of firms (57%) anticipated recouping the extra cost of employer’s national insurance through increased fees, whilst 29% said they would simply reduce their profit margins.
The improvement in profit margins meant median profits per equity partner (PEP) increased by 23% to £340,000 – £204,000 for small firms (up 8%) and £372,000 for large ones (up 23%).
Within this, though, were a quarter of firms reporting growth in PEP of 45% or more, and a quarter seeing declines of 9% or more.
Interest income “remains an important part of the financial model for many law firms” since base rates rose in 2022, Mr Allen wrote.
Interest represented a median 5.6% of firms’ earned income, although for the upper quartile of firms it started at 9.5%.
Converting those results to consider PEP, a median of 21% of PEP arose from interest profits. But for a quarter of firms, it started at 35%.
“Half of the firms reported that between 9% and 35% of their PEP arose from interest profits,” the report said. “Reflecting to 2022 and earlier years this result would have been closer to 1% (or less) for most law firms.”
But Mr Allen said there was evidence that exposure of law firms to interest income has reduced, “in part from lower base rates, higher payments in lieu of interest to clients (i.e. better compliance by law firms with the SRA accounts rules requirements) and higher growth levels in fee income”.
The position was not as bad as 2024, where it was “not unusual” to see firms where 50% of PEP was interest income, while for up to 5% of firms, once profits were set aside for fixed-share members, all of the remaining profit and PEP was interest income.
But he cautioned that, if law firms no longer retained excess interest – as both the Solicitors Regulation Authority (SRA) and Ministry of Justice are considering – “then this would lead to both significant inflation in their fees and most probably the demise of notable volumes of law firms with the associated pressures and challenges that would bring to the SRA intervention team”.
The SRA said last month that it was putting this possible reform on ice until the second half of next year.
The report said: “Joining up some of the results in this report we can see across the sector that there has been healthy growth in top line income levels, the core margins (people costs) have improved in many firms and there is still a high level of interest income being earned.
“The factors combined with more stable overhead growth have driven strong performance at a PEP level for survey respondents in 2025.”
It found too that 84% of firms were optimistic about the future, with 30% very optimistic – “a strong picture” but a little lower when compared to last year.
While attracting and retaining talent still remained the biggest challenge for law firms, with 29% identifying it, this was down from 44% last year and 46% in 2023. One in five firms (21%) did not except any change in headcount by 2026, compared to just 9% last year.
Half of the firms surveyed were actively engaged in using artificial intelligence in their business – compared to 2% two years ago – although most employed in for administrative activity and general matter management rather than delivering legal advice.
David Weaver, head of professional and business services at NatWest, said: “It’s encouraging that the legal sector has exhibited such remarkable resilience with the vast majority of firms having a strong sense of optimism about the future.
“Many of the firms we surveyed demonstrated strong growth in both fee income and profitability despite recent challenges, most notably margin pressures.”
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