Roger Yu

USA TODAY

As large banks start to report earnings this week, they're expected to confirm that low interest rates are a double-edged sword.

JPMorgan Chase will kick off bank earnings Thursday. Its comments will be parsed by Wall Street as it seeks clues about the industry’s exposure to recent shifts in the global economy.

Bank revenue, derived largely from the spread in the interest rates charged on loans and paid on deposits, continues to come under pressure as rates remain stubbornly low. Rates are expected to remain low following the economic uncertainties triggered by the United Kingdom's Brexit vote to sever its economic and political ties with the European Union.

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Another challenge: The industry is still dealing with bad loans to struggling or bankrupt energy companies and money set aside to cover related losses. Potentially making things more difficult, year-ago results were “boosted by strong capital markets revenues, wealth management, and unusually low loan-loss provisions,” Erik Oja, banking analyst at S&P Global Market Intelligence, wrote in a note to investors.

“Without any help from interest rates, bank revenue growth will have to come from asset growth and other income,” he wrote.

Overall, second-quarter earnings for the banks in the S&P 500 index are projected to decline by 11.8%, according to FactSet. Some banks could "guide down expectations” for full-year results and lower earnings per share growth projections by 1% to 5% for 2017, Betsy Graseck, a banking analyst at Morgan Stanley, wrote in a note to clients.

But not all is bleak. U.S. house hunters are increasingly enticed by falling interest rates and likely helped support the banks’ mortgage units. Banks more heavily exposed to the mortgage market — such as Bank of America, Wells Fargo and U.S. Bancorp — may show that mortgage businesses have been beneficiaries.

"Banks may experience a boost in non-interest income as demand for residential refinance ticks up in the low-rate environment," said Bain Rumohr, director at Fitch Ratings.

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Other positive points: The job market is robust and American corporations are sitting on a mountain of cash. The S&P 500 hit an all-time high Tuesday. And the industry’s portfolio of bad loans also remains relatively sound.

BREXIT EFFECT

The aftermath of Brexit could loom over the banking industry for years. The general weakening of the EU doesn’t bode well for an industry so dependent on capital flowing freely. And if the U.K.'s economy contracts, widely expected after Brexit, that could eat into the bank revenue.

“Brexit's direct impact on the U.S. banking industry is not expected to be material, but the unintended consequences could be far-reaching,” Gerard Cassidy, an analyst at RBC Capital Markets, wrote in a recent report.

Given the immediate market shock, the U.S. Federal Reserve likely won't raise short-term rates for at least another year. “The probability of rate increases has been reduced through at least the end of 2017 as The Fed will need to take into consideration the strength of the global, in particular the EU/UK economies, against a backdrop of potentially a stronger U.S. economy with higher inflation,” Cassidy wrote.

Still, some analysts are holding out hope that a flurry of trading after Brexit provided a late-quarter boost to banks’ bottom lines. Trading and investment banking revenues likely rose 3% from the first quarter, typically the strongest quarter of the year, Morgan Stanley estimated.

With interest income shrinking, banks are expected to reiterate during the earnings calls that they continue to cut costs. Consumers will most conspicuously notice the trend in the shrinking number of retail branches. “A prolonged low interest rate environment would make it more difficult and less profitable for banks with the albatross of a large 'dinosaur' branch system,” Cassidy wrote. “Banks with robust mobile/digital delivery options and smaller and more sophisticated branches would drive better profitability metrics.”

Other areas of cuts will likely include data vendors, shared services and employees, Morgan Stanley’s Graseck says. “Banks have more to do on the expense front,” she said.