U.S. troubled loans held by banks declined for the first time in more than four years, pushing bank industry earnings up to $21.6 billion in the second quarter.

The Federal Deposit Insurance Corp's latest quarterly report, issued Tuesday, showed banks putting away less money to cover expected loan losses, relieving an important drag on industry profits.

Banks had collectively earned $17.8 billion in the first quarter and lost $4.4 billion a year ago.

Nevertheless, FDIC Chairman Sheila Bair said the struggling economy continues to weigh on banks.

Earnings remain low by historical standards, and the numbers of unprofitable institutions, problem banks, and failures remain high, she said.

Bair added that while the economic recovery is slow, the FDIC does not anticipate the U.S. will fall back into a recession.

We think our predictions are that we will continue on a slow recovery but a recovery nonetheless, Bair said. But we're also in a somewhat wait-and-see posture.

In one sign of the economy's impact on banks, loan balances continued to decline during the second quarter, with net loan and lease balances decreasing by 1.3 percent. Loans to small businesses and farms -- a major focus of the Obama administration -- fell by 1.8 percent during the quarter.

The number of problem banks continued to rise, to 829 from 775, meaning nearly 11 percent of U.S. banks are on the watch list. The FDIC says the vast majority of banks on that list do not end up failing.

Assets at problem banks declined during the quarter to $403 billion from $431 billion, as the troubles gravitate to smaller banks.

The FDIC does not disclose the names of the institutions, which regulators have flagged for low capital levels, poorly performing assets or other troubles.

Bair said the FDIC still anticipates that the number of failures this year will exceed last year, when 140 banks collapsed, but said the total assets of this year's failures will probably be lower.

BOOST TO INSURANCE FUND

In an encouraging sign for the industry, the FDIC reduced its provisions for insurance losses by $2.6 billion during the second quarter, helping increase the FDIC's insurance fund by $5.5 billion.

The balance of the insurance fund -- which backs individual accounts up to $250,000 -- is still a negative $15.2 billion, but the FDIC has $44 billion of cash on hand after making banks prepay three years of fees.

The banking industry looked positively on the latest report, seeing it as a sign that the industry is moving past the struggles brought on by the recent financial crisis.

You've got a picture that shows the industry has turned the corner and is improving, said Jim Chessen, chief economist at American Bankers Association. Capital is up, earnings are up, margins are improving.

Bair said economic uncertainties mean banks should continue to exercise caution and maintain strong reserves.

But she also highlighted the industry's gains.

The banking sector is gaining strength. Earnings have grown, and most asset quality indicators are moving in the right direction, putting banks in a stronger position to lend, Bair said.

(Reporting by Karey Wutkowski and Dave Clarke; Editing by Andrea Ricci and Tim Dobbyn)

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