The overall health of the U.S. banking industry improved in the first quarter with two-year-high net income of $18 billion, but the gains were disproportionately enjoyed by the largest firms.

The Federal Deposit Insurance Corp provided on Thursday a mixed picture of the recovery of the bank industry, with small institutions still feeling the strains of tough credit conditions but with a slower rate of deterioration.

The number of U.S. problem banks increased about 10 percent during the quarter to 775 -- a smaller jump than during the fourth quarter when the number of problem banks increased 27 percent.

Bank failures and consolidation drove the number of U.S. insured banks down below 8,000 -- the first time in the 76-year history of the agency.

There are encouraging signs in the first-quarter numbers, FDIC Chairman Sheila Bair said in a statement. Industry earnings are up. More banks reported higher earnings, and fewer lost money.

The improvement in earnings was largely due to a reduction in the amount of money that banks set aside for anticipated loan losses. However, the bulk of that reduction was concentrated among a few of the largest banks, the FDIC said.

In a sign the FDIC does not anticipate further big losses to the insurance fund due to bank failures, the agency reported a $145 million increase to the fund balance. That is the first increase in the fund balance in two years.

The FDIC said it set aside in the first quarter $3 billion in additional provisions for expected bank failures, compared to the additional $17.8 billion it set aside in the prior quarter.

The fund balance remains a negative $20.7 billion, but the FDIC has plenty of cash on hand after asking banks to prepay three years of industry assessments.

(Reporting by Karey Wutkowski; Editing by Tim Dobbyn)