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) -- Total assets as part of the

Federal Deposit Insurance Corp.'s

"problem bank" watch list declined for the first time in three years while the list of troubled banks continued to rise, according to the agency's quarterly banking report released Tuesday.

The FDIC said in its second-quarter banking report that while the number of banks on its problem list rose 6.9% to 829, total assets at these institutions fell by 6.5% to $403 billion. It was the first time since the third quarter of 2007 that the asset figure for banks on the problem list declined.

Additionally, while the total number of problem institutions is the highest on record since 1993, the FDIC noted that it was the smallest net increase since the first quarter of 2009.

The FDIC identifies "problem" banks with a so-called CAMELS rating, which is an acronym for the components of the system. Components include capital adequacy, asset quality, management, earnings, liquidity, and market sensitivity.

Banks with a rating of four typically show unsafe or unsound practices or conditions, while banks with a five rating are deemed extremely unsafe or unsound, according to the FDIC web site.

So far 118 banks have failed this year, bringing the total to

283 failed banks

since the beginning of 2008.

The FDIC report gave some encouraging signs of improvement for banks and thrifts.

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Commercial banks and thrifts overall posted an aggregate profit of $21.6 billion for the June-ending quarter, a 20% increase sequentially and up substantially from the $4.4 billion loss banks' posted in the year-ago quarter, the report said. Banks have not posted profits of the same caliber since the third quarter of 2007.

Equally as encouraging, the average return on assets (a basic measure of profitability) rose to 0.65% from 0.13% in the year ago quarter. While this is still low, the sector is gaining strength, according to a statement by FDIC chairwoman Sheila Bair.

"Without question, the industry still faces challenges," Bair said. "Earnings remain low by historical standards and the numbers of unprofitable institutions, problems banks and failures remain high. But the banking sector is gaining strength. Earnings have grown, and most asset quality indicators are moving in the right direction."

A large contributor to the better earnings was the ability of many banks to decrease their loan loss provisions during the quarter as asset-quality trends improved. Provisions dropped 40% to an aggregate $40.3 billion compared to the year ago quarter, the report said.

The FDIC also noted that nonperforming loans at least 90 days past due or in nonaccrual status declined for the first time since the first quarter of 2006. Loans charged off by the banks also declined.

"Today's report indicates that the banking industry continues to regain its strength, though the fragile economy still presents significant challenges," according to a statement by the American Bankers Association.

--Written by Laurie Kulikowski in New York.

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