* US bank industry reports net profit of $914 mln in Q4
* Number of problem banks continues to grow, jumps to 702
* FDIC insurance fund balance sinks to -$20.9 bln
* Agency says has cash to cope with situation (Adds further Bair comments on lending, details on smaller banks' problems)
By Karey Wutkowski
WASHINGTON, Feb 23 (Reuters) - The number of "problem" U.S. banks jumped 27 percent during the fourth quarter of 2009 to 702, the highest level since 1993 and a sign that the industry's recovery remains uneven, regulators reported on Tuesday.
The Federal Deposit Insurance Corp said the industry overall eked out a profit of $914 million for the quarter, benefiting from a healing economy, but said the improvement was concentrated in the largest banks.
FDIC Chairman Sheila Bair said the profit was a huge improvement over the $37.8 billion loss the industry reported for the fourth quarter of 2008. "It's not that this was a strong quarter. It's simply that everything was so bad a year ago," Bair said in a statement.
She later told reporters that although the number of problem banks "sounds scary," the bank industry is "challenged but stable."
The FDIC noted that while the number of banks on the problem list jumped 27 percent, the amount of assets at problem banks only rose 16 percent to $402.8 billion.
That indicates that smaller banks are being added to the list. The list includes troubled institutions with issues related to liquidity, capital levels, or asset quality.
Smaller institutions are still struggling with deteriorating loan portfolios, especially with loans tied to commercial real estate. The FDIC set aside an additional $17.8 billion during the fourth quarter for expected bank failures.
Regulators have closed 20 U.S. banks so far this year and 185 since January 2008, as banks continue to struggle with loan portfolios stocked with souring loans.
The additional provisions for expected bank failures sunk the balance of the FDIC's insurance fund even further to a negative $20.9 billion at the end of the year.
Carmine Grigoli, chief U.S. investment strategist at the equities division of Mizuho Securities USA in New York, said more and more smaller banks were likely to run into trouble due to commercial lending problems. "I don't think that's terribly surprising," said Grigoli.
Despite a negative balance for the FDIC's insurance fund, which safeguards accounts up to $250,000, the agency says it had about $66 billion in cash resources as of the end of the year to operate and back customer accounts.
At the end of 2009, it asked banks to prepay three years of industry fees, worth about $46 billion; but while it received the cash, it could not put the money toward the insurance fund balance.
The FDIC said indicators of asset quality at banks worsened during the fourth quarter.
The annualized net charge-off rate for bad loans rose to 2.89 percent, compared with 2.72 percent during the third quarter. That is the highest net charge-off rate in the 26 years for which data are available.
The woes in the industry have been migrating from mortgage-backed securities to deteriorating home loans and are now largely tied to commercial real estate loans that remain a looming problem.
Bair said the continued rise in loan losses and troubled assets will constrain lending, especially for small banks that have high commercial real estate exposure.
Loan and lease balances dropped for the sixth quarter in a row, falling by 1.7 percent in the fourth quarter, the FDIC said. The Obama administration has repeatedly urged banks to loosen credit for small businesses, a key driver for the economy and job growth.
The FDIC noted that large banks were responsible for 90 percent of the decline in loan balances during the quarter.
"I do think the larger banks do need to do a better job of stepping up to the plate here," Bair said.
She said regulators are trying to take a balanced approach to ensure banks make prudent loans.
Banks have complained that they are getting conflicting messages from policymakers urging lending, on one hand, and from bank supervisors scrutinizing the quality of every loan. (Reporting by Karey Wutkowski; Additional reporting by Rodrigo Campos in New York; Editing by Tim Dobbyn and Gerald E. McCormick)