UPDATE 2-Danske core income drops, sees challenging 2010

* Net profit 937 million DKK, vs forecast 898 million

* Loan losses 3.48 billion DKK vs forecast 3.90 billion

* Net interest income 5.93 billion DKK, vs forecast 6.02 bln

* Sees 2010 loan losses lower than 2009

* Shares down 4 percent

(Adds detail, background, share price, analyst comment)

By Anna Ringstrom

COPENHAGEN, Aug 10 (Reuters) - Danske Bank (DANSKE.CO) core income fell more than expected as Denmark's economic recovery lagged its Nordic neighbours and the lender said the rest of 2010 would be challenging for the sector, hitting its shares.

Danske, the last of the Nordic region's top banks to announce its second-quarter results, swung into a profit in the second quarter after write-offs of bad loans at Denmark's biggest financial institution halved from exceptionally high year-earlier levels, but it said they would stay high this year.

Danske shares fell 4.1 percent by 0959 GMT compared with a 1.7 percent drop in the Nordic banking index .TBNKF, which has outpaced European peers by far this year. The European index .SX7P was down 1.1 percent.

Nordic bank shares have been buoyed by robust regional finances and as risk-averse investors hunted for safer assets and stronger balance sheets. Second-quarter reports from Nordea (NDA.ST), DnB NOR DNBNOR.OL, Handelsbanken (SHBa.ST), SEB (SEBa.ST) and Swedbank (SWEDa.ST) have showed shrinking loan losses and early signs of better lending growth.

Last month, a stress test of European banks put Danske and its large Nordic rivals well inside the top-20 strongest capitalised.

But with a much larger business in Denmark, whose economic recovery is lagging the other Nordic countries', Danske's core lending activities have struggled. Danske, unlike other Nordic banks, also has exposure to Ireland which has been hard hit by the global economic downturn.

Net profit was 937 million crowns ($167 million) against a forecast for 898 million in a Reuters poll, and after a year-earlier loss of 828 million. [ID:nLDE6730T3] The result was, as expected, boosted by a 700 million crown extraordinary gain at Danske Markets.

Net interest income shrank to 5.93 billion crowns from 6.91 billion versus a forecast 6.02 billion.

"Net interest income declined because of lower short-term interest rates, lower lending volumes, narrowing deposit margins and increasing long-term funding costs. Lending margins widened modestly during the period," Danske said.

Loan impairment charges eased for a sixth consecutive quarter to 3.48 billion crowns from 6.55 billion, better than a forecast 3.90 billion.

The Nordic region's fourth-biggest bank by market value said the level of the charges reflects continued difficult economic conditions in Denmark and Ireland. Small and medium-sized businesses accounted for the largest part of the charges.

"In view of the general economic climate, loan impairment charges are likely to remain high in 2010, although somewhat lower than in 2009," Danske said, echoing guidance from May.

"In several of the group's markets, charges are approaching normal levels. This is the case in Finland, Sweden, Norway and the Baltic countries," Chief Executive Peter Straarup said.

Nordea said in a note to clients the underlying result was weaker than expected, despite smaller loan losses than forecast, with disappointments on net interest income, insurance and costs.

"Net interest income was 1 percent short of us and consensus and Danske Bank commented on a continued pressure on deposit margins due to lower short term rates," Nordea noted.

Danske revised down its guidance for short term money market rates and its economic growth outlook for its main market Denmark.

Nordea said loan growth in Denmark was unlikely to pick up sharply in the second half of 2010. (Editing by Dan Lalor and Louise Heavens) ($1 = 5.612 Danish crowns)