UPDATE 3-Hudson City Bancorp Q2 net up, bad loans rise

* CEO says credit losses to rise, not worried

* CEO blames economy, unemployment for credit losses

* Shares fall as banks drop (Adds CEO interview, analyst comment, updated share price)

By Jonathan Stempel

NEW YORK, July 21 (Reuters) - Hudson City Bancorp Inc (HCBK.O), the largest U.S. savings and loan, said second-quarter profit rose 16 percent as increases in mortgage lending and deposits offset a jump in bad loans.

The results suggest that the Paramus, New Jersey-based parent of Hudson City Savings Bank is still able to withstand the recession through its focus on making mortgages and collecting deposits, rather than dabbling in riskier products such as construction loans or subprime mortgages.

Net income rose to $127.9 million, or 26 cents per share, from $110.7 million, or 22 cents, a year earlier.

Analysts, on average, expected profit of 24 cents per share, according to Reuters Estimates. Results included a $21.1 million charge to fund a federal deposit insurance program. Some analysts estimated profit excluding securities gains at 23 cents per share.

In morning trading, Hudson City shares were down 64 cents, or 4.4 percent, at $13.97 on the Nasdaq amid a broad-based decline in banking stocks.

Profit improved though Hudson City set aside $32.5 million for loan losses, up from the first quarter's $20 million, which Chief Executive Ronald Hermance attributed to a deteriorating economy and higher unemployment.

Net charge-offs more than doubled from the first quarter to $9.6 million, and nonperforming loans increased 35 percent to $430.9 million, or 1.40 percent of total loans.

"The pace of asset quality deterioration does cause come concern," wrote Rick Weiss, an analyst at Janney Montgomery Scott LLC in Philadelphia. "Cautious underwriting practices and strong capital levels ease our credit worries."

Hermance, in an interview, said credit losses are "going to trend higher." Yet he said the thrift has sufficient reserves, and could sell some of its $25 billion of government-backed securities if it needed to bolster them.

Hudson City offers jumbo loans, typically in mid-six-figure dollar amounts, to borrowers who plan to live in their homes and can put down 20 percent.

It said it made $1.7 billion in loans and added $1.3 billion in deposits in the quarter. Net interest margin rose to 2.17 percent from 2.06 percent in the prior three-month period as rates fell faster on deposits than on mortgages.

"When this whole story gets written someday, it is consumers' overwhelming desire for additional credit, and the liberal methods by which it was provided, as the single biggest cause of the housing problem -- beyond the type of loans that were made," Hermance said.

Through Monday, Hudson City stock was up 20 percent since June 2007, around when the credit crisis began. In contrast, the KBW Mortgage Finance Index .MFX, which includes the thrift, was down 81 percent. (Reporting by Jonathan Stempel; Editing by Jeffrey Benkoe and Brian Moss)