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Italy working to meet UniCredit conditions for MPS deal, sources say

* Rome must cut 64% stake by mid-2022 at latest

* Treasury has worked for past year to clinch sale

* Two sides still distant, outcome unclear, says source

ROME, July 21 (Reuters) - Italy’s Treasury is working to meet terms set by UniCredit for a possible takeover of Monte dei Paschi in the latest push to offload the ailing state-owned bank to the healthier peer, three sources close to the matter said.

Despite the lack of significant progress in protracted negotiations, the Treasury still sees UniCredit as the best option for Monte dei Paschi (MPS), the sources told Reuters on condition of anonymity because discussions are private.

The three sources said the two parties continued to negotiate, cautioning that any deal would require time. One of the sources said positions were distant and it was too early to predict the outcome of talks. UniCredit declined to comment.

The Treasury shuns for now alternative solutions, such as breaking up MPS, although sources have said it could consider asset spin-offs to ease a sale to a single buyer.

The main condition posed by the Milanese bank in talks that started almost a year ago under former Chief Executive Jean Pierre Mustier is that any deal leaves intact the capital reserves UniCredit worked hard to bolster.

New CEO Andrea Orcel, the former head of investment banking at UBS, has shown little interest in a deal in conversations with Treasury officials, concentrating instead on revamping UniCredit’s structure.

Unveiling the latest organisational changes last week, Orcel said his focus at present was “on the internal”, having previously indicated he could consider mergers and acquisitions to accelerate his strategy to relaunch profits.

After rescuing MPS in 2017 spending 5.4 billion euros ($6.4 billion), Italy’s Treasury has pledged to cut its 64% stake by mid-2022 at the latest.

A key hurdle to a sale has always been some 10 billion euros in legal risks weighing on MPS following years of mismanagement.

The Treasury and its advisers have devised a complex scheme to shield the buyer from legal claims but UniCredit would need to sign off on the plan, sources have said.

To pave the way for a deal, the Treasury has also drastically cut MPS’ soured loan burden and sources have said it stands ready to do more on the bad loan front.

To ensure the deal does not burn through capital, in addition to receiving cash to cover restructuring costs and replenish its reserves, UniCredit also needs to be able to exit without a penalty commercial partnerships MPS has in place on insurance and other financial products, a person familiar with the matter said.

So far Rome has set aside 1.5 billion euros to recapitalise MPS in the context of a merger.

MPS, which is expected to fare poorly in Europe-wide industry stress tests this month, has told the European Central Bank it will raise 2.5 billion euros by April 2022.

The amount of state cash required for a deal to go through has always been one of the sticking points in talks together with MPS’ valuation, people familiar with the process have said.

To sweeten a deal, the Treasury has lined up tax incentives for mergers approved in 2021 that entail a 2.2 billion euro capital boost in a UniCredit-MPS deal. Political opposition in May thwarted an attempt to further beef up the incentives.

$1 = 0.8500 euros Reporting by Giuseppe Fonte in Rome and Valentina Za in Milan; Editing by Edmund Blair

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