By Giuseppe Fonte and Valentina Za

MILAN (Reuters) -Italy attracted strong interest from funds when it sold 25% of Monte dei Paschi di Siena (MPS) for 920 million euros ($1 billion) on Monday, advancing plans to re-privatise the world’s oldest bank two years after a failed first attempt.

The sale is a testimony to the progress Italian banks have made in cleaning up their finances, which contributed to Moody’s unexpected decision on Friday to upgrade its outlook on the country’s credit rating to stable from negative.

It also buys Italy time to find a more permanent solution for its fifth-largest listed bank, including via a merger deal that a dearth of buyers made hard to pursue in the near term.

Strong demand led the Treasury to increase the share offering size, initially set at 20%, and to limit to 4.9% the discount compared to Monday’s closing price. The Treasury had been ready to grant a discount of up to 6%.

MPS shares were down 7.8% at 2.83 euros by 1145 GMT on Tuesday, reflecting the impact of the sale.

The stock closed at 3.07 euros on Monday, 50% above the price of a make-or-break capital raising a year ago that cost Italian taxpayers 1.6 billion euros, after they had already shouldered the bulk of an 8 billion euro rescue in 2017.

Monday’s sale, which a person involved in the deal said brought international investment funds into MPS’ shareholder base, stands in sharp contrast with the difficulties the bank faced to raise cash a year ago, with the state itself covering nearly two thirds of that cash call.

Chief Executive Luigi Lovaglio used that money to fund thousands of voluntary staff departures, bolstering income through cost cuts.

With rising interest rates driving Italian banks’ profits to record highs, MPS has forecast net income will top 1.1 billion euros this year.

Further improving the bank’s prospects, favourable court rulings in recent weeks have prompted MPS to downgrade to “remote” any legal risks stemming from lawsuits that have forced it set aside large sums against damage claims.

EU COMMITMENTS

BofA Securities, Jefferies and UBS Europe coordinated the accelerated bookbuilding for the stake sale, the Treasury said in a statement.

As part of the transaction, Rome committed not to sell more shares on the market for 90 days without the consent of the global coordinators, it added.

Commitments Italy agreed with European Union competition authorities at the time of the bailout bind Rome to eventually sell its entire stake in the bank. Monday’s transaction, when settled, will reduce the stake to 39%.

Reuters was first to report in May that the Treasury was open to cutting its stake via a share sale on the market if conditions were favourable, as long as any significant new investor managed the holding in line with the national interest.

Economy Minister Giancarlo Giorgetti and Prime Minister Giorgia Meloni have repeatedly said the government would try to increase competition among banks with the privatisation of MPS.

This has raised the prospect of a potential deal with other mid-sized peers, namely Banco BPM and BPER Banca, Italy’s third and fourth largest banks respectively.

Both banks have denied any interest in MPS. Two years ago heavyweight UniCredit sank the government’s privatisation efforts, forcing Rome to seek more time from the EU.

The stake sale is seen as giving Italy more flexibility to pursue a long-term solution for MPS via a merger with a rival, after negotiations with UniCredit were complicated by an impending re-privatisation deadline.

($1 = 0.9168 euros)

(Writing by Valentina Za; Editing by Lincoln Feast, Richard Chang and Mark Potter)

---