By Valentina Za and Giuseppe Fonte

MILAN (Reuters) – Unicredit is well placed to secure a beneficial deal with the Italian government in talks to take over Monte dei Paschi di Siena, which it sees as the best M&A option at present, its chief executive Andrea Orcel said.

Orcel defended the merits of a possible MPS acquisition as UniCredit posted a higher than expected second-quarter net profit, a day after agreeing to enter exclusive negotiations over the bailed-out rival.

Italy’s No.2 bank said late on Thursday it had signed an accord with the Treasury setting guidelines for a potential takeover of MPS, in which Rome owns 64% having rescued it in 2017 at a cost of 5.4 billion euros ($6.4 billion).

UniCredit, which had long rebuffed government pressure to buy MPS, said it would only acquire “selected parts” of the lender in a deal that would leave its capital buffers unchanged while boosting earnings per share by a double-digit percentage.

Discussions will unfold over the next few weeks with a decision expected by mid-September, Chief Executive Andrea Orcel, who took over in April, said.

“We feel strongly that, with the principles we have highlighted, given the timing and the ability to (select what we buy), Monte dei Paschi is the best option, and the only option on the table at this point,” he told analysts.

Orcel said the deal would allow significant cost cuts and boost UniCredit’s market position in Italy, where it has fallen behind Intesa Sanpaolo which last year snatched rival UBI to become Italy’s biggest bank.

“Not only MPS would come at the right terms if the principles we have agreed are upheld, but also help us rebalance our presence in Italy towards the centre-north … away from (the country’s poorer) centre-south, and that is healthy.”

UniCredit would be shielded from legal risks weighing on MPS following years of mismanagement and would not take on any problem loans or performing loans it deems too risky.

“The terms set out for negotiations tick all of the boxes for the equity market to potentially like a final deal,” broker Autonomous said.

Shares in UniCredit rose 2.5% by 1230 GMT. MPS surged 7%.

MPS faces a capital shortfall of up to 2.5 billion euros and banking stress test results due later on Friday are set to turn the spotlight on to its frail finances.

IMPROVED OUTLOOK

On Friday UniCredit improved its 2021 outlook for loan loss charges, after lower-than-expected provisions, as well as higher revenue, drove second-quarter profit above market forecasts.

UniCredit now expects its 2021 underlying net profit, excluding one-off items, to be above 3 billion euros versus a previous estimate of around 3 billion, while it stuck to revenue and cost targets.

Net profit for the April-June period came in at 1.03 billion euros versus a company-provided analysts’ average estimate of 736 million.

That compares with 420 million euros a year earlier, when the group wrote down loans to the tune of 937 million euros to prepare for the fallout from the pandemic.

Loan-loss provisions totalled 360 million euros in the period, below the 647 million euros analysts had estimated.

UniCredit said it now expects its cost of risk, which measures provisions against loan volumes, to be below 50 basis points, compared with below 70 basis points forecast earlier.

Shrinking loan losses also helped drive profits at Barclays and Santander earlier this week.

Revenue totalled 4.4 billion euros, above an average 4.3 billion analyst forecast, with fees rebounding by 21% from a year ago when Italy enforced a strict lockdown to fight the pandemic.

Higher fees and trading income more than offset the yearly decline in interest income.

Profit from the core lending business, long a sore spot for UniCredit, edged higher from the previous quarter thanks to the contribution from funds borrowed at negative rates from the European Central Bank as well as a pick-up in volumes.

UniCredit has pledged to boost its lending business, with Orcel – hired after predecessor Jean Pierre Mustier fell out with the board over strategy – saying a phase of “active retrenchment” for the bank was now over.

($1 = 0.8420 euros)

Graphic: UniCredit’s share price performance: https://fingfx.thomsonreuters.com/gfx/mkt/gkplgmjgjvb/Unicredit_Mustier_Orcel.png

(Reporting by Valentina Za; Editing by David Holmes)

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