Italy and UniCredit break off talks to sell Monte dei Paschi

Italy ended talks with UniCredit on the sale of the Monte dei Paschi di Siena (MPS) on Sunday. This represents a significant setback for the longstanding efforts of the government in Rome to return the troubled Tuscan bank to private hands.

If it fails to fill a billion dollar valuation gap between the parties, Italy will not be able to complete the restructuring of its banking system that began six years ago.

The announcement confirmed what Reuters reported exclusively from sources on Saturday.

Rome will now seek to extend the deadlines agreed with EU authorities for the reprivatisation of the MPS and an official from the Treasury Department said he did not expect the talks to be difficult.

The Treasury Department will do its part to recapitalize MPS and plans to continue the balance sheet improvement measures it offered to UniCredit after MPS was identified as the Eurozone's most vulnerable lender in the sector's health check this summer.

"The postponement will be accompanied by management measures that will strengthen the bank," said the official.

"The European authorities understand that we have tried seriously to close a transaction on market terms by the end of the year and that we have not been able to do so because the offer we received is unacceptable," he added added.

Italy began reprivatising MPS shortly after the company was bailed out for 5.4 billion euros ($ 6.3 billion) in 2017 as a first step to get rid of most of its remaining debt.

Seeing a merger with a stronger competitor as the best way to solve the country's biggest banking problems, Rome targeted UniCredit after rival heavyweight Intesa Sanpaolo (OTC: ISNPY) increased its market share with its UBI takeover last year had brought to the limits of antitrust law.

"Despite the efforts of both sides ... the negotiations on the possible acquisition of a certain part of the Banca Monte dei Paschi di Siena will no longer continue," UniCredit and the Treasury Department said in a joint statement.

The news is likely to rock the stocks of the two banks on Monday, particularly hitting the riskier bonds of MPS, which have suffered in recent months from concerns that MPS subordinated bondholders may be called to cash under EU state aid rules for banks if Italy is putting more tax money into the MPS.

Initial talks about reducing the state's 64% stake in MPS through a deal with UniCredit began more than a year ago, but were abruptly cut short with the firing of CEO Jean Pierre Mustier.

When the new UniCredit boss Andrea Orcel agreed to hold exclusive talks with the Treasury Department in July, he demanded that the deal only involve parts of MPS, it should also be capital neutral and offer a profit increase of 10%.

The Treasury Department calculated that the assets selected by UniCredit would have a market value of between € 3.6 billion and € 4.8 billion, with annual net income of € 600 million, according to a person familiar with the matter.

The source added that this opens a gaping void on UniCredit's valuation of the same € 1.3 billion in assets. UniCredit declined to comment.

The Treasury Department also rejected accounting adjustments that UniCredit had incorporated in its € 6.3 billion capital request based on its own more conservative risk models, the sources said.

With the parties also disagreeing on the assets to be divested, and the Treasury Department urging UniCredit to take over MPS units it did not want, Rome concluded that a merger was too costly an alternative for taxpayers.

The MPS is planning a € 2.5 billion capital increase in case it can't find a buyer, and the Treasury Department official said the government is ready to do its part based on a "credible business plan".

Italy is likely to revise the management of the MPS to implement the concept worked out under the UniCredi agreement, which provides for the bank's remaining bad loans to be transferred to the state bad loan administrator AMCO and the legal risks of the bank to be outsourced from the state and guaranteed, according to this source.

The European Central Bank (ECB), which according to a source familiar with the matter is not yet able to come up with a stand-alone plan, has no immediate concerns about MPS's capitalization.

(1 dollar = 0.8593 euros)