By Valentina Za and Giuseppe Fonte

MILAN (Reuters) – Italy’s UniCredit is working on a scheme to offload risks on 11.8 billion euros ($14 billion) of Monte dei Paschi loans deemed in danger of turning sour as it discusses a possible acquisition of the state-owned rival, three sources close to the matter said.

UniCredit reached an exclusive agreement with Italy’s Treasury to purchase “selected parts of Monte dei Paschi” (MPS) on July 29, according to sources close to the matter. This 64%-owned state entity was rescued by a 2017 bailout.

The crunch stage of discussions is expected to begin after the local elections in Italy and the vote in Siena, MPS’ hometown on October 3-4 for the assignment of a vacant seat.

Sources said that the deal would see the state-owned bad-loan manager AMCO, along with other co-investors underwrite the more risky notes in what is known as synthetic securitisation deals, taking over the loss on these loans.

According to a fourth source, the scheme is just one of many options being considered. A final decision on whether or not to proceed is still not made.

AMCO and UniCredit declined to comment.

Synthetic deals, unlike ordinary securitisations leave the loan portfolio at the origin bank but shift related risk, which frees up regulatory capital.

UniCredit agreed to talk about an acquisition of MPS branches in Tuscany Lombardy Emilia Romagna, Veneto. However, UniCredit set strict terms that would not impact its capital.

UniCredit stated that it won’t take MPS’ gross problem loans of 4.2 billion euro. Instead, AMCO will be able to acquire the 7.1 billion euros worth of soured loans the bank had repaid last year to prepare for the sale.

UniCredit stated in July that it could dispose of any MPS loans it considered too risky. As ‘Stage 2″, banks classify loans as in danger of going sour.

According to sources, UniCredit will be protected from risk due to 11.8 billion euro of these loans because the scheme.

MPS owned 15 billion euros worth of Stage 2 loans at the end of June. These loans included 43% of the loans with a moratorium and 27% that are guaranteed by state emergency measures to combat the COVID-19 Crisis.

AMCO, which is an important player on Italy’s market for trouble loans, aiding banks in distress, stated it was preparing to invest through synthetic securitisation agreements in Stage 2 loans.

Co-investors would be required in both the mezzanine and junior tranches. One source estimates that this could amount to 3 billion euros. This will ensure that the MPS transaction takes place under market conditions and is compliant with European Union competition rules.

($1 = 0.8537 euros)