May 9, 2014 / 4:46 PM / 3 years ago

UPDATE 2-Popolare Milano Q1 net up 12 pct, bad debts keep rising

* One of 15 Italian banks under ECB's scrutiny

* In the process of raising 500 mln euros via share sale

* Shareholders rejected governance reform last month (Adds details, comments from conference call)

By Valentina Za

MILAN, May 9 (Reuters) - Banca Popolare di Milano (BPM) said on Friday its net profit rose 12 percent in the first quarter helped by higher interest income and fees as the Italian economy left behind a two-year contraction but remained fragile.

Highlighting the protracted damage that Italy's worst post-war recession caused to banks' balance sheets, BPM said gross problematic loans rose 5.8 percent from the end of December to 5.6 billion euros ($7.7 billion).

Loans least likely to be repaid rose by 167 million euros reflecting difficulties in Italy's real estate and services sectors.

In a sign of caution, the Milanese bank cut loans to clients, especially companies, by 1.6 percent from December.

But Chief Executive Giuseppe Castagna said the bank hoped to be one of the first to ride Italy's recovery by expanding lending.

"We want to take advantage of the fact that we operate in the country's richest areas," he told analysts during a conference call.

"Some of our clients are beginning to talk again about investing... But we need to give fresh motivation to bank staff that for quite some time have had to turn down clients' requests of credit."

After the European Central Bank signalled on Thursday it could ease monetary policy further as early as June, BPM said low market interest rates would weigh on its full-year interest income, which rose 8 percent in the first three months.

BPM, which is carrying out a 500-million-euro rights issue to strengthen its capital base, said that its best-quality Common Equity Tier 1 ratio stood at 7.3 percent of risk-weighted assets at the end of March.

That is short of an 8 percent threshold set by the European Central Bank in a review of banks across the euro zone. BPM is one of 15 Italian banks under scrutiny by the ECB.

The bank said in March the rights issue would boost its Common Equity capital by around 1.3 percentage points.

Following an audit in 2011 which revealed excessive exposure to real estate risks, among other issues, BPM has been forced by the Bank of Italy to apply larger risk-weights than peers to calculate the capital ratios that measure financial strength.

Castagna said that soon after completing the cash call, which runs until May 23, BPM would start talks with the central bank to see whether that could change.

BPM estimates removing the additional risk-weights would add 1.7 percentage points to its best-quality capital.

A stalled governance reform urged by the Bank of Italy to give institutional investors in the bank more influence will not slow the process, Castagna said.

The Bank of Italy has repeatedly told co-operative lenders, whose shareholders have one vote each regardless of the size of their stake, to reform and become more attractive for investors.

Castagna said that BPM would try again in a year to have shareholders approve changes they unexpectedly rejected last month.

$1 = 0.7269 Euros Reporting by Valentina Za; editing by Jason Neely

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