* Sector under pressure due to dearth of bad bank loans to buy

* Sector faced 'perfect storm' scenario, doValue says

* Deal would follow ION's acquisition of Prelios in Italy

* Elliott would back new share issue at merged company

MILAN, March 21 (Reuters) - U.S. fund Elliott has signed a non-binding agreement to combine its Italian bad loan business with Softbank-backed doValue, the latter said on Thursday.

Elliott Management has been present in Italy's bad loan market, Europe's biggest, since 2016, when one of its funds invested in a bad loan company, which could now merge with doValue.

doValue, Italy's biggest bad loan company, said the proposed cash-and-share deal would make Elliott Advisors a leading investor in the combined entity with a 20% stake after merging its Gardant business into doValue.

The U.S. fund would also commit to subscribe to a planned new share issue needed to shore up doValue's finances.

The talks come at a pivotal time for the non-performing loan (NPL) sector, where companies are under pressure to consolidate as banks' surprisingly healthy loan books have reduced the need for the loan disposals that used to feed the NPL market.

"Negotiations will now proceed on an exclusive basis aimed at finalising a binding agreement for the potential combination with Gardant," doValue said in a statement.

Active in Greece and Spain, doValue had 116 billion euros ($126.59 billion) of assets under management (AUMs) as of Dec. 31, 2023, making it the biggest loan manager in southern Europe.

Elliott-backed Gardant has only around 40 billion euros of AUMs, but steadier revenue prospects than peers thanks to long-term collection contracts it has secured.

If finalised, the merger would mark a second deal in quick succession in the Italian NPL sector where international fintech group ION is in the process of buying bad loan manager Prelios for 1.3 billion euros.

Recent market conditions "reflect a 'perfect storm' scenario" with banks having high capital reserves and low impaired debts, doValue said as it unveiled a new multi-year strategy.

With the acquisition, doValue would secure a stream of revenue because Gardant has recently struck a deal with BPER Banca to buy its NPL business and provide collection services to the Italian bank for 10 years.

BPER was the last major Italian bank yet to dispose of its loan recovery operations.

A similar deal ties Gardant since 2019 to lender Banco BPM , while a key contract doValue has with UniCredit runs out in 2025.

Having lost another major contract in Spain in 2022, doValue has been forced to take an impairment on its business there and has seen its share price plunge 45% this year on concerns over its future prospects.

In the strategy unveiled on Thursday, doValue said it aimed to have around 35-40% of non-NPL revenues in 2026.

"The envisaged transaction ... is expected to be accretive to cash earnings per share, cash-flow generation and financial soundness, thus reinforcing its balance sheet," doValue said, adding it would refinance all or part of its existing debt.

When excluding non-recurring items, the combined group aims for a net debt level of around two times core profit by 2025 after carrying out the new share issue, doValue said. ($1 = 0.9163 euros) (Reporting by Valentina Za, editing by Giulia Segreti, Elaine Hardcastle and Susan Fenton)