Valentina Za, Andrea Mandala

MILAN (Reuters – After Italy’s proposal to limit tax incentives for mergers, shares in Italian mid-sized banks Banco BPM & BPER Banca plunged sharply Friday.

Banco BPM shares declined 6% while BPER shares rose 5.4%. These numbers are below the performance of Italy’s bank sector index, which dropped 0.6% due to fall in Italian government bonds prices.

The two banks have been at the centre of M&A speculation after another mid-tier player, UBI, was snapped up by heavyweight Intesa Sanpaolo (OTC:) last year.

The M&A allure was further boosted by tax incentives for mergers Italy has introduced to ease a sale of state-owned Monte dei Paschi.

Reuters obtained a draft budget for next year on Thursday. It showed that Rome would extend current incentives six months, to mid-2022. However, it would also introduce a ceiling of 500 million euros to maximize the benefit.

Morgan Stanley (NYSE:). Analysts calculated that the changes proposed reduced the capital boost of eight-fold in a potential tie up between UniCredit, Banco BPM.

They wrote that a hypothetical UniCredit-Banco BPM deal would result in the largest reduction of… benefits in all possible combinations in Italy.

Banco BPM is seen as the ideal geographic fit for UniCredit due to its roots from wealthy Lombardy. This has resulted in Banco BPM’s shares rising 51% this year against 35% sector growth.

UniCredit walked out of talks with Monte dei Paschi’s government on Sunday. Investors now focus on Banco BPM to be a possible partner.

But UniCredit CEO Andrea Orcel on Thursday said he did not see the tax breaks as a big M&A incentive due to the fee banks pay under the scheme to convert deferred tax assets (DTAs) stemming from past losses into tax credits.

According to a source familiar with the situation, UniCredit had the right to use 80% of DTAs under tie-ups with Banco BPM.

Mediobanca Securities (OTC) reduced Friday’s recommendation regarding Banco BPM & BPER Banca to neutral.

BPER and Banco BPM would be adversely affected by the changes to the budget law. We believe Banco BPM could lose its potential takeover target UniCredit. Therefore, we would expect the approximately 1 billion Euro DTA incentive to be halved in an agreement with BPER.”

Banco and BPER had previously discussed a tie up but failed to come to an agreement. BPER is now more likely to merge with Popolare di Sondrio, after Unipol, BPER’s largest shareholder bought a stake at Sondrio.