July 14 (Bloomberg) -- Banco Santander SA, Spain's biggest bank, agreed to acquire beleaguered U.K. mortgage lender Alliance & Leicester Plc for 1.26 billion pounds ($2.6 billion) after walking away when the price was higher.

Alliance & Leicester rose as much as 54 percent, the most since the company went public in 1997, after Santander said it will provide 1 billion pounds of capital in the takeover of the Leicester, England-based bank. The all-stock offer of 299 pence a share amounts to 317 pence, or 1.33 billion pounds, including the half-year dividend, Santander said in a statement.

Emilio Botin, 73, is buying Alliance & Leicester after making at least $60 billion of acquisitions from Brazil to Mexico since he became Santander chairman in 1985. The takeovers included Abbey National, the U.K.'s second-biggest mortgage lender, for 9.2 billion pounds in 2004. Santander plans to reduce British assets by as much as 30 billion pounds as it combines Abbey and Alliance & Leicester amid the worst housing market in more than 15 years.

``They've shown with Abbey that they can turn a business round in the U.K.,'' said Piers Hillier, the London-based head of European equities at WestLB Mellon Asset Management who manages 6 billion euros, including Santander shares. ``If they buy Alliance & Leicester at this price, it's a great deal for Santander.''

Alliance & Leicester rose 98.5 pence to 317.75 pence at noon in London, valuing the bank at 1.34 billion pounds and paring this year's decline to 50 percent. Credit Agricole SA, France's biggest bank, dropped a bid two years ago to buy Alliance & Leicester when its market value was 5.2 billion pounds.

Botin said Feb. 7 the bank wouldn't bid for Alliance & Leicester after looking at its books earlier this year. The price Santander offered today in the 3-for-1 stock swap is 46 percent below U.K. lender's price of 588 pence on Feb. 7.

`Acutely Aware'

Alliance & Leicester CEO David Bennett pulled back lending this year to prevent a plunge in earnings at the bank, which gets more than half its funding from wholesale markets.

``The board is acutely aware of the significant external risks presented by the deterioration in economic conditions and the continuing turbulence in the financial markets,'' Alliance & Leicester acting Chairman Roy Brown said in a statement today. ``The proposal from Santander represents value for shareholders, and the combination of Alliance & Leicester with Santander's U.K. operations is an excellent fit.''

Santander rose 0.7 percent to 11.31 euros in Madrid, giving the bank a market value of 70.2 billion euros ($111 billion), the second largest in Europe after London-based HSBC Holdings Plc.

Abbey and Alliance & Leicester combined will have 959 branches and 7.6 percent of U.K. market, Santander said. The bank said it can cut costs by more than 180 million pounds in Britain by the end of 2011.

`Deal Machine'

``Santander is a deal machine focused on costs savings,'' said Simon Maughan, a London-based analyst at MF Global Securities Ltd. who has a ``hold'' rating on Alliance & Leicester. ``It's been looking at increasing its returns in the U.K., which are lower than anywhere else in the world. Whenever it looks to increase returns, it does so by acquisition,'' Maughan said.

Santander, a retail bank that acquired the Brazilian unit of Amsterdam-based ABN Amro Holding NV last year for 10.6 billion euros, has had no losses related directly to the collapse of the U.S. subprime market.

Banks and securities firms have raised $324 billion in the past year after record writedowns and credit losses of almost $410 billion from the collapse of the subprime mortgage market.

Santander said first-quarter profit at the Abbey unit was 311 million euros, up 3.8 percent from a year earlier as it tripled its share of the U.K. mortgage market. Net mortgage lending was 2.9 billion pounds in the year's first three months.

Adding to Earnings

The acquisition of Alliance and Leicester, with more than 5.5 million customers and 254 branches in the U.K., will produce a return on investment of about 19 percent by 2011, Santander said. The deal will add to earnings from 2009, it said.

U.K. house prices fell the most in 15 years in June as rising interest rates and reduced mortgage lending exacerbated the worst property slump since the last recession in 1991, according to HBOS Plc, the U.K.'s biggest mortgage lender.

Banks including Edinburgh-based Royal Bank of Scotland Group Plc and Barclays Plc are raising capital and pulling back lending amid the seizure in wholesale funding markets. Northern Rock Plc, the U.K.'s third-biggest mortgage lender, was nationalized by the government in February after the credit seizure closed funding.

Alliance & Leicester, which gets nearly 60 percent of its funding from wholesale markets, abandoned its 2009 profit target in March amid higher funding costs and credit writedowns. The company posted 391 million pounds in credit writedowns and took a funding charge of charge of 49 million pounds in the first four months of the year, it said in May.

Late Payments

About 0.6 percent of Alliance & Leicester's mortgage loans are hampered by late payments, it said in May. That compares with 2.16 percent arrears at Bradford & Bingley Plc, the U.K.'s largest lender to landlords.

The bank will probably post a first-half loss, said Derek Chambers, a London-based analyst at Standard & Poor's Equity Research Ltd. who has a ``hold'' rating on Alliance & Leicester.

``The pressure on margins and volumes makes the free-standing outlook unattractive,'' Chambers said. ``The portfolio might be more profitable if controlled by an owner with lower funding costs,'' Chambers said.

To contact the reporter on this story: Ben Livesey in London blivesey@bloomberg.net

Last Updated: July 14, 2008 08:16 EDT