UPDATE 5-Santander to buy UK bank A&L in $2.6 bln deal

(Adds Santander, A&L executive comments, updates shares)

By Steve Slater and Andrew Hay

LONDON/MADRID, July 14 (Reuters) - Spanish bank Santander (SAN.MC) is buying Alliance & Leicester ALLL.L for 1.3 billion pounds ($2.6 billion) to provide "critical mass" to its existing UK bank Abbey, but its target was slammed for selling out cheaply.

Santander, Europe's second-biggest bank after HSBC (HSBA.L) and long considered a potential buyer of A&L, has been able to secure a knockdown price after a collapse in A&L's share price in the past year.

Santander said it was offering one of its shares for every three A&L shares, plus a cash dividend of 18 pence per share. The deal values A&L stock at 317p, well down from over 1,000p a year ago but a 45 percent premium to Friday's closing price.

A&L shares soared 49 percent to 326 pence by 1445 GMT, having earlier hit 338.75p. Analysts said pressure on capital was likely to deter a counterbid and A&L said it had only received one offer, but some investors expected another bidder to surface.

"They are acquiring Alliance & Leicester on giveaway terms," said David Cumming, head of UK equities at Standard Life Investments, which has a 2.4 percent A&L stake. "I would be amazed if no one else counters with a higher offer in the next few months," he added.

Santander shares were up 0.4 percent at 11.27 euros.

Santander will inject 1 billion pounds of capital into A&L to shield it against more writedowns, bad debts and difficult conditions, and plans to shrink the assets of the combined A&L and Abbey by 20 billion-30 billion pounds over two years.

It expects to reap annual cost savings of 180 million pounds by 2011 and will put A&L on its Partenon IT platform.

Guy de Blonay, fund manager at New Star Asset Management, said Santander is taking advantage of "a very opportunistic situation" to buy cheaply and push through more cost savings.

"In the medium term there is quite a lot of value that could be created for Santander shareholders, but the risk is the Alliance & Leicester mortgage book deteriorates and they are increasing their exposure to the UK mortgage market in a difficult period," said de Blonay, who holds Santander stock.

TOO CHEAP?

Santander held talks with A&L late last year when its share price was more than double its current offer, sources have said.

But the credit crunch has hit all bank valuations, and Santander has the financial firepower to do a deal when many rivals are struggling with their own balance sheets.