By Jesús Aguado

MADRID (Reuters) -Spain's Santander on Tuesday said it had reached an agreement to acquire smaller rival Sabadell's British unit TSB for initially 2.65 billion pounds ($3.64 billion) in an all-cash deal, subject to approval by Sabadell shareholders.

Sabadell's decision to dispose of TSB offers the lender a potential defensive play as it seeks to stop a hostile takeover approach from another Spanish heavyweight, BBVA, while an eventual deal would give Santander the seventh-largest bank branch network in the UK in addition to its own.

Santander, which is the euro zone's biggest lender by market value, said that the deal would help it become the third largest bank in the UK by personal current account balances.

Should any deal for TSB eventually materialise, it would be the latest move towards consolidation in British banking, where smaller banks have struggled to steal market share from the dominant high street lenders.

The acquisition would come at a time when Santander UK is booking subpar profitability compared to the Spanish bank's overall returns, prompting speculation about its commitment to the UK.

Earlier this year Santander had been reviewing its business, with a pullback from the country among the options, a source said. Executive Chair Ana Botin on Tuesday reiterated its commitment to the UK as a core market.

"This transaction expresses our confidence in our strategy, but also in the UK market", Botin told analysts in a call.

Santander expected the deal to generate a return on invested capital of over 20%, contributing to an increase in Santander UK's return on tangible equity from 11% in 2024 to 16% in 2028.

It also expected cost synergies of at least 400 million pounds and the deal to result in earnings per share accretion from the first year and of around 4% in 2028 while consuming 50 basis points of CET1 capital at closing.

Santander said it would operate with around 13% CET1 ratio at year-end 2025 on a pro forma basis for the sale of 49% of Santander Polska and associated share buyback in early 2026 announced earlier in May, and the acquisition of TSB.

It also said that it remained on track to deliver at least 10 billion euros in share buybacks from 2025 and 2026 earnings.

SABADELL UPS REMUNERATION TO 3.8 BLN EUROS

Sabadell said that proceeds from the sale of TSB would be used to fund a 0.50 euro per share extraordinary cash dividend, equivalent to 2.5 billion, in addition to 1.3 billion of ordinary dividends expected to be paid from 2025 earnings.

The initial price of 2.65 billion pounds implied a multiple of 1.5 times TSB's book value, Sabadell said, adding that deal would be adjusted upwards to include profits generated from that date until completion in the first quarter of 2026, with the final price expected to rise to around 2.9 billion pounds.

Sabadell's CEO Cesar Gonzalez-Bueno described the sale as a strategic opportunity the bank could not overlook.

"We will now focus our strategy on Spain, where we see significant growth potential in both business terms and share price performance relative to peers," he said.

Sabadell said it would submit the deal to a required shareholders meeting on August 6 for its approval as it is the target of an offer by BBVA.

($1 = 0.7290 pounds)

(Reporting by Jesús Aguado; additional reportig by Emma Pinedo; editing by Andrei Khalip and Anna Driver)