By Jesús Aguado

MADRID, Mar 25 (Reuters) - BBVA's share price has more than tripled since the end of 2020, narrowing its market valuation gap with Santander in a development that highlights a divergence in the Spanish banks' positions that could be short-lived.

Both banks have their roots in 1857 and neighboring towns in northern Spain, but Santander emerged as the dominant lender in Spain with more than twice as many assets as BBVA and, until very recently, thanks to a much larger market capitalization.

But the gap has narrowed from €20 billion ($22 billion) three years ago to around €5.5 billion, raising questions about who got their strategy right.

The shift reflects how investors are rewarding banks that share more of their profits versus those that prioritize investing in future growth, as well as those that made the right bets outside Europe.

BBVA shares, valued at about 64 billion euros versus Santander's market value of 69.5 billion euros, have been boosted by its subsidiary in Mexico, which owns about a quarter of the retail market.

"BBVA has in Mexico one of the best retail bank franchises in any emerging market and BBVA is doing even better than Santander in Brazil," said Enrique Quemada, president of investment bank ONEtoONE Corporate Finance Group.

Investors have also rewarded BBVA for its decision to exit the United States in November 2020 to focus on delivering more cash to shareholders, analysts and investors told Reuters.

Torres has been chairman since late 2018, when Onur Genç took over as BBVA CEO.

Since 2021, BBVA has distributed €13.19 billion to shareholders, including extraordinary buybacks of €4.16 billion. This is equivalent to 20.6% of its current market valuation, Reuters calculations show.

A more cautious approach to donations under Santander's executive chairman Ana Botín, falling profitability in Brazil and mixed fortunes in some of its top 10 markets have hurt the bank's shares, analysts and investors added.

Botín, whose father Emilio previously ran Santander, has held the post since his death in September 2014.

Santander, which unlike BBVA does not conduct extraordinary buybacks, has paid out €12.8 billion, 18.4% of its market capitalization, according to Reuters calculations.

The focus on capital allocation has boosted shares of other European banks, such as Italy's UniCredit, while the papers of companies with less generous payout policies, including Santander and BNP Paribas, have lagged.

Santander CFO Jose Garcia Cantera told Reuters that investors' preference for payouts today during a period of high interest rates rather than heavily discounted future earnings will not last, as rates fall.

"Future growth will be more valued.... We're starting to see the first signs of that," Cantera said.

BBVA declined to comment.

Analysts at Barclays downgraded BBVA shares to "equal weight" on Monday, saying the stock's "medium-term potential has already been priced in." They also upgraded Santander to "overweight," citing lower interest rates that they said should support the bank.

MORE DIVERSIFIED

While BBVA can't compete with Santander in scope and scale, its shares trade at more than 1.2 times book value thanks to a 32% jump so far in 2024.

Santander shares rose more than 16% over the same period, but trade at just over 0.7 times book value, in the bottom third of large European banks, LSEG data show.

"For Santander there are so many moving parts ... it takes a lot of stars to align," said Michael Christodoulou, a London-based analyst at Berenberg, who expects the lender to benefit because falling rates will ease concerns about asset quality, including in Brazil.

Christodoulou has a "hold" recommendation on both banks.

Whether BBVA shares maintain their momentum will depend both on return on capital and whether it can meet its financial targets in its core Mexican and Spanish markets, given its greater exposure to fewer countries than Santander.

BBVA earns more than two-thirds of its profits in emerging markets and is reinvesting in fewer businesses than Santander.

BBVA expects a return on tangible equity (ROTE), a measure of profitability, of between 17% and 20% in 2024 from 17% in 2023, while Santander is targeting a 16% ROTE in 2024, up from 15.06% last year.

Analysts at brokerage Alantra expect Santander to benefit in the medium to long term from cost savings with the rollout of global units and generate faster earnings growth.

They predict that improving the performance of Santander's auto lending business in Europe and the U.S. should also help.

However, Santander must improve profitability in Brazil, other analysts say, adding that its U.S. expansion plans should pay off after a 48% drop in 2023 net earnings in that market.

To keep BBVA at bay, Santander should be more aggressive on buybacks, said Caixabank analyst Carlos Peixoto, adding, "But right now they are not in a position to do that."

Santander's Tier 1 capital ratio, the strictest measure of solvency, stood at 12.26% at the end of last year, compared with BBVA's 12.67%.

On March 22, Santander said it expects to pay more than €6 billion in dividends and ordinary share buybacks out of 2024 earnings under its policy of distributing half of its profits to shareholders.

Santander's strategy of investing in a more diversified range of businesses will pay off over time, Cantera said.

"As things change and the market starts to value growth more, those banks that didn't invest for the future will be at a disadvantage," he said.

(1 dollar = 0.9245 euros)

(Reporting by Jesús Aguado; additional reporting by Lucy Raitano. Edited in Spanish by Marion Giraldo)