Merger and acquisition activity in the U.S. banking sector will continue, and perhaps accelerate in 2011, as market dynamics point to growing industry consolidation, says Fitch Ratings.

In a new report, the rating agency says that acquisitions have become a viable option for management teams of stronger banks to quickly expand their franchises, grow their balance sheets, deploy capital, and increase earnings via cost savings and economies of scale, in an effort to push returns closer to long-run historical levels at a time when growth opportunities are limited and the regulatory outlook is uncertain. Many weaker banks may also find themselves open to being acquired or an attractive target for an acquirer, Fitch adds.

The rating agency indicates that it expects the increased M&A activity to lead to a concentration of a few large money-center banks and a larger number of “super-regional” banks that dominate specific geographies across the country. Fitch also believes that the growing concentration of market share implies that many community banks may struggle to grow and remain profitable in the short term.

Foreign buyers could also be players in this consolidation, Fitch says, although it expects such deals to come from firms that already have a regional foothold, pointing to Bank of Montreal’s recent acquisition of Marshall & Ilsley as an example. “Since Marshall & Ilsley’s footprint was adjacent to the Chicago market, and since it will be merged into Bank of Montreal’s Harris Bankcorp, Inc. subsidiary in Chicago, this on-the-ground presence likely helped facilitate the transaction,” it says.

TD Bank heads the list of the largest foreign bank holding companies in the U.S., according to the report, with BMO and Royal Bank also ranking in the top 12.

Some private equity firms have also been thought of as potentially playing a more active role in bank consolidation, given their large amounts of capital, Fitch notes. However, it says, given the heightened regulatory oversight in the banking industry and the growing financial wherewithal of existing in-market banks, it expects private equity firms to play a much more passive role in bank consolidation.

Overall credit rating implications and risks are mixed for bank M&A activity and will depend on the asset quality trends and overall valuations of potential acquisition targets, as well as the integration capabilities of acquirers, Fitch says.

IE