In the banking industry, they are known simply as Sheshunoff ratings -- quarterly surveys of the performance of every federally insured bank in the United States. And now, with nearly every bank either plotting an acquisition or expecting to be the target of one, these dry, statistical reports have become nothing less than required reading among bankers, regulators, and a growing audience of corporate-finance officers.

Alex Sheshunoff's first book, The Banks of Texas: 1974, was an instant best-seller when it came out during the go-go years of Texas banking, something of a Sears, Roebuck catalog of Texas banks available for acquisition. Since then, his Austin firm has gone national, cornering the market on packaging and analyzing the mounds of information the government has available about individual banks. So thoroughly, in fact, does Sheshunoff & Co. dominate the flow of bank information that it counts the Federal Deposit Insurance Corp. itself among its most loyal customers.

During the past three years, more than 600 bankers have sought Sheshunoff's advice as they contemplated various proposals for mergers and and acquisitions. INC. senior writers Bruce G. Posner and Tom Richman traveled to Austin with a slightly different question in mind: How does all this reshuffling of the banking industry affect the prospects of the small-business borrower? The answer, it turns out, is that prospects have been greatly improved. INC.: From the outside, it looks as if he banking industry is going through a rather dramatic restructuring. What does it look like from the inside?

SHESHUNOFF: We're seeing banks being forced to abandon their old, somewhat passive ways of doing business. What has happened is that the bank spread is being squeezed rather hard -- the spread, that is, between what banks pay for money and what they sell it for. Not too long ago, banks could rely on low-cost deposits. But with the phaseout of Regulation Q by 1986, the banks' cost of money -- either on the open market or from depositors -- has risen toward the money-market rate. That means that banks can no longer survive taking their money and putting it into T-bills -- the profits from that kind of investment have disappeared. So the real challenge for banks today is to find something better to do with that money, and for most banks that means generating good loan demand.

INC.: And that includes small-business loans?

SHESHUNOFF: In the case of most commercial banks, I'd say the small-business borrower is a key, if not the key, factor.

INC.: That would come as something of a surprise to most businesspeople, to know that bankers are anxious to make them loans.

SHESHUNOFF: Obviously, it will depend on the market. But think of it from the point of view of the bank that wants to grow and become more profitable. In today's environment, a business is much more valuable as a borrower than as a depositor. If you, as a company treasurer, have a couple of hundred thousand to invest in certificates of deposit, for instance, you are going to want something that approaches a T-bill rate on your money. You may think you're a good customer, but it won't be a very profitable piece of business for the bank. If you borrow money, on the other hand, you enable the bank to realize a gross margin of 3% to 3.5% over its cost of funds.

INC.: But why small businesses? It's a lot easier for a bank to make very big loans, isn't it?

SHESHUNOFF: It is. But look at what has been happening in the marketplace for big-business loans.

First of all, the overall market for loans has been shrinking. Companies, especially big companies, are doing a better job at managing their cash flows, so they have less borrowing short-term. And long term, some have found other sources of capital, most notably commercial paper. And then there is the competition from the "nonbank" competitors -- General Motors, Sears, and so forth -- that have been able to borrow money from the public using their own commercial paper and lend it out at bank rates or even a little bit lower. Add to that some very aggressive marketing by a few of the more active and forward-looking banks, and what it means is that the other banks are looking at a loan market that has shrunk by 15% or 20% over the past five years.

The other thing to remember is that you have a very thin spread when you lend to Fortune 500 companies. You're selling a commodity -- all the borrower really cares about is price. Maybe there is a little cash management in there, a little technology, but mostly the profits come from volume, not margin. Now volume is shrinking. At first, these banks responded by going abroad, which hasn't always worked out. So now even the really big money-center banks have discovered the middle market -- small and midsize companies -- and they have begun to work it aggressively.

INC.: Give us a quick primer on where banks are earning their money these days. What are the profit centers?

SHESHUNOFF: Well, one thing I can tell you is that corporate checking accounts, generally speaking, are a lot less profitable to banks than they used to be. Even though banks usually require balances or fees to maintain these checking accounts, the data show that a quarter of all corporate checking accounts end up costing banks money, and another half are barely profitable. Personal checking accounts aren't as profitable as they once were either, for the same reason.

The best way for banks to make money today is by making loans. Home mortgage is one area that's been attractive -- especially variable-rate mortgages, where there's no interest-rate risk. The operating costs on mortgages are very low, and often the loans are repackaged and sold into the secondary markets. Credit cards are also extremely profitable for many banks, although it's an expensive business to get into and to administer, and credit quality can be a problem. Another lucrative area for a lot of banks lately has been loans for the more expensive foreign cars: lending money on a Mercedes looks a lot like a small commerical loan used to look. But having said all that, the best source of loan volume and quality is still for banks to expand their commercial portfolios -- and that means lending to small companies.

INC.: Which for many will be something of a new frontier.

SHESHUNOFF: You know, I've always been amazed by the fact that we've been here in Austin for 15 years, and I don't think I've had more than one or two banks call on us for our banking business. And most of them are our clients! I mean, it's ridiculous. If somebody had just come by, told us what they were doing, and asked for the business, there would have been a good chance of their walking out with some kind of an account. Come to think of it, we've been in this building for two years, and it was a year before the bank located on the bottom floor of this building came up.

But that is going to change -- and change very quickly now -- if only as a matter of survival. The good banks, the ones that will come out on top at the end of all this, are becoming much more proactive in their selling. Picking up the phone. Calling on customers in person. There is a bank in Fort Lauderdale, Fla., for example, that used retired bank chief executive officers to go out and make calls on small and midsize businesses, with good results. And there's a bank in southern California that provides commercial customers with free courier service, so they never have to go to the bank. So there are some successes out there, although you don't hear much about them. The people who do them don't write them up -- they go out and buy another bank and do it all over again.

INC.: In the context of the banking industry, you're describing something of a cultural revolution.

SHESHUNOFF: Very much so. In the old days, the objective was to man your desk and wait for people to come to you. It was a processing-oriented culture -- good risk-free, indoor work. If you wanted to sell, you went to work for IBM. Now a lot of banks are trying to change their cultures, but it's hard. In the end, I think you're going to end up with something on the model of an insurance company, where you have the salespeople out looking for customers and somebody back in the office who has the underwriting or credit-granting authority -- a separation of the two functions.

INC.: Was it merely the culture that defined the dynamic, or are there sound business reasons for it?

SHESHUNOFF: Well, let's say that there was no reason to get very aggressive. Banks consistently had been making 11% to 12% return on equity year after year, with the better ones making 15% or higher through good times and bad. Now, to many businesspeople, that doesn't sound like a very interesting return. But for the risk involved, which was minimal, it was a good deal.

INC.: But was it -- is it -- a good deal gained at the expense of the borrower?

SHESHUNOFF: I don't think so. The fact that the banker takes collateral and charges interest instead of taking equity and becoming your lifelong partner -- there ought to be some advantage to that, something worth one or two extra percentage points of guaranteed return. In the long run, what you need to offer a banker in terms of repayment is, in most cases, still a lot less than what you have to give an equity investor -- a limited partner or a venture capitalist. Think of it as the bank does. When it wins, it wins 4% over the cost of its funds -- if it's lucky. But if it loses, it can lose 100% plus attorneys' fees.

INC.: Other than perhaps separating the selling function from the credit-approval function, is there anything else that banks will have to do to change the culture of their business-lending operations?

SHESHUNOFF: Certainly one of the changes will come in the way loan officers are rewarded. We are always telling bankers that the value of money as a motivator has been grossly underestimated. Bank salaries are very low. A senior loan officer who might control a portfolio of $10 million, say, may make between $50,000 and $60,000.

INC.: And you're saying that's low?

SHESHUNOFF: Low relative to the amount of responsibility and the income produced. A $10-million loan portfolio with a 3% to 4% net interest spread is generating at least $300,000 for the bank.

INC.: So how would you structure a loan officer's compensation?

SHESHUNOFF: You have to define it in terms of both the loan portfolio's growth and the quality. I mean, if you put every loan officer on a sales commission and give each of them all the lending limit of the bank, you could probably break any bank in America in 12 to 18 months, because of all the bad loans you would have on the books. We've not really seen any commission-driven schemes that we've been particularly impressed with.

But there may be ways to refine it. Perhaps you could say, "OK, Charlie, you did a great job of bringing in the loans this year, so we've decided to give you a bonus: a new Mercedes. It's over there in the parking lot and you can walk by it every day on your way past your old car, and as soon as all those loans are paid back, you can drive that Mercedes right off the lot." And with some scheme like that, you can reward people based not only on the quantity of business they're bringing in, but also on the quality of the credit they give.

At the same time, I think you have to change the career paths that have also defined the bank culture, in terms of status. Banking is still a very hierarchical activity, where titles are jealously guarded and a lot of prestige is attached to the number of people or departments reporting to you. A loan officer who is an excellent lender with a large portfolio and a decent spread with few losses doesn't receive the same status. That's got to change. There has got to be more emphasis on the producers rather than on the managers.

INC.: You've sketched the brave new world of aggressive banking from the point of view of the banker. What about the business borrower? Is an aggressive bank preferable?

SHESHUNOFF: Doing business with an aggressive bank may be a very good short-term strategy. If it is known to be aggressively making loans to companies like your own, it is much more likely to be a good source of capital than a bank that has a more conservative reputation. But the problem that we have found, and one that is key to a bank's long-term success, is knowing when to leave the party. A good bank starts backing off before it's finally over, so as to be sure it doesn't give back the money made during the boom times when things begin to tighten up. You see that in all of the high-growth markets. They go three, four, five years making very good money and then give it back over a one- or two-year span, and when that happens, it is not so pleasant to be one of their customers.

INC.: What's a good bank, then?

SHESHUNOFF: First of all, you need a healthy bank, one that is not beset by a siege mentality, one that hasn't gone through a lot of trauma in terms of loan losses. For an individual loan officer, that's tough environment in which to champion the case of a particular customer, no matter how good a customer. You also want a bank that is growing, from the standpoint of profitability, capital, assets -- growing at least as fast as the regional economy. And, given a chance, lean toward a bank that's earning 1% or more on assets -- that's in the upper half among all banks, although there are lots of good banks earning less than that.

You might be interested, by the way, in knowing how bankers themselves evaluate banks. We did a big survey of more than 2,000 bankers recently, and the factor they mentioned most often as the indicator they cared about most wasn't profitability or capital or liquidity. It was quality of assets: the percentage of the portfolio tied up in nonperforming assets. As far as bankers are concerned -- and it doesn't really matter what size bank you're talking about -- asset quality tells you more about the overall health of the bank than any other single factor.

All of those factors are ones you can measure pretty easily. Less easy to measure, but just as important, is the degree to which a bank invests in the quality of its loan officers -- in compensation that allows it to attract and retain good people.

INC.: How do you determine the quality of a loan officer?

SHESHUNOFF: I think some of it is simply sitting down and interviewing the banker the same way you interview anybody else who is going to provide you services. You try to get a feel for it. Tell him or her that you've got some credit needs, some short term, some long term. And then ask, "What can you provide me in the way of expertise, professionalism, and so on?" Ask about the turnover on the bank's staff. Find out if there are other people from your industry -- suppliers, customers, competitors -- who use the bank's services. To some loan officers, your loan may be a terribly complex piece of business -- and one that they don't want to bother understanding. You don't want to waste your time with them.

INC.: Do you really think most businesspeople feel comfortable going in and conducting an aggressive interview like that with a banker, somebody who may very well hold the future of their businesses in his or her hands?

SHESHUNOFF: Well, a lot of people have that fear, but if theirs are well-managed, growing companies with significant credit needs, and if they have actually accomplished what they said they were going to do -- paid off loans when they said they would and so on -- there is no reason to go hat in hand to a bank. What they are really doing is going cash in hand -- they are the major source of earnings growth for that bank, remember. And if the bank is going to get those earnings by charging 3% to 4% over its cost of funds, then the person who is going to borrow $100,000 over the next year has to ask himself, "OK, who is going to give me the most service for this $4,000 I'm going to spend?" And the banker is going to say to himself, "What service can I afford to give him? Do I give him two hours of my time this year? Obviously, yes. Can I give him 200 hours of my time? Probably not." But somewhere in between there is a level of service that customers can expect for the money that they're spending. And customers are perfectly within their rights to ask about that.

INC.: Realistically, though, how demanding can you be about what loan officers can do for you other than help you get the money?

SHESHUNOFF: In this environment, you can be quite demanding. How well does this guy understand my industry? How does he understand the regional and national and international economic trends and how they might affect the business that I'm in? Does he understand the alternative financing sources that might be important to me? How plugged in is he to venture capital? Can he help secure an IRB [industrial revenue bond]? Is he able to do a good cash-flow analysis on his personal computer? Does his loan officer appear to have influence upstairs?

INC.: You mean a banker might say, "Well, you probably ought to see about increasing your trade credit over here, and I can set you up with a couple of venture capitalists on your R&D, and we can finance the receivables." There are bankers who actually talk that way?

SHESHUNOFF: There are -- or we understand that there are. We've met a few of them, although there are not many. One reason is that when they get that good, they go into business for themselves. After all, once they understand a business that well, they get frustrated. Real estate has been the prime example. They say, "Hell, I don't want to lend to a developer. I want to be one."

INC.: And begin to make some real money . . .

SHESHUNOFF: The compensation is part of it. But another part of it is wanting to be a player, not a provider of services to players. There's an ego thing there.

INC.: You have talked about shopping around for quality of service from a bank. What about price?

SHESHUNOFF: I don't think that competition will take the form of price competition. From the standpoint of the business borrowers, most probably would rather pay 1% extra to know that a well-qualified lender is going to be there in good times and bad, and is someone who understands the business. That's a small price to pay for something that important. On a $100,000 loan, 1% translates into only $83 more a month.

INC.: But is it true that some banks consistently charge more than other banks?

SHESHUNOFF: Sometimes that is because they offer a better-quality service. Other times I think the reason they get the higher loan rates is that they just ask for them -- and because what's most important for so many customers is that they get the loan, they often pay it. Of course, the customer can avoid that by shopping around before he actually needs the loan.

INC.: Do you recommend doing business with more than one bank at a time to help keep things competitive?

SHESHUNOFF: The history of Western civilization has been a search for second sources. It has been true in salvation and sex, and it is true in banking. You can't put all your eggs in one basket, or pin all your hopes on one bank or one loan officer. You might have a primary bank with 80% of your business and a secondary one that you use for some other purpose. But the secondary one can still be kept up to date on your business in case the primary bank is taken over or is going through a bad period.

INC.: Hardly a day goes by now that there isn't a new bank takeover or merger announced in the papers. What is the shape of things to come? How can the climate continue to be competitive with fewer and fewer banks?

SHESHUNOFF: You know, 10 years ago there were something like 14,000 commercial banks in the United States. Today, we still have about that number. Oh yes, banks get very big. But in more than a few cases, some of the good people who work in those big banks decide that they've lost touch with their work, with their customers, and -- voila -- they go out and start their own bank, taking their customers with them. And then 18 months or two years later, they sell out at two and a half times book value and go out and start it all over again. It has been happening in California for years, and you see it happening now in Florida and New England.

INC.: So, in spite of the frenzy of consolidation going on at one level, you see banking as continuing to be quite competitive, even entrepreneurial, with smaller banks and regional banks holding their own against the interstate giants?

SHESHUNOFF: I don't think size will be as important as how aggressive a bank is. Those banks that are actively selling are going to take business away from those that are depending on old, passive marketing techniques, and they are going to move market share very fast.

INC: And the others?

SHESHUNOFF: The others are either going to respond, or they are going to have to worry about survival.

INC.: And aggressive banks will come in every size -- is that what you are saying?

SHESHUNOFF: Yes. Some will be the money-center banks in New York and Chicago. You'll also be hearing more about the North Carolina banks like First Union, Wachovia, and NCNB. They have all acquired banks in Georgia and other southern states, and I anticipate their business will extend throughout the South. But a bank can be small -- much less than $1 billion in assets -- and still be profitable and aggressive. The fact is that banking is one of those endeavors where there aren't many economies of scale. And often, the larger the entity, the more difficult it is to run efficiently.

INC.: So if economies of scale are not driving the consolidation, what is?

SHESHUNOFF: Mostly it is the need to find new earning assets: if you can't make any more new loans, then buy them. And that, in effect, is one of the things you have to do when you buy a bank.

The other thing you buy is the good loan officers with their contacts and their established customers. Of course, what some banks have found is that it is much cheaper to buy the banker than to buy the bank. In other words, if the banker has $5 million in good loans with a 4% spread on them, that's $200,000 a year of income that he brings with him. And what we see is that some of these acquiring banks are stealing away these aggressive loan officers and putting them in very small two-and three-person storefronts with the idea of hustling business from their old customers. And it is a very cost-effective way for a bank to develop new markets -- even out of state.

INC.: Where would you open such a storefront?

SHEHUNOFF: Right next door to a bank that has lots of unhappy customers!

INC.: Looking to the future a bit, do you see a movement toward merchant banking, where banks might offer some combination of equity and debt financing?

SHESHUNOFF: There has been some of that in the real estate area, where a bank might get its principal and interest back and then share in the equity after payout -- and if the project is sold, maybe get a percentage of the profit. Recently, I heard a story about a major bank in New York City that loaned money for some coal-mining equipment: in addition to the monthly payments, the bank participates in the success of the business by getting a royalty on the production. But, in general, I think banks have been reluctant to get into this kind of lending. And, frankly, I think a lot of people would feel that the bank would be too conservative to have as an equity partner. Even as it gets more aggressive in its marketing, banking should remain a fairly simple business. As someone else once said, When it gets complex, it's wrong.