KA WAH Bank is one of Hongkong's oldest banks, having been originally formed in Guangzhou in 1922 to finance trade between China and Southeast Asia. The bank has enjoyed annual compound profit growth of 40 per cent over the past five years under the ownership of CITIC Hongkong, which rescued the bank from financial trouble in 1986. Other major mainland investors include the People's Construction Bank of China, China Insurance, and China Travel Service. Ka Wah Bank's retail business is typical of an old, medium-sized Chinese bank in Hongkong. The loan portfolio is biased towards residential mortgages and trade finance - each estimated to make up 35 per cent. More than 80 per cent of loans are pegged against the prime rate. Retail deposits are matched against retail loans, and corporate deposits against corporate loans to minimise mismatch and margin squeeze. The loan over deposit split is maintained at 55 to65 per cent to ensure liquidity and prevent capital constraints. The bank enjoys one advantage in retail banking. Through its CITIC ownership it is a natural home for mainland depositors, some of whom will undoubtedly be connected to the CITIC group. Although it is believed that interest rates in Hongkong are only likely to rise slowly as US inflationary pressures remain under control, Ka Wah Bank's deposits should continue to grow by 20 per cent per annum. With the loan over deposit ratio at around 60:40, loan growth is expected to be of a similar order, and the loan book is likely to be shifted further towards high-margin trade finance loans for small companies developing their activities in South China, enabling margins to be preserved. Ka Wah Bank's subsidiary Ka Wah International Merchant Finance acts as the arranger of more syndicated loans for China parties than any other bank. As such, it earns both an arrangement fee and a recurrent agency fee over the life of the loan, usually less than five years. Disclosed profits, which have risen by 533 per cent since 1987, are expected to increase by a further 115 per cent between 1992 and 1995. Brokerage S. G. Warburg predicts the bank will register a profit of $200 million in 1993, and $260 million in 1994. The bank is now trading at 15.1 times 1993 prospective P/E ratio. The bank's growth potential and conservative policy on profit disclosure suggest that its underperformance of the banking sector over the past year is undeserved. As one of the purer China plays in the Hongkong market, the stock deserves to be re-rated. On the same disclosed P/E ratio as Bank of East Asia, S. G. Warburg expects the price to rise to $5.50 from Friday's close of $5.05.