Should You Invest in the Best Online Bank in the U.S.?

By Markets Fool.com

For 2014, Money magazine named Ally Financial the best online bank in the United States. In fact, Ally has received this honor four years in a row, so it must be doing something right.

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For banking customers, Ally offers better interest rates and more convenience. However, for investors, is Ally a better pick than a more traditional bank? Let's take a look at what Ally does, how it makes money, and how things have been going.

Why Ally was named the best online bank
In short, Ally was chosen over its competitors for providing great yields combined with a variety of product offerings.

As of this writing, Ally pays up to 0.60% interest on its checking accounts, as well as an excellent 0.99% annual percentage yield on its online savings accounts. Other account types, such as CDs and money market accounts, also pay excellent rates.

While these rates aren't quite enough to get income-seeking investors excited, they're much better than the rates offered by the big brick-and-mortar banks, which currently pay rates as low as 0.01%. For someone who keeps a $10,000 emergency fund in a savings account, this means the difference of about $100 per year.

Ally's account holders can also use any ATM for free, without any fees or surcharges. Further, live customer service is available by phone or instant message 24 hours a day.

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And while some competitors can offer higher rates -- GE Capital offers 1.05% APY on savings accounts -- Ally was named the best because it is the highest-paying online bank that also offers checking accounts to its customers.

So far this strategy seems to be working. Ally's bank deposits have grown by 12% over the past year to $56.4 billion. The bank currently has about 885,000 customers, and given that this metric has grown by 17% in the past year alone, I wouldn't be surprised to see the bank hit 1 million in the near future.

Source: Ally's Q3 investor presentation.

More than checking and savings
Basically, Ally's business model is to grow its banking deposits and then use those deposits to fund its auto lending business. In fact, Ally is the No. 1 auto lender by market share in the U.S., a title it recently took back from Wells Fargo .

Ally has about $78 billion in outstanding consumer auto loans, as well as more than $31 million in commercial loans. During the most recent quarter alone, Ally originated $11.8 billion in new consumer auto loans -- a 23% year-over-year increase.

Ally is also about to get a unique competitive advantage by becoming the first U.S. auto lender to provide its customers with free access to their FICO credit scores through FICO's "Open Access" program. Several credit card issuers have adopted the program, but no other auto lenders have. So Ally may have an extra appeal to credit-conscious borrowers once the new program is rolled out to all of the company's customers this summer.

Is it a good investment?
Going against the overall trend in the financial sector, Ally is trading for nearly 20% less than it was a year ago. Some of this is due to a sharp recent decline owing to general weakness in the sector, and some is due to the risk associated with Ally's business model.

ALLY Chart

For example, Ally is heavily dependent on auto lending, including subprime loans, which some experts have referred to as a "bubble." Ally's extensive subprime auto lending has brought the company under the scrutiny of both the Securities and Exchange Commission and the U.S. Department of Justice, and if the economy performs poorly, Ally could get hit hard. However, so long as the economic recovery stays strong, I don't think there's much reason to worry.

And the company's recent growth looks impressive. Net financing revenue is up 17% year over year, and interest margins have expanded by 31 basis points. The bank's capitalization and leverage are both well within the FDIC requirements, and shares trade for a substantial discount of about 28% below tangible book value and just over 10 times 2015's expected earnings.

So, although Ally Financial isn't without risk, an investment may make sense here, given the cheap share price and the bank's recent growth.

The article Should You Invest in the Best Online Bank in the U.S.? originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.