What happened

Shares of Axos Financial (AX 3.87%), Fifth Third Bancorp (FITB 2.18%), and Discover Financial Services (DFS 1.58%) fell 27.2%, 39.1%, and 45.6% respectively just in the month of March, according to data from S&P Global Market Intelligence.

The outbreak of COVID-19 will undoubtedly cause a recession, and we just don't know how long the shelter-in-place orders will stay in place, nor how the economy will recover from its government-induced coma.

Recessions are never good for financial stocks, and the prospect of a downturn also sparks particular fears in smaller regional banks that may lack the resources of giant money-center banks. While Axos is the only name of the bunch that can be considered a small-cap stock, with a market cap just over $1 billion, both Discover and Fifth Third are midsize regional banks with market caps of roughly $10 billion.

A sign that says the word Bank on it outside a building.

Bank stocks were hit hard last month. Image source: Getty Images.

So what

Each company makes a majority of its money from lending, but with varying business models directed to consumers and businesses alike. Lending businesses suffer in a recession because inevitably, some loans go bad. In addition, interest rates fall, which helps out borrowers, but can also squeeze financial institutions' net interest margins. Basically, economic downturns usually mean bank stocks go down hard, and this month was no different.

Axos had a core businesses in jumbo mortgages to wealthier borrowers, but has since expanded into commercial and industrial loans as well as securities trading and lending in recent years. Axos is also a technologically advanced bank with no bank branches, which may afford it more cost flexibility than the others. Its relatively well-off mortgage borrowers and lower cost structure could be why its stock decreased less than the other two.

Fifth Third is a large regional bank based in Cincinnati with significant operations across the Midwest and Southeast. It has a much more commercial and industrial-focused business, with about two-thirds of its business in commercial loans and one third in diverse consumer loans. While many of its loans are backed by assets, banks typically don't want to foreclose on property or equipment and then resell it if they don't have to.

Fifth Third's stock probably wouldn't have fallen by nearly as much in March, but it had the added headwind of being sued by the Consumer Financial Protection Bureau (CFPB) on March 9, which accused Fifth Third of opening fake accounts, not unlike the scandal that enveloped Wells Fargo (WFC 0.30%) in 2016. That's a serious allegation, but Fifth Third vigorously denied wrongdoing in a rather sharply worded statement:

Fifth Third's compensation and employee incentive structure does not reward retail employees for opening unauthorized accounts, nor does it give them sales quotas or product-specific targets. Our controls are designed to prevent and detect unauthorized account openings. For almost a decade, our incentive compensation system has focused on account quality. In fact, it claws back compensation from employees for accounts that are unused or closed shortly after they were opened. ... After an investigation spanning more than three years and involving nearly half a billion pieces of data produced by the Bank, the CFPB has not informed us of any unauthorized accounts beyond the fewer than 1,100 accounts that the Bank itself identified out of 10 million -- or approximately 0.01 percent of accounts opened between 2010 and 2016. These accounts involved less than $30,000 in improper customer charges that were ultimately waived or reimbursed to customers years ago. While even a single unauthorized account is one too many, we took appropriate and decisive action to address each situation."

Finally, Discover Financial Services fell the hardest of the three. That may be because Discover's largest lending segment by far is credit card loans, which make up over 75% of its total loans outstanding. Since these loans are unsecured, it's likely that investors think major potential job losses could lead to widespread defaults on credit card loans, which don't have any collateral behind them. I happen to think the hate may have gone too far on Discover, which was still profitable through the Great Recession of 2008-2009, though the long-term fallout from this crisis still a big unknown. It will be several quarters at least before we get the full picture on card charge-offs and delinquencies.

Now what

All three bank stocks are trading in bargain-basement territory as investors sell first and ask questions later. Axos' P/E ratio is now 5.7, Fifth Third's PE ratio is 4, and Discover's PE ratio is 3.1!

Clearly, all three banks' earnings are going to be hit by the incoming recession and decrease, and investors don't know the amount nor the duration of the declines. The good news is, all banks now have much better balance sheets than before the Great Recession, thanks to rules imposed by the government, and are very, very likely to survive through this crisis. 

Taking a long-term view, even if these banks make no money for the next two years and then get back to "normal," (i.e., last year's earnings), the stocks look like bargains. Thus, brave investors may want to scoop up these high-quality financial stocks during the current scary downturn. But keep in mind, it will be very difficult to hold these stocks through what will most certainly be a harrowing few months or quarters, before more is known about the extent of the crisis and its effect on bank earnings. Therefore, keep any positions in these stocks small for now.