Most U.S. banks will repay government bailout funds by the fourth quarter of 2009, and banks will likely issue more stock over the next few quarters, analysts at Morgan Stanley said.

Analysts led by Betsy Graseck, however, said most large banks will repay funds from the Treasury's Troubled Asset Relief Program in the third quarter, while Bank of America Corp and Citigroup Inc may make a second round of payments in the fourth.

Morgan Stanley analysts raised their price targets by an average 33 percent for bank stocks including JPMorgan Chase & Co and Wells Fargo & Co .

The pace at which loans deteriorate should slow down over the next few quarters, with nonperforming loans peaking in the fourth quarter of this year and declining in first half of next year, the analysts wrote in their note to clients.

Credit costs should remain elevated in 2010 through the beginning of 2011, the analysts said. But the large gap between the short-term interest rates at which banks fund and the long-term rates at which they lend should translate into higher lending margins, which helps earnings, the analysts said.

They downgraded SunTrust Banks Inc to underweight from equal weight, saying the bank has a relatively higher exposure to Southeast residential construction lending.

The KBW Banks Index <.BKX> was down 0.6 percent in morning trading.

(Reporting by Tenzin Pema; Editing by Brian Moss)