UPDATE 4-CIT eyes debt exchange or prepack bankruptcy-sources

* Plans exchange offer for $32 bln unsecured debt-sources

* Eyes prepackaged bankruptcy if not successful-sources

* Board yet to approve plan, but regularly briefed-sources

* Shares down 99 cents at $1.21, debt also drops
(Adds analyst comment)

By Dan Wilchins and Paritosh Bansal

NEW YORK, Sept 30 (Reuters) - CIT Group Inc (CIT.N) is
planning to offer its unsecured debt holders two options:
either exchange their debt voluntarily, or face a prepackaged
bankruptcy, sources close to the situation said on Wednesday.

The commercial lender is struggling to reduce debt and
raise equity to stay in business. But repairing its balance
sheet is just one step toward returning to health -- it must
still figure out how to fund future business, analysts said.

"At the end of the day, the business is not sustainable as
it is," said Faris Saah, research analyst at Aladdin Capital in
Stamford, Connecticut.

The exchange offer is likely to essentially turn the
company over to bondholders, sources said Tuesday. Debt
investors would get some combination of new debt secured by
assets and shares in the company, and the company's overall
debt levels would shrink. Little would likely be left for
current shareholders, and CIT's shares fell 45 percent on
Wednesday. Bonds also fell.

Engineering the exchange could be difficult. A debt
exchange typically requires participation from owners of about
90 percent of the securities eligible to be swapped. For CIT,
eligible securities would be roughly $32 billion of unsecured
debt.

CIT plans to encourage bondholders to swap their notes by
threatening a prepackaged bankruptcy, which could require
holders of only about two-thirds of the company's total debt to
sign on, sources familiar with the situation said.

CIT believes that a prepackaged bankruptcy could take one
or two months, the sources said, asking not to be identified
because the plan is not yet public. Some bondholders could do
better in bankruptcy than a debt exchange.

Finance companies that file for the protection of
bankruptcy courts are usually signing their own death
certificate, but CIT believes it is an unusual case. The
company has been around for more than a century, and many
customers have signaled their loyalty to the lender, sources
said.

And with credit generally tight for the small and mid-sized
businesses that CIT caters to, there are few options for many
of CIT's borrowers.

But a bankruptcy could still have some cost, noted Dan
Fuss, vice chairman of Loomis Sayles, which oversees more than
$140 billion of assets and owns some CIT debt. The company
could lose future tax advantages from recent net losses if it
files for bankruptcy, he said, which could hit its balance
sheet.

"My preference for them would be the debt exchange because
then they won't go through the disruption of a bankruptcy,"
Fuss told Reuters.

If the company files for bankruptcy, it may not be able to
emerge as a going concern and might instead have to wind down
its business, Aladdin Capital's Saah said.

CIT's longer term plan is to essentially turn itself into a
bank. The company is one of scores of lenders and underwriters
that relied on bond markets to fund its operations, only to
suffer as the credit crunch has raged for two years.

Becoming a bank may not be easy, analysts said. CIT has a
small bank subsidiary with about $5 billion of deposits,
compared with CIT's overall assets of about $71 billion.
Regulators have barred CIT Bank from accepting new deposits.

Although CIT received $2.3 billion in December under the
Troubled Asset Relief Program (TARP), federal regulators this
year declined further requests by CIT for funds.

In July, CIT bought some time to restructure with the help
of an emergency loan from a group of bondholders.

CIT's board has yet to sign off on the restructuring plan,
but the board is briefed frequently and knows what the
management has been working on, the sources said.

Bond giant PIMCO, Centerbridge Partners LP, Oaktree Capital
Management, Baupost Group, Capital Research & Management Co and
Silver Point Capital were part of a group that provided a $3
billion loan to the lender this summer.

Under the terms of the $3 billion July loan, CIT must come
up with a restructuring plan agreeable to lenders by Oct. 1.
That plan will likely include debt exchange offers, the company
said in a regulatory filing in August.

If the company goes through a prepackaged bankruptcy, it
would need a debtor-in-possession loan to finance it during the
process. Banks including Bank of America, Barclays, and
Citigroup have talked to CIT about providing financing, but it
was not clear which bank was lined up for DIP financing.

CIT's notes maturing next year with a 4.75 percent coupon
fell about 2 cents on the dollar to 69.375 cents, according to
MarketAxess data.

Debt protection costs for CIT rose on concerns about the
company's restructuring. CIT's five-year credit default swaps
rose to an upfront payment of 36.2 percent the sum insured plus
500 basis points a year from 34 percent, according to CMA
DataVision. That means it would cost $3.62 million to insure
$10 million of debt plus $500,000 a year.

CIT shares fell 99 cents to close at $1.21.
(Reporting by Dan Wilchins and Paritosh Bansal; additional
reporting by Jennifer Ablan and Walden Siew; editing by John
Wallace, Matthew Lewis and Andre Grenon)