Oct. 30 (Bloomberg) -- CIT Group Inc. bond and credit- default swap prices show that investors are betting the 101- year-old commercial lender will file for bankruptcy after the deadline for a debt exchange expired overnight.

Since CIT Chief Executive Officer Jeffrey Peek started a $30 billion debt swap Oct. 1, the company’s notes due Nov. 3 dropped 12 cents to 68 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Holders of the $500 million in notes were offered 90 cents on the dollar in new debt and equity in an out- of-court exchange that expired at 11:59 p.m. yesterday in New York. They would get 70 cents on the dollar in bonds and new stock in a pre-packaged bankruptcy.

“We believe they will file for bankruptcy within the week, provided nothing unexpected occurs,” Adam Steer, an analyst with CreditSights Inc. in New York, said in a telephone interview before the deadline passed.

CIT, which lost $5 billion in the past nine quarters and failed to get a second round of taxpayer funding in July, sought to avert collapse by asking bondholders to agree to the swap or vote for the pre-packaged bankruptcy. It faces opposition from billionaire investor Carl Icahn, who says he’s the largest bondholder, with $2 billion in debt. If CIT is forced into a “free-fall” bankruptcy, unsecured claims may fetch as little as 6 cents on the dollar, said Peek, who plans to leave the company at yearend.

Keith Rodwell, a spokesman for CIT in Sydney, declined to comment on the outcome of the debt-exchange offer. Curt Ritter, a company spokesman in New York, declined to comment yesterday.

Bankruptcy Alternative

If the debt swap fails, CIT plans to file for bankruptcy before $800 million of bonds mature next week, according to people familiar with the situation who declined to be identified because the talks are private. A group of bondholders that provided emergency financing in July has always preferred a pre- packaged bankruptcy that would have the New York-based company emerge from court proceedings in 60 days, the people said.

In a statement this week, the lender said “through the substantial deleveraging featured in CIT’s restructuring plan, whether completed in or out of court, the company is confident that CIT will emerge as a strong bank-holding company with improved capital, liquidity and earnings potential.”

CIT finances about 1 million businesses from Dunkin’ Brands Inc. in Canton, Massachusetts, to Eddie Bauer Holdings Inc., the clothing chain in Bellevue, Washington, that’s operating under bankruptcy protection. The company says it’s the third-largest U.S. railcar-leasing firm and the world’s third-biggest aircraft financier.

Bondholder Assistance

CIT said Oct. 28 it received $4.5 billion in loans from a “diverse group” of lenders, including some of its bondholders, to finance its restructuring, spurning an offer for a loan of the same size from Icahn. The money will be used to “finance a portion of the company’s existing secured indebtedness, which may come due as a result of restructuring,” it said in a statement.

The CIT notes due Nov. 3 gained 1 cent to 68 cents on the dollar as of 3:14 p.m. yesterday in New York, Trace data show. The company’s $548 million 5.65 percent notes due in 2017 fell 2.5 cents to 64.5 cents on the dollar, Trace data show.

The company’s stock dropped 1 cent, or 1.1 percent, to 94 cents as of 4:31 a.m. in pre-market New York trading, after falling 10 percent yesterday. CIT, which traded at more than $61 each in February 2007, has lost 79 percent this year.

Default Protection

The cost to protect CIT debt against default for five years has risen 5.4 percentage points to 39.4 percent upfront since Sept. 30, according to CMA DataVision. That means it would cost $3.94 million initially and $500,000 annually to protect $10 million of CIT bonds from default for five years.

The cost of the credit-default swaps implies that traders have priced in an 86.5 percent chance that the company will default within five years, a standard pricing model used by Bloomberg shows. The model assumes investors could recover 40 cents on the dollar in a bankruptcy proceeding.

“The credit-default-swap market is telling you default is imminent,” Kevin Starke, an analyst at CRT Capital Group LLC in Stamford, Connecticut, said in a telephone interview. “The bond prices are indicating the pre-pack is likely.”

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt or to hedge against losses. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Corporate Raider

Icahn, 73, who built his reputation in the 1980s as a corporate raider, said this week that CIT debt is worth more in a traditional bankruptcy and proposed to buy holders’ bonds for 60 cents on the dollar in a tender offer lasting 30 days if they reject CIT’s plans.

About $9.11 billion of CIT loans and bonds mature through 2010, according to data compiled by Bloomberg. The company has $47.3 billion of loans and bonds, Bloomberg data show.

CIT altered the terms of its debt-exchange plan Oct. 28 so that if it filed for a pre-packaged bankruptcy, bondholders will get to recommend a majority of its directors.

The steering committee comprising Capital Research & Management Co., Centerbridge Partners LP, Oaktree Capital Management LLC and Silver Point Capital LP will identify four of the 13 directors. Other investors who own at least 1 percent of CIT’s bonds and unsecured bank debt can recommend three directors.

CIT turned to its bondholders in July for the $3 billion rescue financing after failing to win access to a Federal Deposit Insurance Corp. program to sell U.S.-backed debt. The company had received $2.33 billion in taxpayer funds in December to stay afloat.

To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net

Last Updated: October 30, 2009 04:46 EDT