My old '77 GMC Jimmy had the NP203 transfer case that was like that. If you have locking hubs then it has been converted. The neat thing about that transfer case (NP 203) is that you can have 2WD HI and 2wd LO. Not that I cared about that but it's just cool to know.
Sounds like something isnt jiving in the transfer case. If what you have is the NP 203 then it is worth fixing. Although it is not the gear drive NP 205 it is still a very strong case.
Check with the folks at
http://coloradok5.com/ Those guys know everything that there is to know about this subject. Sorry that I couldnt be of more help - it's been a while since I had that GMC Jimmy.