Oct. 22 (Bloomberg) -- U.S. nonprofit hospitals sold $2.5 billion in tax-exempt bonds this week, after their borrowing costs fell and derivatives contracts became easier to cancel.

Catholic Health Initiatives, the second-largest Catholic health-care system after Ascension Health, today offered about $1.19 billion in bonds to replace variable- and auction-rate debt, reimburse itself for previous capital spending and cover new projects. State agencies in Colorado and Kentucky and in Ohio’s Montgomery County are issuing the bonds and banks led by Morgan Stanley marketed them.

Easing the way for hospital borrowers are a drop this year in fixed-rate debt costs and lower penalties for canceling derivatives contracts linked to types of adjustable-rate debt popular before the credit crisis, according to Concord, Massachusetts-based research firm Municipal Market Advisors.

“The health-care book is jumping up in size,” said Matt Dalton, chief executive of Belle Haven Investments, a fixed- income management firm in White Plains, New York.

The yield gap between Merrill Lynch & Co. indexes of hospital bonds and AAA municipal debt tightened to a 10-month low of 186 basis points on Oct. 14, before rising to 191 basis points yesterday. A basis point is 0.01 percentage point.

Municipal Market Advisors’ daily survey of benchmark 30- year bond yields slid 1 basis point to 4.99 percent today after reaching a six-week high of 5.02 percent on Oct. 14.

Health-care bond sales in the municipal market fell 38 percent to $30.1 billion during the first three quarters of 2009, compared with the year-earlier period, which was boosted by hospitals refinancing debt that jumped in cost, according to data compiled by Thomson Reuters.

Fixed, Put Bonds

Denver-based Catholic Health Initiatives is selling $872.4 million of fixed-rate bonds and $315 million of so-called put bonds, or long-term securities that the holders will have to sell back to the issuer three to six years from now for adjustment of interest rates.

Thirty-year debt that the system can call at par, or buy back at face value, in 2019 was priced to yield 5.25 percent. Put bonds with a 2039 final maturity and a 2014 mandatory tender date were priced to yield 3.53 percent.

“From a hospital treasurer’s perspective,” those yields represent “pretty attractive financing,” said R.J. Gallo, who oversees $600 million of municipal bonds as portfolio manager at Federated Investors in Pittsburgh.

The health-care system operates 78 hospitals in 20 states and has annual revenue of $8.2 billion, according to its Web site. It carries credit grades of AA from Fitch Ratings and Standard & Poor’s, and Aa2 from Moody’s Investors Service.

Dayton Hospitals

Earlier this week, Kettering Health Network in the Dayton area of Ohio raised money for hospital construction with a $100 million debt offering. Thirty-year revenue bonds rated A by S&P and A2 by Moody’s were priced to yield 5.625 percent.

Intermountain Healthcare, rated AA+ by S&P and Aa1 by Moody’s, borrowed $250 million in a deal arranged by Riverton, Utah. Bonds set to mature in 2041 had a 5.1 percent yield.

Henry Ford Health System in Detroit sold 30-year bonds at a 6 percent yield with ratings of A1 from Moody’s and A from S&P as part of a $330.7 million transaction this week.

Issuers in Indiana, Mississippi, North Carolina and Tennessee also sold hospital revenue bonds on behalf of health- care systems this week, according to data compiled by Bloomberg.

Among other municipal deals today, Minnesota sold $576.2 million of general obligation bonds. The deal was scaled back in size by 36 percent from $906 million as this month’s increase in borrowing costs for highly rated state borrowers cut into projected savings from refinancing.

Ten-year tax-exempt Minnesota bonds were priced to yield 3.14 percent. Securities paying 4 percent with a maturity year of 2029 and a call option in 2019 had a 3.98 percent yield.

California’s Public Works Board also sold $250 million of 8.361 percent taxable Build America Bonds due in October 2034, the highest coupon interest rate on an issue larger than $100 million since the federal subsidy program began, data compiled by Bloomberg show.

To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net.

Last Updated: October 22, 2009 16:31 EDT