A confluence of forces is sparking increases in both trading and issuance of taxable municipal bonds in recent months.

The looming threat of sequestration — automatic cutbacks in federal spending mandated by last year’s budget deal — has become a concern for holders of the class of taxable municipals known as Build America Bonds.

Trading in BABs has picked up since Sept. 14, when the White House Office of Management and Budget raised the possibility of reductions in the federal direct-pay subsidy to BAB issuers under the American Recovery and Reinvestment Act of 2009, from 35% to 32.34%.

Interactive Data observed 100 block trades (size $1 million and greater) per day on average for these bonds from Sept. 18 to28, or approximately twice the average for the preceding days.

Some market participants are concerned that the estimated cut in the direct-pay BAB subsidy rate could trigger special redemption provisions, resulting in bondholder recovery rates below current market prices.

For example, on Oct. 5, a New Jersey Economic Development Authority revenue bond (CUSIP 645918YE) traded in blocks at prices as low as 111.425, or 3.7% below Interactive Data’s prior day evaluated price, which was based on historical spread relationships and market observations for this particular issue.

Although the reasons behind the block trades aren’t clear, the offering statement for the New Jersey bond contains both extraordinary optional redemption and make-whole redemption clauses for certain series.

Extraordinary redemption can be invoked “if a material adverse change has occurred to [the Internal Revenue Code]… pursuant to which the Authority’s 35% cash subsidy payment from the United States Treasury is reduced or eliminated.”

In that instance, bondholders would receive the greater of par or the present value of the remaining principal and interest payments through maturity, discounted at the nearest-maturity Treasury yield plus 100 basis points.

(In case of make-whole redemption, bondholders would receive the greater of par or principal and interest discounted at the Treasury yield plus 30 basis points.)

Meanwhile, issuance of taxable municipal bonds has turned upward in the past six months, according to data from Interactive Data’s MuniViewSM service. From May through October, municipal taxable issuance totaled $19.6 billion, a 31% increase over the same period of 2011.

Among taxable deals coming to market in recent weeks was the Port Authority of New York and New Jersey’s sale of $2 billion in debt, and a Fort Lauderdale, Fla., pension obligation bond sale for $337 million.

While new issuance of BABs ceased with the statutory expiration of the program in 2010, traditional tax-exempt issuers are finding other taxable funding structures attractive for other reasons.

Since August, nonprofit hospital systems including the Mayo Clinic, San Francisco-based Dignity Health and New York’s North Shore-Long Island Jewish hospital system have each issued taxable bonds without using a state issuer or other conduit.

Each of these issues is currently evaluated by Interactive Data’s corporate evaluations team.

In addition, the nationwide problem of underfunded pension liabilities is expected to spur greater issuance of POBs, or taxable pension obligation bonds.