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FEDERAL HOME LOAN BANK OF PITTSBURGH - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations

May 8, 2014

Forward-Looking Information

Statements contained in this Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of Pittsburgh (the Bank), may be "forward-looking statements." These statements may use forward-looking terms, such as "anticipates," "believes," "could," "estimates," "may," "should," "will," or their negatives or other variations on these terms. The Bank cautions that, by their nature, forward-looking statements involve risk or uncertainty and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: economic and market conditions, changes in real estate, credit and mortgage markets; volatility of market prices, rates, and indices related to financial instruments; political, legislative, regulatory, litigation, or judicial events or actions; changes in assumptions used in the quarterly other-than-temporary impairment (OTTI) process; risks related to mortgage-backed securities (MBS); changes in the assumptions used in the allowance for credit losses; changes in the Bank's capital structure; changes in the Bank's capital requirements; membership changes; changes in the demand by Bank members for Bank advances; an increase in advances' prepayments; competitive forces, including the availability of other sources of funding for Bank members; changes in investor demand for consolidated obligations and/or the terms of interest rate exchange agreements and similar agreements; changes in the Federal Home Loan Bank (FHLBank) System's debt rating or the Bank's rating; the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risks associated with new products and services; the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability; applicable Bank policy requirements for retained earnings and the ratio of the market value of equity to par value of capital stock; the Bank's ability to maintain adequate capital levels (including meeting applicable regulatory capital requirements); business and Capital Plan adjustments and amendments; technology risks; and timing and volume of market activity. This Management's Discussion and Analysis (MD&A) should be read in conjunction with the Bank's unaudited interim financial statements and notes and Risk Factors included in Part II, Item 1A of this Form 10-Q, as well as the Bank's 2013 Form 10-K (2013 Form 10-K), including Risk Factors included in Item 1A of that report.

Executive Summary

Overview. In the first quarter of 2014, some impediments to growth in the U.S. economy persisted as the labor market and businesses reacted cautiously due to their concerns surrounding the political debate over the U.S. government's funding and the U.S. Treasury debt limits. In early February, the debt ceiling crisis was once again averted before the impending deadline. Economic data such as non-farm payrolls, fourth quarter 2013 GDP, and housing starts came in below expectations, with much of the blame being placed on the excessively cold winter in the U.S.

The Bank's financial condition and results of operations are influenced by the interest rate environment, global and national economies, local economies within its three-state district, and the conditions in the financial, housing and credit markets. Although the period-end balance for advances was down from year-end, during the first quarter of 2014 the Bank's average advance portfolio increased 30% from first quarter 2013, while net income rose to $79.9 million, compared with $28.6 million in the first quarter of 2013. The increase in net income includes $36.6 million, which is net of legal fees and expenses, from the settlement of claims against certain defendants arising from investments the Bank made in private label MBS. In February and April 2014, the Bank declared quarterly dividends of 2.5% and 4.0% on an annualized basis, respectively. The Bank continues to repurchase excess capital stock monthly.

Interest Rate Environment. During the first quarter of 2014, the debt markets stabilized compared to fourth quarter of 2013 as market participants began to incorporate the impacts of reduced Federal Reserve purchasing as well as a negotiated federal budget deal. The Federal Open Market Committee (FOMC) continued to link future monetary policy tightening to threshold levels on unemployment and inflation but also indicated that it will move away from them and toward an approach of assessing the realized and expected progress in meeting these thresholds. The market's reaction resulted in a rise in interest rates across the yield curve. The Federal Reserve also continued tapering its monthly purchase of Agency mortgage-backed securities and longer-term U.S. Treasuries (i.e., quantitative easing) and is expected to conclude the program later in 2014. The increases in interest rates impacted the Bank's risk measures (i.e., duration of equity, earned dividend spread (EDS), and market

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value of equity to par value of capital stock (MV/CS)) which is discussed further in the "Risk Management" section of this Form 10-Q.

The interest rate environment significantly impacts the Bank's profitability. Net interest income is affected by several external factors, including market interest rate levels and volatility, credit spreads and the general state of the economy. To manage interest rate risk, a portion of the Bank's advances and debt have been hedged with interest-rate exchange agreements in which 3-month LIBOR is received (advances) or paid (debt). Short-term interest rates also directly affect the Bank's earnings on invested capital. The Bank expects its near-term ability to generate significant earnings on short-term investments will be limited in light of the Federal Reserve announcement regarding the Federal funds rate noted below. Finally, the Bank's mortgage-related assets make it sensitive to changes in mortgage rates. The Bank earns relatively narrow spreads between yields on assets (particularly advances, its largest asset) and the rates paid on corresponding liabilities.

With ample liquidity available in the domestic banking system, the effective rate on Federal funds remained in a narrow range and averaged approximately 7 basis points during the first quarter of 2014. If the Federal funds effective rate remains in this expected lower range, the Bank's earnings on capital which are invested in short-term assets will continue to be low. The Federal Reserve anticipates the target range for the Federal funds rate to remain at zero to 25 basis points for a considerable time after its asset purchase program ends later in 2014 and that economic conditions are likely to warrant exceptionally low levels for the Federal funds rate at least through mid-2015.

The following table presents key market interest rates.

1st 1st Quarter Quarter 2014 4th Quarter 2013 Average 2013 Average Average Federal funds effective rate 0.07% 0.08% 0.14% 3-month LIBOR 0.24% 0.24% 0.29% 2-year U.S. Treasury 0.36% 0.32% 0.26% 5-year U.S. Treasury 1.59% 1.43% 0.81% 10-year U.S. Treasury 2.76% 2.73% 1.93% 15-year mortgage current coupon (1) 2.51% 2.49% 1.84% 30-year mortgage current coupon (1) 3.45% 3.41% 2.57%



Notes:

(1) Simple average of Fannie Mae and Freddie Mac MBS current coupon rates.

Interest Rates and Yield Curve Shifts. The Bank's earnings are affected not only by rising or falling interest rates but also by the particular path and volatility of changes in market interest rates and the prevailing shape of the yield curve. The flattening of the yield curve tends to compress the Bank's net interest margin, while steepening of the curve offers better opportunities to purchase assets with wider net interest spreads. During the first quarter of 2014, the yield curve remained steep with average short-term U.S. Treasury rates decreasing slightly and the average 10-year Treasury rate increasing. As of March 31, 2014 the spread between average 2-year and 10-year U.S. Treasuries decreased one basis point compared to the prior quarter and remained relatively wide at 240 basis points. In the first quarter of 2014, average 3-month LIBOR remained unchanged from the previous quarter, while 3-month U.S. Treasury bills decreased 3.5 basis points.

Mortgage application and refinancing activities decreased during the first quarter of 2014 as compared to the same prior year period. The performance of the Bank's mortgage asset portfolios is particularly affected by shifts in the 10-year maturity range of the yield curve, which is the point that heavily influences mortgage rates and potential refinancings. Yield curve shape can also influence the pace at which borrowers refinance or prepay their existing loans, as borrowers may select shorter-duration mortgage products. The Bank continues to adjust its prepayment estimates in its models to better reflect actual borrower activity in this extended period of historically low rates. In addition, when higher coupon mortgage loans prepay, the unscheduled return of principal cannot be invested in assets with a comparable yield, resulting in a decline in the aggregate yield on the remaining loan portfolio and a possible decrease in the net interest margin.

The Federal Housing Finance Agency (Finance Agency), along with Fannie Mae and Freddie Mac, continue to support the Home Affordable Refinance Program (HARP) in an effort to assist more eligible borrowers who can benefit from refinancing their home mortgage. The Finance Agency has directed Fannie Mae and Freddie Mac to extend HARP through December 31, 2015. Other federal agencies have implemented other programs in recent years to prevent foreclosure (including the Home Affordable Modification Program and the Principal Reduction Alternative). In addition, for borrowers meeting certain criteria, the Bank offers a loan modification program for its Mortgage Partnership Finance® (MPF®) Program. The Bank does not

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expect the HARP changes, the Bank's MPF loan modification program, or existing foreclosure prevention programs to have a significant impact on the Bank's mortgage portfolios. However, program execution and related changes, as well as any additional new programs at the local, state, or federal level, including new principal reduction programs or local or state use of eminent domain power, may alter this perspective.

The volatility of yield curve shifts may also have an effect on the Bank's duration of equity and the cost of maintaining duration within limits. Volatility in interest rates may cause management to take action to maintain compliance with these limits, even though a subsequent, sudden reversal in rates may make such hedges unnecessary. Volatility in interest rate levels and the shape of the yield curve may increase the cost of compliance with the Bank's duration limits. In the past few years, the typical cash flow variability of mortgage assets has become less pronounced. If this trend continues, the duration of assets could be extended and the cost to fund these assets could increase.

Housing Trends. During the first quarter of 2014, the housing market momentum continued but was affected by the combination of higher mortgage rates, low inventories and unfavorable weather conditions impacting sales and building activity. Home price appreciation remained strong in the first quarter, but it is expected to transition to a slower, more sustainable pace as the year progresses.

Results of Operations. During the first quarter of 2014, the Bank recorded net income of $79.9 million, up $51.3 million from $28.6 million in the first quarter of 2013. This increase includes $36.6 million from the settlement of claims against certain defendants arising from investments the Bank made in private label MBS and is net of legal fees and expenses. The additional increase in net income was driven primarily by higher net interest income.

Net Interest Income. Net interest income for the first quarter of 2014 was $62.3 million, up $16.9 million compared to $45.4 million for the first quarter of 2013. The increase in net interest income was primarily due to lower interest expense on consolidated obligation bonds. The provision (benefit) for credit losses was $(3.9) million for the first quarter of 2014 compared to $(0.1) million in the same period in 2013 due to a decrease in delinquencies, overall improvement in the housing market and a refinement of the allowance estimate methodology. The net interest margin for the first quarter of 2014 was 37 basis points compared to 31 basis points in the first quarter of 2013. The six basis point improvement was due primarily to lower funding costs on bonds.

Financial Condition. Advances. Advances totaled $46.1 billion at March 31, 2014 down from $50.2 billion at December 31, 2013, which included short-term advance demand from large members that was paid down or partially refinanced in the first quarter. As the size of the advance portfolio decreased during the first three months of 2014, the average life of an advance has increased. At March 31, 2014, approximately 66% of the par value of advances in the portfolio had a remaining maturity of more than one year, compared to 55% at December 31, 2013.

The ability to grow and/or maintain the advance portfolio is affected by, among other things: (1) the liquidity demands of the Bank's borrowers; (2) the composition of the Bank's membership; (3) advance pricing; (4) current and future credit market conditions; (5) housing market trends; and (6) the shape of the yield curve.

Investments. At March 31, 2014, the Bank held $14.0 billion of total investments, including trading, available-for-sale (AFS) and held-to-maturity (HTM) investment securities, as well as interest-bearing deposits and Federal funds sold. These investments totaled $13.9 billion at December 31, 2013. In terms of the Bank's private label MBS portfolio, the Bank has experienced overall improvement in the fair value of these investments since the low point at the end of 2008. Prices can change for many reasons, and the Bank is unable to predict future prices on these investments. The balance of the private label MBS continues to decline due to paydowns; the Bank has not purchased any new private label MBS since 2007.

Consolidated Obligations of the FHLBank System. During the first quarter of 2014, the FHLBanks continued to maintain sufficient access to funding. As the market gained more clarity on Federal Reserve tapering and the debt ceiling expiration was avoided, interest rates settled into a range. In addition, with the start of a new year, dealer balance sheets seemed more readily available to position FHLBank System debt. The combination of these factors contributed to a $29 billion increase in FHLBank System bond trading volume in the first quarter of 2014 when compared to the fourth quarter 2013. On a weighted average basis, when compared to 3-month LIBOR, FHLBank System weighted average quarterly swapped bond funding costs improved by four basis points from fourth quarter 2013. In addition, during the first quarter of 2014, consolidated obligations outstanding decreased by $13 billion with a $26 billion decline in discount notes partially offset by a $13 billion increase in bonds outstanding.

The Bank's consolidated obligations totaled $59.8 billion at March 31, 2014, a decrease of $6.1 billion from December 31, 2013. This decrease in consolidated obligations was due to a $6.3 billion decrease in discount notes. The decrease in discount

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notes was primarily due to a decline in short-term advance activity. At March 31, 2014, bonds represented 63% of the Bank's consolidated obligations, compared with 57% at December 31, 2013. Discount notes represented 37% of the Bank's consolidated obligations at March 31, 2014 compared with 43% at year-end 2013.

Capital Position and Regulatory Requirements. Total retained earnings at March 31, 2014 were $748.8 million, up from $685.7 million at December 31, 2013 reflecting the Bank's net income for the first three months of 2014 partially offset by dividends paid. Total accumulated other comprehensive income (AOCI) was $70.3 million at March 31, 2014, an increase of $26.0 million from December 31, 2013. This improvement was primarily due to a decrease in net unrealized losses on Agency securities in the AFS portfolio.

In the Finance Agency's most recent determination, as of December 31, 2013 the Bank was deemed "adequately capitalized." As provided for under the Finance Agency's final rule on FHLBank capital classification and critical capital levels, the Director of the Finance Agency has discretion to reclassify the Bank's capital classification even if the Bank meets or exceeds the regulatory requirements established. As of the date of this filing, the Bank has not received final notice from the Finance Agency regarding its capital classification for the quarter ended March 31, 2014. The Bank exceeded its risk-based, total and leverage capital requirements at March 31, 2014, as presented in the Capital Resources section of this Item 2.

The Bank measures capital adequacy with the key risk indicator MV/CS. See the "Risk Governance" discussion in the Risk Management section of this report and the Bank's 2013 Form 10-K for additional details regarding this risk metric.

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