**Asfiled with the Securities and Exchange Commission on June 28, 2006**

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 20-F**

(Mark One)

| o      |   | Registration statement pursuant to  Section 12(b) or 12(g) of the Securities Exchange Act of 1934 |
|--------|--------|------------------------------------------------------------------------------------------------------------------|
|   |   | or                                                                                                               |
| x      |   | Annual  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934                 |
|   |   | For the  fiscal year ended December 31, 2005                                                                |
|   |   | or                                                                                                               |
| o      |   | Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934             |
|   |   | For the  transition period from __________ to ___________                                                        |
|   |   | or                                                                                                               |
| o      |   | Shell  Company report pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934          |
|   |   | Date of  event requiring this shell company report ___________                                                   |

 

Commission file number:            333-122182

**PERMANENT FINANCING (NO.7) PLC**

(*Exact Name of Registrant 1 as specified in its charter*)

**United Kingdom**

(*Jurisdiction of Incorporation or Organization*)

**35 Great St. Helen’s,London, EC3A 6AP, United Kingdom, (011 44 20) 7398 6300**

*(Addressof Principal Executive Offices*)

**PERMANENT FUNDING (NO. 1)LIMITED**

(*Exact Name of Registrant 2 as specified in its charter*)

**United Kingdom**

(*Jurisdiction of Incorporation or Organization*)

**35 Great St. Helen’s,London, EC3A 6AP, United Kingdom, (011 44 20) 7398 6300**

*(Addressof Principal Executive Offices*)

**PERMANENT MORTGAGESTRUSTEE LIMITED**

(*Exact Name of Registrant 3 as specified in its charter*)

**Jersey, Channel Islands**

(*Jurisdiction of Incorporation or Organization*)

**47 Esplanade, St. Helier,Jersey JE1 0BD, (011 44 1534) 510 924**

*(Addressof Principal Executive Offices*)

 

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Securities registered or to be registered pursuant to Section 12(b) ofthe Act:                          None.

Securities registered or to be registered pursuant to Section 12(g) ofthe Act:                          None.

Securities for which there is a reporting obligation pursuant to Section 15(d) ofthe Act:

Title of each class

$1,400,000,000 series 2 class A notes due September 2014

$60,700,000 series 2 class B notes due June 2042

$59,200,000 series 2 class C notes due June 2042

Series 2 term AAA advance1

Series 2 term AA advance1

Series 2 term BBB advance1

Funding 1 interest in the mortgages trust1

Indicate the number of outstanding sharesof each of the issuer’s classes of capital or common stock as of the close ofthe period covered by the annual report.

Not applicable.

Indicate by check mark if the registrant isa well-known seasoned issuer, as defined in Rule 405 of the SecuritiesAct.

Yes o No x

If this report is an annual or transitionreport, indicate by check mark if the registrant is not required to filereports pursuant to section 13 or 15(d) of the Securities Exchange Act of1934.

Yes o No x

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes x No o

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filed and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o   Accelerated Filer o   Non-accelerated filer x

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1 These items have not been offered directly toinvestors. Permanent Mortgages Trustee Limited is the registrant for theFunding 1 interest in the mortgages trust and is holding the Funding interestin the mortgages trust on behalf of Permanent Funding (No. 1) Limited. TheFunding 1 interest in the mortgages trust is the primary source of payments onthe term advances listed. Permanent Funding (No. 1) Limited is the registrantfor the term advances and has issued the term advances to Permanent Financing(No. 7) PLC. The term advances are the primary source of payments on the series2 notes. Permanent Financing (No. 7) PLC is the registrant for the series 2notes.

 

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Indicate by check mark which financialstatement item the registrant has elected to follow.

Not applicable.

If this is an annual report, indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act)

Yes o No x

Indicate by check mark whether theregistrant has filed all documents and reports required to be filed by Sections12, 13 or 15(d) of the Securities Exchange Act of****1934 subsequent to the distribution ofsecurities under a plan confirmed by a court.

Not applicable.

 

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**PRESENTATIONOF INFORMATION**

This annual reporton Form 20-F relates to Permanent Financing (No. 7) PLC (the “issuer”)and the following securities (the “issuer notes”), which were issued pursuantto a trust deed dated March 23, 2005 (the “issuer trust deed”), betweenthe issuer and The Bank of New York, as note trustee (the “note trustee”):

·                  $1,400,000,000series 2 class A notes due September 2014

·                  $60,700,000series 2 class B notes due June 2042

·                  $59,200,000series 2 class C notes due June 2042

This annual reporton Form 20-F also relates to the following advances made pursuant tothe intercompany loan agreement dated March 23, 2005 (the “issuerintercompany loan agreement”), between the issuer, Permanent Funding (No. 1)Limited (“Funding 1”), The Bank of New York, as security trustee (the “securitytrustee”) and Citibank, N.A., as agent bank:

·                  £732,218,000series 2 term AAA advance

·                  £31,747,000series 2 term AA advance

·                  £30,963,000series 2 term BBB advance

This annual reporton Form 20-F further relates to Funding 1’s interest in themortgages trust, comprising, among other things, the initial portfolio of loansand their related security assigned to Permanent Mortgages Trustee Limited (the“mortgages trustee”) by Halifax plc (the “seller”) on June 14, 2002, andon several subsequent dates any new loans and their new related securityassigned to the mortgages trustee by the seller after March 23, 2005(the “closingdate”), any increase in the outstanding principal balance of a loan due to theborrower taking payment holidays or making underpayments under a loan or aborrower making a drawing under any flexible loan, any interest, principal andother amounts (excluding third party amounts) paid by borrowers on their loansand their related security, the rights under the insurance policies that areassigned to the mortgages trustee or of which the mortgages trustee has thebenefit, and amounts on deposit and interest earned on the mortgages trusteeguaranteed investment contract. The mortgages trustee guaranteed investmentcontract, or GIC, account is the bank account in which the mortgages trusteeholds any cash that is part of the trust property until it is distributed tothe beneficiaries. Any actual losses in relation to the loans, any actualreductions occurring in respect of the loans and distributions of principalmade from time to time to the beneficiaries or the mortgages trust will bededucted from the trust property. The composition of the trust property willfluctuate as drawings under flexible loans and new loans are added and as theloans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

Certain terms usedherein and not defined have the same meaning ascribed to such terms in theRegistration Statement filed on Form S-11 (the “RegistrationStatement”) relating to the securities (file number 333-122182).

Certain items in Form 20-Fare not applicable to annual reports filed on Form 20-F. Therefore,as used in this filing, “Not applicable to annual reports filed on Form 20-F”means that the response to the referenced item is omitted in reliance on theinstructions to Form 20-F published by the United States Securitiesand Exchange Commission (the “SEC”) as of the date 

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of this annual report that specifically state that theitem is inapplicable to annual reports filed on Form 20-F.

Certain items in Form 20-Fare not applicable to the issuer, Funding 1 or the mortgages trustee.Therefore, as used in this filing, “Not Applicable” means the response to thereference item is omitted in reliance on the procedures outlined in numerousno-action letters issued by the staff of the SEC with respect to issuers ofsubstantially similar asset-backed securities that file annual reports on Form 10-K,or that the referenced item is otherwise not applicable.

**FORWARD-LOOKINGSTATEMENTS**

This annual reportincludes forward-looking statements including, but not limited to, statementsmade under the “Risk Factors” section. These forward-looking statements can beidentified by the use of forward-looking terminology, such as the words “believes”,“expects”, “may”, “intends”, “should” or “anticipates”, or the negative orother variations of those terms. These statements involve known and unknownrisks, uncertainties and other important factors that could cause the actualresults and performance of the issuer notes, the seller or the UK residentialmortgage industry to differ materially from any future results or performanceexpressed or implied in the forward-looking statements. These risks,uncertainties and other factors include, among others: general economic andbusiness conditions in the UK; currency exchange and interest fluctuations;government, statutory, regulatory or administrative initiatives affecting the seller,changes in business strategy, lending practices or customer relationships andother factors that may be referred to in this annual report.

Some of the mostsignificant of these risks, uncertainties and other factors are discussed inthe section of this annual report entitled “Risk Factors”. Investors areencouraged to carefully consider those factors prior to making an investmentdecision regarding the issuer notes.

**INCORPORATIONOF CERTAIN DOCUMENTS BY REFERENCE**

Each of theissuer, Funding 1 and the mortgages trustee incorporates by reference itsperiodic filings on Form 6-K, which contain all financialinformation relating to the securities relevant to the holders of the issuernotes.

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**PART I**

**Item 1. Identity of Directors,Senior Management and Advisers**

Not applicable toannual reports filed on Form 20-F.

**Item 2. Offer Statistics andExpected Timetable**

Not applicable toannual reports filed on Form 20-F.

**Item 3. Key Information**

A.*           Selected FinancialData*

Each of theissuer, Funding 1 and the mortgages trustee incorporates by reference andattaches hereto as exhibits the following reports, filed on Form 6-K,which include all financial information relating to the securities that isrelevant to holders of the issuer notes:

·                  Investor’sReport for the month of March 2005

·                  Investor’sReport for the month of April 2005

·                  Investor’sReport for the month of May 2005

·                  Investor’sReport for the month of June 2005

·                  Investor’sReport for the month of July 2005

·                  Investor’sReport for the month of August 2005

·                  Investor’sReport for the month of September 2005

·                  Investor’sReport for the month of October 2005

·                  Investor’sReport for the month of November 2005

·                  Investor’sReport for the month of December 2005

B.*            Capitalization andIndebtedness*

Not applicable toannual reports filed on Form 20-F.

C.*            Reasons for the Offerand Use of Proceeds*

Not applicable toannual reports filed on Form 20-F.

D*.            Risk Factors*

*Thissection describes the principal risk factors associated with an investment inthe issuer notes. Investors considering purchasing the issuer notes shouldcarefully read and think about all the information contained in this document,including the risk factors set out here, prior to making any investmentdecision.*

**Noteholderscannot rely on any person other than the issuer to make payments on the issuernotes**

The issuer noteswill not represent an obligation and are not the responsibility of any Halifaxplc or any of its affiliates, the managers, the underwriters, the mortgagestrustee, the note trustee or any other party to the transaction other than theissuer.

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**Theissuer has a limited set of resources available to the issuer to make paymentson the issuer notes**

The issuersability to make payments of principal and interest on the issuer notes and topay its operating and administrative expenses will depend primarily on thefunds being received under the issuer intercompany loan. In addition, theissuer will rely on the issuer dollar currency swaps and the issuer eurocurrency swaps to provide payments on the issuer notes denominated in USdollars and euro, respectively.

Funding 1 hasentered into the Funding 1 liquidity facility, which is available (subject tosatisfying certain conditions precedent) to pay certain amounts due and payableon the term advances made by the issuer and the previous issuers. In the eventthat the seller suffers certain ratings downgrades, Funding 1 will be requiredto fund the liquidity reserve fund, though there can be no assurance thatFunding 1 will have sufficient resources to do so at such time, and Funding 1may draw money from the liquidity reserve fund to the extent it has beenfunded, to pay amounts due to the issuer.

The issuer willnot have any other significant sources of funds available to meet itsobligations under the issuer notes and/or any other payments ranking inpriority to the issuer notes.

**Funding 1is not obliged to make payments on the issuer term advances if it does not haveenough money to do so, which could adversely affect payments on the issuernotes**

Funding 1’s ability topay amounts due on the issuer term advances will depend upon:

·                  Funding 1receiving enough funds from its entitlement to the trust property on or beforeeach Funding 1 interest payment date;

·                  Funding 1receiving the required funds from the Funding 1 swap provider;

·                  the amount offunds credited to the general reserve fund;

·                  the amount offunds credited to the liquidity reserve fund; and

·                  the allocationof funds between the issuer term advances, the previous term advances and anynew term advances.

According to theterms of the mortgages trust deed, the mortgages trustee is obliged to pay toFunding 1 the Funding 1 share percentage of revenue receipts on the loansby crediting those amounts to the Funding 1 GIC account on each distributiondate. The mortgages trustee is obliged to pay to Funding 1 principal receiptson the loans by crediting those amounts to the Funding 1 GIC account as andwhen required pursuant to the terms of the mortgages trust deed.

Funding 1 will beobliged to pay revenue receipts due to the issuer under the issuer intercompanyloan only to the extent that it has revenue receipts left over after makingpayments ranking in priority to the issuer, such as payments of certain feesand expenses of Funding 1 and payments on certain term advances (under anyintercompany loan agreements) with higher ranking designations.

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Funding 1 will beobliged to pay principal receipts due to the issuer under the issuerintercompany loan only to the extent that it has principal receipts availablefor that purpose after repaying amounts ranking in priority to the issuer(including repaying any previous term advances or new term advances with higherrating designations).

If there is ashortfall between the amounts payable by Funding 1 to the issuer under theissuer intercompany loan agreement and the amounts payable by the issuer on theissuer notes, the noteholders may, depending on what other sources of funds areavailable to the issuer and to Funding 1, not receive the full amount of interestand/or principal which would otherwise be due and payable on the issuer notes.

**Failureby Funding 1 to meet its obligations under the issuer intercompany loanagreement would adversely affect payments on the issuer notes**

If Funding 1 doesnot make payments due and payable on the issuer intercompany loan, then theissuer may not have enough money to make payments on the issuer notes, and inaddition the issuer will have only limited recourse to the assets of Funding 1.If Funding 1 does not pay amounts under the issuer intercompany loan because itdoes not have enough money available, those amounts will be deemed not to bedue and payable, so there will not be an event of default under the issuerintercompany loan, and the issuer will not have recourse to the assets ofFunding 1 in that instance.

**On thefinal repayment date of the issuer intercompany loan any outstanding amounts inrespect of the issuer term AA advances and the issuer term BBB advances will beextinguished, which would cause a loss on any class B issuer notes and anyclass C issuer notes still outstanding**

The transactionhas been structured in the expectation that on the final repayment date of theissuer intercompany loan in June 2042, the interest and principal due andpayable on the issuer term AA advances and the issuer term BBB advances will bein an amount equal to the sum available to pay all outstanding interest and/orprincipal (including interest and/or principal deferred and unpaid) on theissuer term AA advances and the issuer term BBB advances (after paying amountsof a higher order of priority as required by the Funding 1 priority ofpayments).

If there is ashortfall between the amount available to pay such interest and/or principaland the amount required to pay all outstanding interest and/or principal on theissuer term AA advances and the issuer term BBB advances, then the shortfallwill be deemed to be not due and payable under the issuer intercompany loanagreement and the issuer will not have any claim against Funding 1 for theshortfall.

If there is such ashortfall in interest and/or principal payments under the issuer intercompanyloan agreement, the noteholders may not receive the full amount of interestand/or principal which would otherwise be due and payable on the class B issuernotes or the class C issuer notes outstanding.

**Enforcementof the issuer security is the only remedy for a default in the issuer’sobligations, and the proceeds of that enforcement may not be enough to makepayments on the issuer notes**

The only remedyfor recovering amounts on the issuer notes is through the enforcement of theissuer security. The issuer has no recourse to the assets of Funding 1 unlessFunding 1 has 

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also defaulted on its obligations under the issuerintercompany loan and the Funding 1 security has been enforced.

If the securitycreated as required by the issuer deed of charge is enforced, the proceeds ofenforcement may be insufficient to pay all principal and interest due on theissuer notes.

**Thetransaction has been structured in the expectation that the series 2 issuernotes will be redeemed before the series 3 issuer notes and so on**

The transactionhas been structured in the expectation that:

·                  the series 2issuer notes will be redeemed in full prior to the redemption of the series 3issuer notes, the series 4 issuer notes and the series 5 issuer notes;

·                  the series 3issuer notes will be redeemed in full prior to the redemption of the series 4issuer notes and the series 5 issuer notes; and

·                  the series 4issuer notes will be redeemed in full prior to the redemption of the series 5issuer notes.

This means, amongother things, that the series 2 class B issuer notes and the series 2 class Cissuer notes are expected to be redeemed before the series 3 class A issuernotes, the series 4 class A issuer notes, and the series 5 class A issuernotes, even though the series 3 class A issuer notes, the series 4 class Aissuer notes and the series 5 class A issuer notes have a higher rating thanthe series 2 class B issuer notes and the series 2 class C issuer notes.Similarly, the series 3 class B issuer notes and the series 3 class C issuernotes are expected to be redeemed before the series 4 class A issuer notes andthe series 5 class A issuer notes, and so on for each series of issuer notes.

However, there isno assurance that the series 2 issuer notes will be redeemed in full before theseries 3 issuer notes, the series 4 issuer notes and the series 5 issuer notesor that the series 3 issuer notes will be redeemed in full before the series 4issuer notes and the series 5 issuer notes or that the series 4 issuer noteswill be redeemed in full before the series 5 issuer notes. In each case,redemption of the issuer notes is ultimately dependent on, among other things,repayment and redemptions on the loans and on the rating designation of theissuer term advances.

Further, if on anyinterest payment date, amounts are due and payable in respect of the class Aissuer notes of any series and amounts are due and payable in respect of theclass B issuer notes of any series and/or the class C issuer notes of anyseries, then payments of principal will be made on the class A issuer notes inpriority to payments of principal on the class B issuer notes and the class Cissuer notes. Similarly, if on any interest payment date, amounts are payablein respect of the class B issuer notes of any series and the class C issuernotes of any series, then payments of principal will be made on the class Bissuer notes in priority to payments of principal on the class C issuer notes.

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**There maybe conflicts between the noteholders’ interests and the interests of any of theissuer’s other secured creditors, and the interests of those secured creditorsmay prevail over the noteholders’ interests**

The issuer deed ofcharge requires the security trustee to consider the interests of each of theissuer secured creditors in the exercise of all of its powers, trusts,authorities, duties and discretions, but requires the security trustee, in theevent of a conflict between the noteholders’ interests and the interests of anynoteholders with a higher class designation and the interests of noteholderswith a lower class designation or any of the other issuer secured creditors, toconsider only the noteholders’ interests with a higher class designation.

**Thesecurity trustee may agree modifications to the issuer transaction documentswithout the noteholders’ prior consent, which may adversely affect thenoteholders’ interests**

Pursuant to theterms of the Funding 1 deed of charge and the issuer deed of charge, thesecurity trustee may, without the consent or sanction of Funding 1’s securedcreditors or the issuer’s secured creditors, concur with any person in makingor sanctioning any modifications to the transaction documents:

·                  which in theopinion of the security trustee it may be expedient to make, provided that thesecurity trustee is of the opinion that such modification will not bematerially prejudicial to the interests of the secured creditors or, if it isnot of that opinion in relation to any secured creditor, such secured creditorhas given its written consent to such modification; or

·                  which in theopinion of the security trustee is made to correct a manifest error or an errorestablished as such to the satisfaction of the security trustee or is of aformal, minor or technical nature.

The securitytrustee will be entitled to assume that the exercise of its discretions willnot be materially prejudicial to the noteholders’ interests if each of therating agencies has confirmed that the then current rating by it of the noteswould not be adversely affected by such exercise.

In addition, thesecurity trustee will give its consent to any modifications to the mortgagesale agreement, the servicing agreement, the cash management agreement, theFunding 1 deed of charge, the Funding 1 liquidity facility agreement, theFunding 1 swap agreement, the intercompany loan terms and conditions, the bankaccount agreement and the master definitions and construction schedule, that arerequested by Funding 1 or the cash manager, provided that Funding 1 or the cashmanager certifies to the security trustee in writing that such modificationsare required in order to accommodate:

i)                 theentry by Funding 1 into new intercompany loan agreements, and/or the issue ofnew types of notes by new issuers and/or the addition of other relevantcreditors to the transaction;

ii)              theinclusion of Permanent Funding (No. 2) PLC (“Funding 2”) as a beneficiaryof the mortgages trust;

iii)           theissue of notes by Funding 2;

iv)          thesale of new types of loans to the mortgages trustee;

v)             changesto be made to the general reserve fund required amount, the liquidity reservefund required amount and/or the manner in which the reserve funds are funded;

 

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vi)          changesto be made to the definitions of asset trigger event and non-asset triggerevent; and

vii)       theinclusion of an additional Funding 1 liquidity facility;

and provided furtherthat:

·                  in respect ofthe matters listed in paragraphs (i) to (iv), the relevant conditionsprecedent to, as applicable, the addition of new issuers, the inclusion ofFunding 2 as a beneficiary of the mortgages trustee, have been satisfied; and

·                  in respect ofthe matters listed in paragraphs (i) to (vii), the security trustee hasreceived written confirmation from each of the rating agencies that therelevant modifications will not adversely affect the then current ratings ofthe notes.

The modificationsrequired to give effect to the matters listed in paragraphs (i) to (vii) abovemay include, *inter alia*,amendments to the provisions of the Funding 1 deed of charge relating to theapplication of monies. Accordingly, there can be no assurance that the effectof the modifications to the transaction documents will not ultimately adverselyaffect the noteholders’ interests. Any modifications to the documents describedabove will require the actual consent of the Funding 1 liquidity facilityprovider, the Funding 1 swap provider and each of the issuer swap providers (inrespect of each document to which they are a party), as applicable, suchconsent not to be unreasonably withheld and to be deemed given if no writtenresponse (affirmative or negative) is given within 10 business days after thewritten request for consent is sent to each such party.

**There may be a conflictbetween the interests of the holders of class A issuer notes, the holders ofclass B issuer notes and the holders of class C issuer notes, and the interestsof one class of noteholders may prevail over the interests of other classes ofnoteholders**

The issuer trustdeed and the terms of the issuer notes will provide that the note trustee is tohave regard to the interests of the holders of all the classes of issuer notes.There may be circumstances, however, where the interests of one class of thenoteholders conflict with the interests of another class or classes of thenoteholders. The issuer trust deed and the terms of the issuer notes willprovide that where, in the sole opinion of the note trustee there is such aconflict, then:

·                  the note trusteeis to have regard only to the interests of the class A noteholders in the eventof a conflict between the interests of the class A noteholders on the one handand the class B noteholders and/or the class C noteholders on the other hand;

·                  the note trusteeis to have regard only to the interests of the class B noteholders in the eventof a conflict between the interests of the class B noteholders on the one handand the class C noteholders on the other hand.

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**There maybe a conflict between the interests of the holders of each series of the classA issuer notes, the holders of each series of the class B issuer notes and theholders of each series of the class C issuer notes, and the interests of oneseries of noteholders may prevail over the interests of other series ofnoteholders**

There may also becircumstances where the interests of the class A noteholders of one series ofthe issuer notes conflicts with the interests of the class A noteholders ofanother series of the issuer notes. Similarly, there may be circumstances wherethe interests of the class B noteholders of one series of the issuer notesconflicts with the interests of the class B noteholders of another series ofthe issuer notes or the interests of the class C noteholders of one series ofthe issuer notes conflicts with the interests of the class C noteholders ofanother series of the issuer notes.

The issuer trustdeed and the terms of the issuer notes will provide that where, in the soleopinion of the note trustee there is such a conflict, then a resolutiondirecting the note trustee to take any action must be passed at separatemeetings of the holders of each series of the class A issuer notes, or, asapplicable, each series of the class B issuer notes or each series of the classC issuer notes. A resolution may only be passed at a single meeting of thenoteholders of each series of the relevant class if the note trustee is, in itsabsolute discretion, satisfied that there is no conflict between them.

Similar provisionswill apply in relation to requests in writing from holders of a specifiedpercentage of the principal amount outstanding of the issuer notes of eachclass within each series (the principal amount outstanding being converted intosterling for the purposes of making the calculation). Noteholders should notethat as a result of repayments of principal first to the series 2 issuer notes,then to the series 3 issuer notes, then to the series 4 issuer notes and thento the series 5 issuer notes the principal amount outstanding of each series ofthe issuer notes will change after the closing date.

**PermanentHoldings Limited (“Holdings”) has established another company, Funding 2, whichmay become an additional beneficiary under the mortgages trust**

Holdings hasestablished a separate entity, Funding 2, which may issue notes from time totime and use the proceeds to pay for a direct interest in the trust propertyrather than lending the proceeds to Funding 1. Simultaneously with theacquisition by Funding 2 of an interest in the trust property, the seller andFunding 1, as existing beneficiaries of the mortgages trust, would be requiredto agree to a decrease in their beneficial interests in the trust property(which would require a partial release of security by Funding 1 over its sharein the trust property).

The seller,Funding 1 and Funding 2 would each have a joint and undivided interest in thetrust property but their entitlement to the proceeds from the trust propertywould be in proportion to their respective shares of the trust property. Oneach distribution date the mortgages trustee would distribute interest andprincipal receipts to one, two or all three beneficiaries, depending on theterms of the mortgages trust.

It is anticipatedthat Funding 2 will issue notes directly or indirectly to investors from timeto time backed by its share of the trust property. Noteholders would not have adirect or indirect interest in Funding 2’s share of the trust property.

Amendments wouldbe made to a number of the issuer transaction documents as a result of theinclusion of Funding 2 as a beneficiary of the mortgages trust. In particular(but without limitation), amendments would be made to:

·                  the mortgagesale agreement to enable the purchase by Funding 2 of interests in the trustproperty;

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·                  the mortgagestrust deed (i) to establish Funding 2 as a beneficiary of the trust, (ii) toenable the acquisition by Funding 2 of an interest in the trust property fromtime to time and (iii) to regulate the distribution of interest andprincipal receipts in the trust property to Funding 2 and the otherbeneficiaries;

·                  the cashmanagement agreement to regulate the application of monies to Funding 2;

·                  the servicingagreement, to ensure that Funding 2 receives the benefit of the servicer’sduties under that agreement; and

·                  the masterdefinitions and construction agreement.

In addition,Funding 1, Funding 2 and the seller may enter into new agreements to regulatethe making of decisions between them.

There may beconflicts of interest between Funding 1 and Funding 2, in which case it isexpected that the mortgages trustee will follow the directions given by therelevant beneficiary (excluding the seller) that has the largest share of thetrust property at that time. The interests of Funding 1 may not prevail, whichmay adversely affect the noteholders’ interests.

Noteholders’ priorconsent to the inclusion of Funding 2 as a beneficiary of the mortgages trustand the subsequent amendments to the documents and/or release of security byFunding 1 will not be required. Before becoming a beneficiary of the mortgagestrust, however, Funding 2 will be required to satisfy a number of conditions,including:

·                  obtaining awritten confirmation from each of the rating agencies that the then currentratings of the notes outstanding at that time will not be adversely affected asa result of Funding 2 becoming a beneficiary of the mortgages trust;

·                  providingwritten certification to the security trustee that no event of default underany of Funding 1’s intercompany loan agreements outstanding at that time hasoccurred which has not been remedied or waived and no event of default willoccur as a result of Funding 2 becoming a beneficiary of the mortgages trust;and

·                  providingwritten certification to the security trustee that no principal deficiency isrecorded on the principal deficiency ledger in relation to Funding 1’s termadvances that are outstanding at that time.

There can be noassurance that the inclusion of Funding 2 as a beneficiary of the mortgagestrust would not affect cashflows available to pay amounts due on thenoteholders’ issuer notes and therefore adversely affect the noteholders’interests.

**IfFunding 1 enters into new intercompany loan agreements, then the new termadvances may rank ahead of issuer term advances as to payment, and accordinglynew notes may rank ahead of issuer notes as to payment**

Since the closingdate, Holdings has established new issuers to issue new notes to investors, andit is likely that Holdings will establish new issuers in the future. Theproceeds of each new issue will be used by the new issuer to make a newintercompany loan to Funding 1. Funding 1 will use the proceeds of the newintercompany loan to:

·                  pay the sellerin relation to the initial consideration for new loans and their relatedsecurity to be sold to the mortgages trustee;

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·                  pay the sellerfor a portion of the seller share of the trust property, which will result inan increase in Funding 1’s share of the trust property;

·                  refinance inwhole or in part an intercompany loan or intercompany loans outstanding at thattime (and if the issuer intercompany loan to Funding 1 is refinanced,noteholders could be repaid early); and/ or

·                  deposit some ofthose proceeds in the general reserve fund.

The payment andsecurity priorities of the issuer notes relative to each other as set out inthe issuer deed of charge and the issuer cash management agreement will not beaffected as a result of an issue of new notes by a new issuer, because the newissue will be constituted by separate documents which do not affect the issuerdeed of charge or the issuer cash management agreement. However, Funding 1 maybe required to pay to a new issuer amounts owing under a new term advance aheadof or in the same order of priority as amounts owing to the issuer on theissuer term advances, depending on the rating designation, and the scheduledrepayment date of that new term advance and other rules regarding therepayment of principal by Funding 1. If this is the case, then the relevant newnoteholders will be paid before the noteholders.

If Holdingsestablishes new issuers to make new intercompany loans to Funding 1, thenoteholders will not have any right of prior review or consent with respect tothose new intercompany loans or the corresponding issuance by new issuers ofnew notes. Similarly, the terms of the Funding 1 transaction documents(including the mortgage sale agreement, the mortgages trust deed, the Funding 1deed of charge, the definitions of the trigger events, the criteria for thesale of new loans to the mortgages trustee and the amount available to be drawnunder the Funding 1 liquidity facility) may be amended to reflect the newissue. Noteholders’ consent to these changes will not be required. There can beno assurance that these changes will not affect the cashflows available to payamounts due on the issuer notes.

However, beforeissuing new notes, a new issuer will be required to satisfy a number ofconditions, including:

·                  obtaining awritten confirmation from each of the rating agencies that the then currentratings of the notes outstanding at that time will not be adversely affectedbecause of the new issue;

·                  providingwritten certification to the security trustee that no event of default underany of the intercompany loan agreements outstanding at that time has occurredwhich has not been remedied or waived and no event of default will occur as aresult of the issue of the new notes; and

·                  providingwritten certification to the security trustee that no principal deficiency isrecorded on the principal deficiency ledger in relation to the term advancesoutstanding at that time.

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**Funding1 has entered into the other intercompany loan agreements with other issuers,and some of the term advances in other intercompany loans rank ahead of some ofthe issuer term advances in the issuer intercompany loan as to payment, andaccordingly some of the notes issued by the previous issuers rank ahead of someof the issuer notes as to payment**

The other issuersissued the previous notes to investors, the sterling equivalent of the netissue proceeds of which were used by the other issuers to make intercompanyloans to Funding 1. Funding 1 used most of the proceeds of these intercompanyloans from Permanent Financing (No. 1) PLC to pay the seller for theinitial loans (together with their related security) that it assigned to themortgages trustee on the initial closing date which comprised Funding 1’soriginal share of the trust property. Funding 1 used most of the proceeds ofeach other issuers’ intercompany loan to pay the seller for loans (togetherwith their related security) sold to the mortgages trustee or to payconsideration to the seller for an increase in Funding 1’s share in themortgages trust.

The payment andsecurity priorities of the issuer notes relative to each other as set out inthe issuer deed of charge and the issuer cash management agreement are notaffected as a result of the issue of the notes by the other issuers, becausethe other issues were constituted by separate documents which do not affect theissuer deed of charge or the issuer cash management agreement. However, Funding1 may be required to pay to the other issuers amounts that are owing under oneor term advances ahead of or in the same order of priority as amounts owing tothe issuer on the issuer term advances, depending on the rating designation,the scheduled repayment date of that previous term advance and other rules regardingthe payment of interest and the repayment of principal by Funding 1. If this isthe case, then the other noteholders will be paid before holders of the issuernotes.

**Othercreditors will share in the same security granted by Funding 1 to the securitytrustee, and this may adversely affect payments on the issuer notes**

If Funding 1enters into a new intercompany loan agreement, then if required it will alsoenter into a new start-up loan agreement with a new start-up loan provider andthe security trustee.

If required by therating agencies, Funding 1 will use part of the proceeds of the new start-uploan to fund further the general reserve fund. Similarly, if necessary, Funding1 will also enter into a new Funding 1 swap with either the Funding 1 swapprovider or a new Funding 1 swap provider and the security trustee.

The new issuer,any new start-up loan provider and any new Funding 1 swap provider will becomeparty to the Funding 1 deed of charge and will be entitled to share in thesecurity granted by Funding 1 for its benefit (and the benefit of the other Funding1 secured creditors) under the Funding 1 deed of charge. In addition, theliabilities owed to the Funding 1 liquidity facility provider and the Funding 1swap provider which are secured by the Funding 1 deed of charge may increaseeach time that Funding 1 enters into a new intercompany loan agreement. Thosefactors could ultimately cause a reduction in the payments noteholders receiveon the issuer notes. Noteholders consent to the requisite changes to thetransaction documents will not be required.

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**Theremay be conflicts between the issuer and any new issuers, and the issuersinterests may not prevail, which may adversely affect payments on the issuernotes.**

The securitytrustee will exercise its rights under the Funding 1 deed of charge only in accordancewith directions given by the issuers (which could be the issuer, and, ifFunding 1 enters into new intercompany loans, any new issuer) that have thehighest rating designation at that time, provided that the security trustee isindemnified and/or secured to its satisfaction.

If the securitytrustee receives conflicting directions, it will follow the directions given bythe relevant issuers representing the largest principal amount outstanding ofthe term advances with the highest rating designation. If the issuer is not inthe group representing that largest principal amount, then the issuersinterests may not prevail. This could ultimately cause a reduction in thepayments noteholders receive on the issuer notes. For example, if the termadvances with the highest rating designation at the time of a direction are theterm AAA advances, then in the event of conflicting direction being given byissuers with outstanding term AAA advances, the security trustee will followthe direction given by those issuers holding the largest principal amountoutstanding of term AAA advances.

**Asnew loans are sold to the mortgages trustee, the characteristics of the trustproperty may change from those existing at the closing date, and those changesmay adversely affect payments on the issuer notes**

There is noguarantee that any new loans sold to the mortgages trustee will have the samecharacteristics as the loans in the initial portfolio as at the closing date.In particular, new loans may have different payment characteristics from theloans in the initial portfolio. The ultimate effect of this could be to delayor reduce the payments noteholders receive on the issuer notes.

**Theyield to maturity of the issuer notes may be adversely affected by prepaymentsor redemptions on the loans**

The yield tomaturity of the issuer notes of each class will depend mostly on (a) theamount and timing of payment of principal on the loans and (b) the pricepaid by the noteholders of each class of issuer notes. The yield to maturity ofthe issuer notes of each class may be adversely affected by a higher or lowerthan anticipated rate of prepayments on the loans.

No assurance canbe given that Funding 1 will accumulate sufficient funds during the cashaccumulation period relating to the issuer series 2 term AAA advance and/or thecash accumulation period relating to each scheduled amortization installmentunder the issuer series 3 term AAA advance, the issuer series 4 term AAAadvance and the issuer series 5 term AAA advance to enable it to repay theseissuer term advances to the issuer so that the corresponding classes of issuernotes will be redeemed in accordance with their scheduled redemption dates.

During the cashaccumulation period for the issuer bullet term advances and scheduled amortizationinstallments, repayments of principal will only be made on the issuer term AAadvances or the issuer term BBB advances that are due and payable if thequarterly CPR of the loans in the trust property is greater than 15 per cent.and certain other conditions are met. This means that there may be nocorresponding repayments of principal on the class B issuer notes or the classC issuer notes.

The extent towhich sufficient funds are saved by Funding 1 during a cash accumulation periodor received by it from its share in the mortgages trust for application on ascheduled repayment date will depend on whether the actual principal prepaymentrate of the loans is the same as the assumed principal prepayment rate. IfFunding 1 is not able to save enough money 

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during a cash accumulation period or does not receiveenough money from its share in the mortgages trust for application on ascheduled repayment date to repay the relevant issuer term AAA advance (and ifit is unable to make a drawing on the reserve funds to make good the shortfall)so that the issuer can redeem the class A issuer notes of the correspondingseries on their respective scheduled redemption date(s), then Funding 1 will berequired to pay to the issuer on those scheduled redemption dates only theamount that it has actually saved or received. Any shortfall will be deferredand paid on subsequent Funding 1 interest payment dates when Funding 1 hasmoney available to make the payment. In these circumstances, there will be avariation in the yield to maturity of the relevant class of issuer notes.

**Theissuers ability to redeem the series 2 class A issuer notes on their scheduledredemption dates is affected by the rate of prepayment on the loans**

The rate ofprepayment of loans is influenced by a wide variety of economic, social andother factors, including prevailing mortgage market interest rates, theavailability of alternative financing programs, local and regional economicconditions and homeowner mobility. For instance, prepayments on the loans maybe due to borrowers refinancing their loans and sales of properties byborrowers (either voluntarily or as a result of enforcement action taken). Inaddition, if the seller is required to repurchase a loan or loans under amortgage account and their related security because, for example, one of theloans does not comply with the representations and warranties in the mortgagesale agreement, then the payment received by the mortgages trustee will havethe same effect as a prepayment of all of the loans under that mortgageaccount. Because these factors are not within the issuers control or thecontrol of Funding 1 or the mortgages trustee, the issuer cannot give anyassurances as to the level of prepayments that the portfolio may experience.

Variation in therate of prepayments of principal on the loans may affect each class of issuernotes differently depending upon amounts already repaid by Funding 1 to theissuer under the issuer intercompany loan and whether a trigger event hasoccurred, or a loan is subject to a product switch or a further advance or thesecurity granted by the issuer under the issuer deed of charge has beenenforced. If prepayments on the loans occur less frequently than anticipated,then there may not be sufficient funds available to redeem the series 2 class Aissuer notes in full on their scheduled redemption dates.

**Theseller may change the lending criteria relating to loans that are subsequentlysold to the mortgages trustee, which could affect the characteristics of the trustproperty and which may adversely affect payments on the issuer notes**

Each of the loanswas originated in accordance with the seller’s lending criteria at the time oforigination. These lending criteria consider a variety of factors such as apotential borrower’s credit history, employment history and status andrepayment ability, as well as the value of the property to be mortgaged. In theevent of the sale of any new loans and new related security to the mortgagestrustee, the seller will warrant that those new loans and new related securitywere originated in accordance with the seller’s lending criteria at the time oftheir origination. However, the seller retains the right to revise its lendingcriteria as determined from time to time, and so the lending criteriaapplicable to any loan at the time of its origination may not be or have beenthe same as those when other loans were originated.

If new loans thathave been originated under revised lending criteria are sold to the mortgagestrustee, the characteristics of the trust property could change. This couldlead to a delay or a reduction in the payments received on the issuer notes.

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**Theseller has adopted procedures relating to investigations and searches forremortgages which could affect the characteristics of the trust property andwhich may adversely affect payments on the issuer notes**

The seller doesnot require a solicitor, licensed conveyancer or (in Scotland) qualifiedconveyancer to conduct a full investigation of the title to a property in allcases. Where the borrower is remortgaging there will be a limited investigationto carry out some but not all of the searches and investigations which wouldnormally be carried out by a solicitor conducting a full investigation of thetitle to a property. Properties which have undergone such a limitedinvestigation may be subject to matters which would have been revealed by afull investigation of title and which may have been remedied or, if incapableof remedy, may have resulted in the properties not being accepted as securityfor a loan had such matters been revealed, though to mitigate against this risksearch indemnity insurance is obtained in respect of such properties. Theintroduction of loans secured by such properties into the trust property couldresult in a change of the characteristics of the trust property. This couldlead to a delay or a reduction in the payments received on the issuer notes.

**Thetiming and amount of payments on the loans could be affected by various factorswhich may adversely affect payments on the issuer notes**

The loans areaffected by credit, liquidity and interest rate risks. Various factorsinfluence mortgage delinquency rates, prepayment rates, repossession frequencyand the ultimate payment of interest and principal, such as changes in thenational or international economic climate, regional economic or housingconditions, changes in tax laws, interest rates, inflation, the availability offinancing, yields on alternative investments, political developments and governmentpolicies. Other factors in borrowers’ individual, personal or financialcircumstances may affect the ability of borrowers to repay loans. Loss ofearnings, illness, divorce and other similar factors may lead to an increase indelinquencies by and bankruptcies of borrowers, and could ultimately have anadverse impact on the ability of borrowers to repay loans.

If a borrowerfails to repay its loan and the related property is repossessed, the likelihoodof there being a net loss on disposition of the property is adversely affectedby a higher debt-to-value ratio. In addition, the ability of a borrower to sella property given as security for a loan at a price sufficient to repay theamounts outstanding under the loan will depend upon a number of factors,including the availability of buyers for that property, the value of thatproperty and property values in general at the time. As at January 1,2006, 2.88 per cent., of the loans had a loan-to-value ratio of at least 90 percent.

The portfolio mayalso be subject to geographic concentration risks. To the extent that specificgeographic regions within the United Kingdom have experienced or may experiencein the future weaker regional economic conditions and housing markets thanother regions, a concentration of the loans in such a region may be expected toexacerbate all of the risks relating to the loans described in this section.The economy of each geographic region within the United Kingdom is dependent ondifferent mixtures of industries. Any downturn in a local economy or particularindustry may adversely affect the regional employment levels and consequentlythe repayment ability of the borrowers in that region or the region that reliesmost heavily on that industry. Any natural disasters in a particular region mayreduce the value of affected mortgaged properties. This may result in a lossbeing incurred upon sale of the mortgaged property. These circumstances couldaffect receipts on the loans and ultimately result in losses on the issuernotes.

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Further, themortgage loan industry in the United Kingdom is highly competitive. Thiscompetitive environment may affect the rate at which the seller originates newloans and may also affect the level of attrition of the seller’s existingborrowers.

The principalsource of income for repayment of the issuer notes by the issuer is the issuerintercompany loan. The principal source of income for repayment by Funding 1 ofthe issuer intercompany loan is its interest in the loans held on trust by themortgages trustee for Funding 1 and the seller. If the timing and payment ofthe loans is adversely affected by any of the risks described in this section,then the payments on the issuer notes could be reduced or delayed.

**Theoccurrence of trigger events and enforcement of the issuer security mayadversely affect the scheduled redemption dates of the series 2 class A issuernotes, series 3 class A issuer notes, series 4 class A issuer notes and/orseries 5 class A issuer notes**

If no triggerevent has occurred and the issuer security has not been enforced in accordancewith the terms of the issuer deed of charge, then payments of principal willnot occur on the series 2 class A issuer notes, series 3 class A issuer notes,series 4 class A issuer notes and/or series 5 class A issuer notes before theirrespective scheduled redemption dates.

If a trigger eventoccurs or the issuer security is enforced in accordance with the issuer deed ofcharge prior to the scheduled redemption dates for the series 2 class A issuernotes, series 3 class A issuer notes, series 4 class A issuer notes and/orseries 5 class A issuer notes, then the relevant classes of issuer notesoutstanding will not be repaid on their scheduled redemption dates but will berepaid on each interest payment date from monies received from Funding 1 on theissuer term AAA advances of the corresponding series as described in thefollowing three risk factors.

**Ifan asset trigger event occurs, any series 2 class A issuer notes, series 3class A issuer notes, series 4 class A issuer notes and/or series 5 class Aissuer notes then outstanding will not be repaid on their scheduled redemptiondates**

When an assettrigger event has occurred, the mortgages trustee will distribute principalreceipts on the loans to Funding 1 and the seller proportionally and equallybased on their percentage shares of the trust property (that is, the Funding 1share percentage and the seller share percentage). When an asset trigger eventhas occurred, after making requisite payments to the Funding 1 liquidityfacility provider and replenishing the reserve funds, Funding 1 will repay:

*first,*the term AAA advances in respect of the issuer intercompany loan, the previousintercompany loans and any new intercompany loans, until each of those term AAAadvances is fully repaid;

*then,*the term AA advances in respect of the issuer intercompanyloan, the previous intercompany loans and any new intercompany loans, untileach of those term AA advances is fully repaid;

*then*,the term A advances in respect of the previous intercompany loans and any newintercompany loans, until each of those term A advances is fully repaid; and

 

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*then*,the term BBB advances in respect of the issuer intercompany loan, the previousintercompany loans and any new intercompany loans, until each of those term BBBadvances is fully repaid.

If an assettrigger event occurs, any series 2 class A issuer notes, series 3 class Aissuer notes, series 4 class A issuer notes and/or series 5 class A issuernotes then outstanding will not be repaid on their scheduled redemption dates,and there is also a risk that they will not be repaid by their final maturity dates.

**Ifa non-asset trigger event occurs, any series 2 class A issuer notes, series 3class A issuer notes, series 4 class A issuer notes and/or series 5 class Aissuer notes then outstanding will not be repaid on their scheduled redemptiondates**

If a non-assettrigger event has occurred but an asset trigger event has not occurred, themortgages trustee will distribute all principal receipts to Funding 1 until theFunding 1 share percentage of the trust property is zero. When a non-assettrigger event has occurred, after making requisite payments to the Funding 1liquidity facility provider and to replenish the reserve funds, Funding 1 willrepay:

*first*,the term AAA advance with the earliest final repayment date, then to repay theterm AAA advance with the next earliest final repayment date, and so on untilthe term AAA advances in respect of the issuer intercompany loan, the previousintercompany loans and any new intercompany loans are fully repaid;

*then*,the term AA advances in respect of the issuer intercompany loan, the previousissuer intercompany loans and any new intercompany loans, until each of thoseterm AA advances is fully repaid;

*then*,the term A advances in respect of the previous intercompany loans and any newintercompany loans, until each of those term A advances is fully repaid; and

*finally*,the term BBB advances in respect of the issuer intercompany loan, the previousissuer intercompany loans and any new intercompany loans, until each of thoseterm BBB advances is fully repaid.

If a non-assettrigger event occurs, any series 2 class A issuer notes, series 3 class Aissuer notes, series 4 class A issuer notes and/or series 5 class A issuernotes then outstanding will not be repaid on their scheduled redemption dates.

**Ifthe issuer security is enforced, any series 2 class A issuer notes, series 3class A issuer notes, series 4 class A issuer notes and/or series 5 class Aissuer notes then outstanding will not be repaid on their scheduled redemptiondates**

If the issuersecurity is enforced, then the mortgages trustee will distribute funds asrequired under the terms of the transaction agreements. In these circumstances,any series 2 class A issuer notes, series 3 class A issuer notes, series 4class A issuer notes and/or series 5 class A issuer notes then outstanding willnot be repaid on their scheduled redemption dates and there is also a risk thatthose class A issuer notes may not be repaid by their final maturity dates.

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**Loanssubject to further advances will be repurchased by the seller from themortgages trustee, which will affect the prepayment rate of the loans, and thismay affect the yield to maturity of the issuer notes**

If the seller atits discretion decides to grant a borrower a further advance under a loan whichhas been sold to the mortgages trustee, then the seller will be required torepurchase that loan under the relevant mortgage account and its relatedsecurity from the mortgages trustee save for any loan in arrears at a priceequal to the outstanding principal balance of those loans together with anyaccrued and unpaid interest and expenses to the date of purchase. The yield tomaturity of the issuer notes may be affected by the repurchase of loans subjectto further advances.

**Inlimited circumstances, loans subject to product switches will be repurchased bythe seller from the mortgages trustee, which will affect the prepayment rate ofthe loans, and this may affect the yield to maturity of the issuer notes**

Loans subject toproduct switches will not be repurchased unless on any distribution date, theseller is in breach of the conditions precedent to the sale of new loans to themortgages trustee. From and including that date to but excluding the date whenthose conditions precedent have been satisfied, the seller will be required torepurchase any loans and their related security that are subject to productswitches. The seller will be required to repurchase the relevant loan or loansunder the relevant mortgage account and their related security from themortgages trustee at a price equal to the outstanding principal balance ofthose loans together with accrued and unpaid interest and expenses to the dateof purchase.

A loan will besubject to a product switch if the borrower and the seller agree on or theservicer sends an offer of a variation in the financial terms and conditionsapplicable to the relevant borrower’s loan, other than:

·                  any variationagreed with a borrower to control or manage arrears on the loan;

·                  any variation tothe interest rate as a result of a borrower being linked to HVR 2;

·                  any variation inthe maturity date of the loan unless, while the issuer intercompany loan isoutstanding, it is extended beyond June 2040;

·                  any variationimposed by statute;

·                  any variation ofthe rate of interest payable in respect of the loan where that rate is offeredto the borrowers of more than 10 per cent. by outstanding principal amount ofloans in the trust property in any interest period; or

·                  any variation inthe frequency with which the interest payable in respect of the loan ischarged.

The yield tomaturity of the issuer notes may be affected by the repurchase of loans subjectto product switches.

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**Ratingsassigned to the issuer notes may be lowered or withdrawn after the noteholderspurchase the issuer notes, which may lower the market value of the issuer notes**

The ratingsassigned to each class of issuer notes address the likelihood of full andtimely payment to the noteholders of all payments of interest on each interestpayment date under those classes of issuer notes. The ratings also address thelikelihood of “ultimate’’ payment of principal on the final maturity date ofeach class of issuer notes. Any rating agency may lower its rating or withdrawits rating if, in the sole judgment of the rating agency, the credit quality ofthe issuer notes has declined or is in question. If any rating assigned to theissuer notes is lowered or withdrawn, the market value of the issuer notes maybe reduced. A change to the ratings assigned to a class of issuer notes willnot affect the rating designation of each issuer term advance in theintercompany loans.

**Principalpayments on the original pass-through term advances will be deferred in somecircumstances**

Principalrepayments on the issuer term AA advances and/or the issuer term BBB advanceswill be deferred in the following circumstances:

If on a Funding 1interest payment date:

·                  there is a debitbalance on the BBB principal deficiency sub-ledger, the A principal deficiencysub-ledger or the AA principal deficiency sub-ledger, after application of theFunding 1 available revenue receipts on that Funding 1 interest payment date;or

·                  the adjustedgeneral reserve fund level is less than the general reserve fund threshold; or

·                  the aggregateoutstanding principal balance of loans in the mortgages trust, in respect towhich the aggregate amount in arrears is more than three times the monthlypayment then due, is more than 5 per cent. of the aggregate outstandingprincipal balance of loans in the mortgages trust;

then to the extent thatany term AAA advance remains outstanding (whether or not such term AAA advanceis then due and payable) after the allocation of principal on that Funding 1interest payment date to those term advances, the issuer term AA advances andissuer term BBB advances will not be entitled to principal repayments until therelevant circumstance as described above has been remedied or otherwise ceasesto exist. In addition, if any term AA advance remains outstanding (whether ornot such term AA advance is then due and payable) after the allocation ofprincipal on that Funding 1 interest payment date to those term advances, theissuer term BBB advances will not be entitled to principal repayments until therelevant circumstances as described above have been remedied or otherwise ceaseto exist and if any term A advance remains outstanding (whether or not suchterm A advance is then due and payable) after the allocation of principal onthat Funding 1 interest payment date to those term advances, the issuer termBBB advance will not be entitled to principal repayments until the relevantcircumstances as described above have been remedied or otherwise cease toexist. This means that payments of principal on the class C issuer notes of allseries and, as applicable, the class B issuer notes of all series will bedeferred until the earlier of the time when the relevant circumstance describedin this risk factor has been remedied (if ever) and the final maturity date ofthe relevant issuer notes.

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Furthermore, if, on aFunding 1 interest payment date prior to the issuer step-up date:

·                  one or morebullet term advances and/or scheduled amortization installments are then in acash accumulation period; and

·                  the quarterlyCPR is less than 15 per cent.; and

·                  there is a cashaccumulation shortfall at that time;

then, on or before theirstep-up dates, the issuer term advances which are original pass-through termadvances will be entitled to principal repayments only to the extent permittedunder the pass- through repayment restrictions

**Series 2issuer notes, series 3 issuer notes, series 4 issuer notes and series 5 issuernotes may be subject to risk if the trust property deteriorates after repaymentof previous series of the issuer notes**

If the loanscomprising the trust property do not perform as expected at any time after therepayment of previous series of issuer notes, then the unpaid series of issuernotes will be adversely affected.

**Noteholdersmay be subject to risks relating to exchange rates on the issuer notes**

Repayments of principaland payments of interest on the series 2 issuer notes will be made in USdollars and on the series 3 issuer notes will be made in euro, but the issuerterm advances to be made by the issuer to Funding 1 and repayments of principaland payments of interest by Funding 1 to the issuer under the issuerintercompany loan will be in sterling.

To hedge itscurrency exchange rate exposure, including the interest rate exposure connectedwith that currency exposure, the issuer has entered into the issuer dollarcurrency swaps for the series 2 issuer notes with the issuer dollar currencyswap providers and the issuer euro currency swaps for the series 3 issuer noteswith the issuer euro currency swap provider.

If the issuerfails to make timely payments of amounts due or certain other events occur inrelation to the issuer under an issuer swap and any applicable grace period hasexpired then the issuer will have defaulted under that issuer swap. If theissuer defaults under an issuer swap due to non-payment or otherwise, therelevant issuer swap provider will not be obliged to make further paymentsunder that issuer swap and may terminate that issuer swap. If an issuer swapprovider is not obliged to make payments, or if it exercises any right toterminate that it may have under the relevant issuer swap, or if it defaults inits obligations to make payments of amounts in US dollars or euro, asapplicable, equal to the full amount to be paid by it on the payment datesunder the relevant issuer swap (which are the same dates as the interestpayment dates in respect of the issuer notes), the issuer will be exposed tochanges in US dollar/sterling or euro/sterling currency exchange rates and inthe associated interest rates on these currencies. Unless a replacement issuerswap is entered into, as a result of any adverse movements in the relevant spotexchange rates, the issuer may have insufficient funds to make payments due onthe issuer notes of any class and any series that are then outstanding.

Each issuer swapprovider will be obliged to gross up payments made by it to the issuer ifwithholding taxes are imposed on payments under the relevant issuer swap due toa change in law. However, if such a gross up is required, the relevant issuerswap provider may, subject to obtaining the consent of the security trustee(which, if certain conditions are satisfied, will not be withheld), terminatethe relevant issuer swap. If it does terminate the relevant issuer swap, the 

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issuer will be exposed to changes in currency exchangerates and in the associated interest rates on these currencies. Unless areplacement issuer swap is entered into, the issuer may have insufficient fundsto make payments due on the issuer notes of any class and any series that arethen outstanding.

**Themortgages trustee GIC provider or the Funding 1 GIC provider may cease tosatisfy certain criteria to provide the mortgages trustee GIC account or theFunding 1 GIC account**

The mortgagestrustee GIC provider and the Funding 1 GIC provider are required to satisfycertain criteria (including certain criteria and/or permissions set or requiredby the Financial Services Authority (the “FSA”) from time to time) in order tocontinue to receive deposits in the mortgages trustee GIC account and theFunding 1 GIC account respectively. If either the mortgages trustee GICprovider or the Funding 1 GIC provider ceases to satisfy those criteria thenthe relevant account may be transferred to another entity which does satisfythose criteria. In these circumstances the new GIC provider may not offer a GICon terms as favorable as those provided by the mortgages trustee GIC provideror the Funding 1 GIC provider.

The criteriareferred to above include a requirement that the short-term, unguaranteed andunsecured debt ratings of the mortgages trustee GIC provider or the Funding 1GIC provider, as the case may be, are at least A-1+ by Standard &Poor’s, F1+ by Fitch and P-1 by Moody’s, unless each rating agencyconfirms that its then current rating of the notes would not be adverselyaffected as a result of such ratings falling below these minimum ratings.

**Terminationpayments on the issuer swaps may adversely affect the funds available to makepayments on the issuer notes**

If any of theissuer swaps terminates, the issuer may as a result be obliged to make atermination payment to the relevant issuer swap provider. The amount of thetermination payment will be based on the cost of entering into a replacementissuer swap. Under the issuer intercompany loan agreement, Funding 1 will berequired to pay the issuer an amount equal to any termination payment due bythe issuer to the relevant issuer swap provider. Funding 1 will also be obligedto pay the issuer any extra amounts which it may be required to pay to enterinto a replacement swap.

The issuer cannotgive noteholders any assurance that Funding 1 will have the funds available tomake that payment or that the issuer will have sufficient funds available tomake any termination payment under any of the issuers’ issuer swaps or to makesubsequent payments to noteholders in respect of the relevant series and classof issuer notes. Nor can the issuer give noteholders any assurance that it willbe able to enter into a replacement issuer swap or, if one is entered into,that the credit rating of the replacement issuer swap provider will besufficiently high to prevent a downgrading of the then current ratings of theissuer notes by the rating agencies.

Except where therelevant issuer swap provider has caused the relevant issuer swap to terminateby its own default, any termination payment due by the issuer will rank equallynot only with payments due to the holders of the series and class of issuernotes which rank equally with the series and class of issuer notes to which therelevant issuer swap relates but also with payments due to the holders of anyother series and class of issuer notes which rank equally with the series andclass of issuer notes to which the relevant issuer swap relates. Any additionalamounts required to be paid by the issuer following termination of the relevantissuer swap 

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(including any extra costs incurred (for example, fromentering into “spot’’ currency transactions or interest rate swaps) if theissuer cannot immediately enter into a replacement swap) will also rank equallynot only with payments due to the holders of the series and class of issuernotes to which the relevant issuer swap relates but also with payments due tothe holder of any other series and class of issuer notes which rank equallywith the series and class of issuer notes to which the relevant issuer swaprelates. Furthermore, any termination payment or additional payment oradditional amounts required to be paid by the issuer following termination ofan issuer swap will rank ahead of payments due to the holders of any series andclass of issuer notes which ranks below the series and class of issuer notes towhich the relevant issuer swap relates. Therefore, if the issuer is obliged tomake a termination payment to the relevant issuer swap provider or to pay anyother additional amount as a result of the termination of the relevant issuerswap, this may affect the funds which the issuer has available to make paymentson the issuer notes of any class and any series.

**Risksassociated with the Funding 1 swap**

To provide a hedgeagainst (a) the mortgages trustee variable base rate payable on thevariable rate loans, the rates of interest payable on the tracker rate loansand the fixed rates of interest payable on the fixed rate loans; and (b) therate of interest payable by Funding 1 on the intercompany loans, Funding 1 hasentered into the Funding 1 swap agreement. If Funding 1 fails to make timelypayments under the Funding 1 swap, it will have defaulted under the Funding 1swap. The Funding 1 swap provider is obliged only to make payments under theFunding 1 swap if and for so long as Funding 1 makes payments under the same.If the Funding 1 swap provider is not obliged to make payments, or if itexercises any right to terminate that it may have under the Funding 1 swap, orif it defaults in its obligation to make payments under the Funding 1 swap,Funding 1 will be exposed to the variance between the rates of interest payableon the loans and the rate of interest payable by it under the intercompanyloans unless a replacement Funding 1 swap is entered into. If the Funding 1swap terminates, Funding 1 may as a result be obliged to make a terminationpayment to the Funding 1 swap provider. Any variance between the rates ofinterest payable on the loans and the rate of interest payable by Funding 1under the intercompany loans and any termination payment payable by it to theFunding 1 swap provider may adversely affect the ability of Funding 1 to meetits obligations under the issuer intercompany loan agreement.

Funding 1 willreceive interest receipts on the loans on one basis but will pay amounts underthe Funding 1 swap on another basis, thereby exposing it to some basis risk. Onthe one hand Funding 1 will receive interest on the variable rate loans basedon HVR 1 (which is the variable mortgage rate set by the seller applicableto certain loans beneficially owned by the seller on the seller’s residentialmortgage book), HVR 2 (which is the second variable base rate that wasmade available to borrowers between 1 March 2001 and 1 February 2002)or the Halifax flexible variable rate (which is the variable rate applicable toflexible loans). On the other hand the payment obligations of Funding 1 underthe Funding 1 swap will, among other things, be based on the average of thestandard variable mortgage rates or their equivalent charged to existingborrowers on residential mortgage loans as published from time to time, afterexcluding the highest and the lowest rate, of Abbey National plc, HSBC Bank plc,Cheltenham & Gloucester plc, National Westminster Bank Plc, NationwideBuilding Society, Northern Rock plc and Woolwich plc (and where those bankshave more than one standard variable rate, the highest of those rates). Whileit is anticipated that the average rate will broadly track both HVR 1, HVR 2and the Halifax flexible variable rate, the variance between the average rateand HVR 1, HVR 2 and the Halifax flexible variable rate, respectively, mayaffect the ability of Funding 1 to meet its payment obligations under theFunding 1 swap agreement.

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**Theissuer relies on third parties to perform services in relation to the issuernotes, and the noteholders may be adversely affected if they fail to performtheir obligations**

The issuer is aparty to contracts with a number of other third parties that have agreed toperform services in relation to the issuer notes. For example, the issuer swapproviders have agreed to provide their respective issuer swaps, the corporateservices provider has agreed to provide corporate services and the payingagents and the agent bank have agreed to provide payment and calculationservices in connection with the issuer notes. In the event that any of theseparties were to fail to perform their obligations under the respective agreementsto which they are a party, the noteholders may be adversely affected.

**Theissuer may be unable to pay, in full or at all, interest due on the issuernotes if there is an income or principal deficiency**

If, on any Funding1 interest payment date, revenue receipts available to Funding 1 (including thereserve funds) are insufficient to enable Funding 1 to pay interest on theissuer term advances, previous term advances and any new term advances andother expenses of Funding 1 ranking higher in seniority to interest due onthese term advances, then Funding 1 may use principal receipts on the loansreceived by it in the mortgages trust to make up the shortfall.

Funding 1 will useprincipal receipts that would have been applied to repay the term advances withthe lowest rating designation rating to pay interest on those other termadvances and senior expenses described in the preceding paragraph where thereis a shortfall of monies to pay those amounts. At the closing date, therelevant rating designation include the issuer term BBB advances. If Funding 1uses principal to repay interest and senior expenses in this manner, there willbe less principal available to repay the issuer term BBB advances and thecorresponding classes of issuer notes.

Funding 1 will beobliged to keep a ledger that records any principal applied to pay interest andsenior expenses (as well as any losses on the loans causing a principaldeficiency). When the amount recorded on the ledger is equal to the principalamount outstanding of the term BBB advances, then Funding 1 will use principalreceipts that would have been applied to repay the term advance with the nextlowest rating designation to pay interest on the term advances and seniorexpenses where there is a shortfall of money to pay those amounts. When theamount recorded on the principal deficiency ledger exceeds the principal amountoutstanding on the term A advances, Funding 1 will use principal receipts thatwould have been applied to repay the term AA advances to pay those amounts.When the amount recorded on the principal deficiency ledger exceeds theprincipal amount outstanding on the term AA advances, Funding 1 will useprincipal receipts that would have been applied to repay the term AAA advancesto pay those amounts.

During the term ofthe transaction, however, it is expected that any principal deficiencies ofthis sort will be recouped from subsequent excess revenue receipts and amountsstanding to the credit of the reserve funds. The revenue receipts will beapplied first to cover any principal deficiency in respect of the term advanceswith the highest rating designation and then the term advances with the nexthighest rating designation and so on down to the term advances with the lowestrating designation

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If there areinsufficient funds available because of revenue or principal deficiencies, thenone or more of the following consequences may occur:

·                  the interest andother net income of Funding 1 may not be sufficient, after making the paymentsto be made in priority, to pay, in full or at all, interest due on the issuerterm BBB advances and the issuer term AA advances;

·                  there may beinsufficient funds to repay the principal due and payable on any of the issuerterm BBB advances and the issuer term AA advances prior to their finalrepayment dates unless the other net income of Funding 1 is sufficient, aftermaking other prior ranking payments, to reduce any principal deficiency inrespect of the term BBB advances, term A advances and term AA advances;

·                  if the amount ofprincipal deficiencies exceeds the principal amount outstanding of any of theterm advances (and the principal deficiencies cannot be covered by the otherincome of Funding 1), then the issuer may not receive the full principal amountof any or all of the issuer term advances and, accordingly, noteholders may notreceive the full face value of the class C issuer notes, the class B issuernotes and the class A issuer notes, as the case may be; and/or

·                  the issuer maybe unable to pay, in full or at all, interest due on the issuer notes.

**Theseller share of the trust property does not provide credit enhancement for theissuer notes**

Any losses fromloans included in the trust property will be allocated to Funding 1 and theseller proportionally on each distribution date in accordance with the Funding1 share percentage and the seller share percentage of the trust property. Theseller’s share of the trust property therefore does not provide creditenhancement for the Funding 1 share of the trust property or the issuer notes.Losses on the loans in the portfolio are allocated proportionately between theseller and Funding 1 depending on their respective shares in the trustproperty.

**Theissuer will only have recourse to the seller if there is a breach of warrantyby the seller, but otherwise the seller’s assets will not be available to theissuer as a source of funds to make payments on the issuer notes**

After anintercompany loan acceleration notice under an intercompany loan is given thesecurity trustee may, but shall not be obliged to, sell the Funding 1 share ofthe trust property. There is no assurance that a buyer would be found or thatsuch a sale would realize enough money to repay amounts due and payable underthe issuer intercompany loan agreement.

The issuer,Funding 1 and the mortgages trustee will not, have any recourse to the sellerof the loans, other than in respect of a breach of warranty under the mortgagesale agreement.

The issuer,Funding 1, the mortgages trustee, and the security trustee will not, undertakeany investigations, searches or other actions on any loan or its relatedsecurity and each of them will rely instead on the warranties given in themortgage sale agreement by the seller.

If any of thewarranties made by the seller (a) in the case of each loan in theportfolio, was materially untrue on the date that loan was assigned to themortgages trustee or (b) in the case of each new loan, is materiallyuntrue on the date that new loan is assigned to the mortgages trustee, then theseller will be required to remedy the breach

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If the sellerfails to remedy the breach then the seller will be required to repurchase theloan or loans under the relevant mortgage account and their related security attheir outstanding principal balance as of the date of repurchase together withany arrears of interest and accrued and unpaid interest and expenses. There canbe no assurance that the seller will have the financial resources to repurchasethe loan or loans under the relevant mortgage account and their relatedsecurity. However, if the seller does not repurchase those loans and theirrelated security when required, then the seller’s share of the trust propertywill be deemed to be reduced by an amount equal to the principal amountoutstanding of those loans together with any arrears of interest and accruedand unpaid interest and expenses.

Other than asdescribed here, neither the noteholders nor the issuer has any recourse to theassets of the seller.

**Therecan be no assurance that a borrower will repay principal at the end of the termon an interest-only loan, which may adversely affect repayments on the issuernotes**

Each loan in theportfolio is repayable either on a principal repayment basis or aninterest-only basis. Of the loans in the portfolio as at January 1, 2006,approximately 31.97 per cent. were interest-only loans. For interest-onlyloans, because the principal is repaid in a lump sum at the maturity of theloan, the borrower is recommended to have some repayment mechanism (such as aninvestment plan) in place which is intended to provide sufficient funds torepay the principal at the end of the term. However, the seller does not ensurethat a repayment mechanism is in place in all cases and does not take securityover these repayment mechanisms. The borrower is also recommended to take out alife insurance policy in relation to the loan but, as with repaymentmechanisms, the seller does not take security over these life insurancepolicies.

The ability of aborrower to repay the principal on an interest-only loan at maturity depends onthe borrower ensuring that sufficient funds are available from an investmentplan or another source, such as ISAs, pension policies, personal equity plansor endowment policies, as well as the financial condition of the borrower, taxlaws and general economic conditions at the time.

There can be noassurance that the borrower will have the funds required to repay the principalat the end of the term. If a borrower cannot repay the loan and a loss occurson the loan, then this may affect repayments of principal on the issuer notesif that loss cannot be cured by application of excess Funding 1 availablerevenue receipts.

**Theremay be risks associated with the fact that the mortgages trustee has no legaltitle to the loans and their related security, which may adversely affectpayments on the issuer notes**

The sale by theseller to the mortgages trustee of the English mortgages will take effect inequity only. The sale by the seller to the mortgages trustee of the Scottishmortgages has been given effect by a Scottish declaration of trust by theseller (and any sale of Scottish mortgages on the closing date and in thefuture will be given effect by further Scottish declarations of trust) by whichthe beneficial interest in the Scottish mortgages has been or will betransferred to the mortgages trustee. In each case this means that legal titleto the loans in the trust property remains with the seller, but the mortgagestrustee has all the other rights and benefits relating to ownership of eachloan and its related security (which rights and benefits are subject to thetrust in favor of the beneficiaries). The mortgages trustee has the right todemand that the seller give it legal title to the loans and the related securityin certain circumstances and until then the mortgages trustee 

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will not give notice of the sale of the Englishmortgages to any borrower or apply to the Land Registry or the Central LandCharges Registry to register or record its equitable interest in the Englishmortgages or take any steps to complete or perfect its title to the Scottishmortgages.

Because themortgages trustee has not obtained legal title to the loans or their relatedsecurity, there are risks, as follows:

·                  first, if theseller wrongly sold a loan which has already been assigned to the mortgagestrustee to another person, and that person acted in good faith and did not havenotice of the interests of the mortgages trustee or the beneficiaries in theloan, then she or he might obtain good title to the loan, free from theinterests of the mortgages trustee and the beneficiaries. If this occurred thenthe mortgages trustee would not have good title to the affected loan and itsrelated security and it would not be entitled to payments by a borrower inrespect of that loan. This may affect the ability of the issuer to repay theissuer notes; and

·                  second, therights of the mortgages trustee and the beneficiaries may be subject to therights of the borrowers against the seller, such as the rights of set-off whichoccur in relation to transactions or deposits made between some borrowers andthe seller and the rights of borrowers to redeem their mortgages by repayingthe loan directly to the seller. If these rights were exercised, the mortgagestrustee may receive less money than anticipated from the loans, which mayaffect the ability of the issuer to repay the issuer notes.

However, if aborrower exercises any set-off rights, then an amount equal to the amount setoff will reduce the total amount of the seller share of the trust propertyonly, and the minimum seller share has been sized in an amount expected tocover this risk, although there is no assurance that it will. If the minimumseller share is exhausted, then the amount of any set-offs would be applied toreduce the Funding 1 share of the trust property.

**Independentset-off risks which a borrower has against the seller may adversely affect thefunds available to the issuer to repay the issuer notes**

Once notice hasbeen given to borrowers of the transfer of the loans and their related securityto the mortgages trustee, independent set-off rights which a borrower hasagainst the seller will crystallize (such as, for example, set-off rightsassociated with borrowers holding deposits with the seller) and further rightsof independent set-off would cease to accrue from that date and no new rightsof independent set-off could be asserted following that notice. Set-off rightsarising under transaction set-off (which are set-off claims arising out of atransaction connected with the loan) will not be affected by that notice. Theseset-off rights if exercised could reduce the loan receipts available to themortgages trustee to distribute to Funding 1, and could ultimately affect theamounts available to the issuer for payments on the issuer notes.

**Set-offrisks in relation to flexible loans and delayed cashbacks may adversely affectthe funds available to the issuer to repay the issuer notes**

The seller hasmade, and in the future may make, an equitable assignment of the relevant loansand their related security, or in the case of Scottish loans a transfer of thebeneficial interest in the relevant loans and their related security, to themortgages trustee, with legal title being retained by the seller. Therefore,the rights of the mortgages trustee may be subject to the direct rights of theborrowers against the seller, including rights of set-off existing prior tonotification

 

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to the borrowers of the sale of the mortgages. Themortgages trust includes flexible loans and delayed cashbacks. Set-off rights(including analogous rights in Scotland) may occur if the seller fails toadvance to a borrower a drawing or permit the borrower to make an underpaymentor to take a payment holiday under a flexible loan when the borrower isentitled to draw additional amounts or make an underpayment or take a paymentholiday under a flexible loan or if the seller fails to pay to a borrower any delayedcashback which the seller had agreed to pay to that borrower after completionof the relevant loan.

If the sellerfails to advance the drawing or permit the borrower to make an underpayment ortake a payment holiday or pay the delayed cashback, then the relevant borrowermay set off any damages claim (or exercise analogous rights in Scotland)arising from the seller’s breach of contract against the seller’s (and, asassignee or holder of the beneficial interest in the loans and their relatedsecurity, the mortgages trustee’s) claim for payment of principal and/orinterest under the loan as and when it becomes due. These set-off claims willconstitute transaction set-off as described in the immediately preceding riskfactor.

The amount of theclaim in respect of a drawing will, in many cases, be the cost to the borrowerof finding an alternative source of finance although, in the case of flexibleloans or delayed cashbacks which are Scottish, it is possible that the borrower’srights of set-off could extend to the full amount of the relevant drawing: theborrower may obtain a loan elsewhere in which case the damages would be equalto any difference in the borrowing costs together with any consequentiallosses, namely the associated costs of obtaining alternative funds (forexample, legal fees and survey fees). If the borrower is unable to obtain analternative loan, he or she may have a claim in respect of other losses arisingfrom the seller’s breach of contract where there are special circumstances communicatedby the borrower to the seller at the time the mortgage was taken out or whichotherwise were reasonably foreseeable. In either case, the damages claim willbe limited by general legal principles concerning remoteness of loss andmitigation. These include (i) the principle that something, which is areal possibility but would only occur in a small minority of cases, will notusually fall within the contractual measure of damages, and (ii) theborrower’s duty to mitigate his loss.

In respect of adelayed cashback, underpayment or payment holiday the claim is likely to be inan amount equal to the amount due under the delayed cashback together withinterest and expenses and consequential losses (if any).

A borrower mayalso attempt to set-off against his or her mortgage payments an amount greaterthan the amount of his or her damages claim (or exercise analogous rights inScotland). In that case, the seller will be entitled to take enforcementproceedings against the borrower although the period of non-payment by theborrower is likely to continue until a judgment is obtained.

The exercise ofset-off rights by borrowers would reduce the incoming cashflow to the mortgagestrustee during the exercise. However, the amounts set-off will be applied toreduce the seller share of the trust property only.

Further there maybe circumstances in which certain drawings may rank behind security created bya borrower after the date upon which the borrower entered into its mortgagewith the seller.

The minimum sellershare has been sized in an amount expected to cover this risk, although thereis no assurance that it will. If the minimum seller share is not sufficient inthis 

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respect then there is a risk that noteholders may notreceive all amounts due on the issuer notes or that payments may not be madewhen due.

**Ifthe servicer is removed, there is no guarantee that a substitute servicer wouldbe found, which could delay collection of payments on the loans and ultimatelycould adversely affect payments on the issuer notes**

The seller hasbeen appointed by the mortgages trustee and the beneficiaries as servicer toservice the loans. If the servicer breaches the terms of the servicingagreement, then the mortgages trustee, Funding 1 and/or the security trusteewill be entitled to terminate the appointment of the servicer and appoint a newservicer in its place.

There can be noassurance that a substitute servicer with sufficient experience ofadministering mortgages of residential properties would be found who would bewilling and able to service the loans on the terms of the servicing agreement.In addition, as described below, any substitute servicer will be required to beauthorized under the FSMA (as defined below) in order to administer loans thatconstitute regulated mortgage contracts. The ability of a substitute servicerfully to perform the required services would depend, among other things, on theinformation, software and records available at the time of the appointment. Anydelay or inability to appoint a substitute servicer may affect payments on theloans and hence the issuers ability to make payments when due on the issuernotes.

You should notethat the servicer has no obligation itself to advance payments that borrowersfail to make in a timely fashion.

**Funding1 may not receive the benefit of any claims made on the buildings insurancewhich could adversely affect payments on the issuer notes**

No assurance canbe given that Funding 1 will always receive the benefit of any claims madeunder any applicable insurance contracts. This could reduce the principalreceipts received by Funding 1 according to the Funding 1 share percentage andcould adversely affect the issuers ability to redeem the issuer notes. Thenoteholders should note that buildings insurance is renewed annually.

**If the issuer’sinterpretation of certain technical rules under the Consumer Credit Act(the “CCA”) were held to be incorrect by a court or the Ombudsman or waschallenged by a significant number of borrowers, or borrowers exercise rightsof set-off insofar as available under the CCA, there could be materialdisruption in the income from the mortgages trust**

In the UnitedKingdom, the Office of Fair Trading (the “OFT”) is responsible for the issue oflicenses under, and the superintendence of the working and the enforcement ofthe CCA, related consumer credit regulations and other consumer protectionlegislation. The OFT may review businesses and operations, provide guidelinesto follow and take actions when necessary with regard to the mortgage market inthe United Kingdom.

Currently, acredit agreement is regulated by the CCA where: (a) the borrower is orincludes an individual; (b) the amount of “credit” as defined in the CCAdoes not exceed the financial limit, which is £25,000 for credit agreementsmade on or after May 1, 1998, or lower amounts for credit agreements madebefore that date; and (c) the credit agreement is not an 

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exempt agreement under the CCA (for example, incertain circumstances, a credit agreement to finance the purchase of land is anexempt agreement under the CCA).

Any creditagreement that is wholly or partly regulated by the CCA or to be treated assuch has to comply with requirements under the CCA as to licensing of lendersand brokers, documentation and procedures of credit agreements, and (in so faras will be applicable) pre-contract disclosure. If it does not comply withthose requirements, then to the extent that the credit agreement is regulatedby the CCA or to be treated as such, it is unenforceable against the borrower: (a) withoutan order of the OFT, if the lender or any broker does not hold the requiredlicense at the relevant time; (b) totally, if the form to be signed by theborrower is not signed by the borrower personally or omits or mis-states a ‘‘prescribedterm’’; or (c) without a court order in other cases and, in exercising itsdiscretion whether to make the order, the court would take into account anyprejudice suffered by the borrower and any culpability of the lender.

Any creditagreement intended to be a regulated mortgage contract under the FinancialServices and Markets Act 2000 (the “FSMA”) (as described below) or unregulatedmight instead be wholly or partly regulated by the CCA or treated as suchbecause of technical rules on: (a) determining whether any creditunder the CCA arises, or whether the financial limit of the CCA is exceeded; (b) determiningwhether the credit agreement is an exempt agreement under the CCA; and (c) changesto credit agreements.

A court orderunder section 126 of the CCA is necessary to enforce a land mortgage securing acredit agreement to the extent that the credit agreement is regulated by theCCA or to be treated as such. In dealing with such application, the court hasthe power, if it appears just to do so, to amend the credit agreement or toimpose conditions upon its performance or to make a time order (for example,giving extra time for arrears to be cleared).

Under section 75of the CCA in certain circumstances: (a) the lender is liable to theborrower in relation to misrepresentation and breach of contract by a supplierin a transaction financed by the lender, where the related credit agreement isor is treated as entered into under pre-existing arrangements, or incontemplation of future arrangements, between the lender and the supplier; and (b) thelender has an indemnity from the supplier against such liability, subject toany agreement between the lender and the supplier.

The borrower mayset off the amount of the claim against the lender against the amount owing bythe borrower under a loan or under any other loan that the borrower has taken.Any such set-off may adversely affect the issuer’s ability to make payments onthe issuer notes.

**In December 2003, the DTIpublished a White Paper proposing amendments to the CCA and to secondarylegislation made under it.**

In June 2004,secondary legislation was made on: (a) amending requirements as todocumentation of credit agreements, coming into force on May 31, 2005, or August 31,2005 for agreements given to the borrower for signature but not made before May 31,2005; (b) pre-contract disclosure, coming into force on May 31, 2005;and (c) replacing the formula for calculating the maximum amount payableon early settlement with a formula more favorable to the borrower, coming intoforce on May 31, 2005 for new agreements or on May 31, 2007 or May 31,2010 (depending on the term of the agreement) for agreements existing before May 31,2005.

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In December 2004,the UK Parliament published a consumer Credit Bill proposing to amend the CCAby, among other things: (a) removing the financial limit for consumerlending and (b) repealing the rule that, to the extent that a creditagreement is regulated by the CCA or treated as such, it may be unenforceabletotally. Once these changes come into force, then any credit agreement made orchanged such that a new contract is entered into after this time, other than anexempt agreement under the CCA, will be regulated by the CCA. Such creditagreement will have to comply with requirements as described above and, if itdoes not comply, it will be unenforceable without an order of the OFT orwithout a court order as described above.

This consumer Credit Billalso proposed to amend the CCA by: (a) strengthening the licensing regime;(b) changing the grounds for challenging a credit agreement from “extortionatecredit bargain” to “unfair relationship” between the lender and the borrower,with retrospective effect on existing arrangements (and expressly imposingliability to repay the borrower on both the originator and any assignee, suchas the mortgages trustee); and (c) extending the jurisdiction of theOmbudsman (as described below) to license holders under the CCA. The ConsumerCredit Bill was enacted as the Consumer Credit Act 2006 on 30th March 2006.The resulting amendments to the CCA will come into force on such days as theSecretary of State for Trade and Industry may appoint. Further proposals toamend the CCA and secondary legislation made under it are expected at anunspecified time.

The seller hasinterpreted certain technical rules under the CCA in a way common withmany other lenders in the mortgage market. If such an interpretation were heldto be incorrect by a court or the Ombudsman, then a credit agreement, to theextent that it is regulated by the CCA or treated as such, would beunenforceable as described above. If such interpretation were challenged by asignificant number of borrowers, then this could lead to significant disruptionand shortfall in income of the mortgages trustee. Court decisions have beenmade on technical rules under the CCA against certain mortgage lenders,but such decisions are very few and are generally county court decisions notbinding on other courts.

**Failure by the seller orany servicer to hold relevant authorizations and permissions under FSMA inrelation to regulated mortgage contracts may have an adverse effect onenforceability of mortgage contracts**

In the UnitedKingdom, regulation of residential mortgage business by the FSA under theFinancial Services and Markets Act 2000 (the “FSMA”) came into force on October 31,2004, the date known as “N(M)”.****Enteringinto, arranging, advising on and administering regulated mortgage contracts,and agreeing to do any of these things,****are(subject to applicable exemptions) regulated activities under the FSMA.

A credit agreementis a regulated mortgage contract under the FSMA if, at the time it is enteredinto on or after N(M): (a) the borrower is an individual or trustee; (b) thecontract provides for the obligation of the borrower to repay to be secured bya first legal mortgage or, in Scotland, a first ranking standard security onland (other than timeshare accommodation) in the UK; and (c) at least 40per cent. of that land is used, or is intended to be used, as or in connectionwith a dwelling by the borrower or (in case of credit provided to trustees) byan individual who is a beneficiary of the trust, or by a related person.

The main effectsare that, on or after N(M), unless an exclusion or exemption applies: (a) eachentity carrying on a regulated mortgage activity by way of business has to holdauthorization and permission from the FSA to carry on that activity; and (b) generally,each financial promotion in respect of an agreement relating to a qualifyingcredit has to be issued or approved by a person 

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holding authorization and permission from the FSA. Ifrequirements as to authorization and permission of lenders and brokers or as toissue and approval of financial promotions are not complied with, a regulatedmortgage contract will be unenforceable against the borrower except with theapproval of a court. An unauthorized person who administers a regulatedmortgage contract entered into on or after N(M) may commit a criminaloffence, but this will not render the contract unenforceable against theborrower.

Any creditagreement intended to be a regulated mortgage contract under the FSMA mightinstead be wholly or partly regulated by the CCA or treated as such, orunregulated, and any credit agreement intended to be unregulated might insteadbe a regulated mortgage contract under the FSMA, because of technical rules on:(a) determining whether the credit agreement falls within the definitionof “regulated mortgage contract”; and (b) changes to credit agreements.

The seller isrequired to hold, and holds authorization and permission to enter into and toadminister and, where applicable, to advise on regulated mortgage contracts.Subject to any exemption, brokers will be required to hold authorization and permissionto arrange and, where applicable, to advise on regulated mortgage contracts.

The issuer andmortgages trustee are not and do not propose to be authorized persons under theFSMA. The issuer and mortgages trustee will not require authorization in orderto acquire legal or beneficial title to a regulated mortgage contract. Theissuer and mortgages trustee do not carry on the regulated activity ofadministering (servicing) mortgage contracts, because the loans are servicedpursuant to the servicing agreement by the servicer, which has the required FSAauthorization and permission. If the servicing agreement terminates, however,the issuer and mortgages trustee will have a period of not more than one monthin which to arrange for mortgage servicing to be carried out by a replacementservicer having the required FSA authorization and permission. In addition,from N(M) no variation has been or will be made to the loans, and nofurther advance or product switch has been or will be made in relation to a loan,where it will result in the issuer, Funding 1, Funding 2 or the mortgagestrustee arranging, or advising in respect of, administering (servicing) orentering into a regulated mortgage contract or agreeing to carry on any ofthese activities, if the issuer Funding 1, Funding 2 or the mortgages trusteewould be required to be authorized under the FSMA to do so.

**If a significant number of borrowers attempt toset off claims for damage based on contravention of an FSA rule againstthe amount owing by the borrower under a loan, there could be a materialdecrease in receipts to the issuer from the mortgages trust**

The FSA Mortgages:Conduct of Business Sourcebook (“MCOB”), which sets out its rules forregulated mortgage activities, came into force on October 31, 2004. These rules cover,inter alia, certain pre-origination matters, such as financial promotion andpre-application illustrations, pre-contract and start of contract andpost-contract disclosure, contract changes, charges and arrears andrepossessions. FSA rules for prudential and authorization requirements formortgage firms and insurance intermediaries, and for extending the appointedrepresentatives regime came into force on October 31, 2004 for mortgagesand on January 14, 2005 for general insurance.

A borrower who isa private person is entitled to claim damages for loss suffered as a result ofany contravention by an authorized person of an FSA rule, and may set-off theamount of the claim against the amount owing by the borrower under a loan or anyother loan that the borrower has taken (or exercise analogous rights inScotland). Any such set-off may adversely affect the issuer’s ability to makepayments on the issuer notes.

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So as to avoid dual regulation it is intended that regulated mortgagecontracts will not be regulated by the CCA, and relevant regulations under FSMAare designed to clarify the position in this regard. This exemption onlyaffects credit agreements made on or after N(M), and credit agreements madebefore N(M) but subsequently changed such that a new contract is enteredinto on or after N(M) and constitutes a regulated mortgage contract. A courtorder under section 126 of the CCA is, however, necessary to enforce a landmortgage securing a regulated mortgage contract that would, apart from thisexemption, be regulated by the CCA or be treated as such.

No assurance canbe given that additional regulations from the OFT, the FSA or any otherregulatory authority will not arise with regard to the mortgage market in theUnited Kingdom generally, the seller’s particular sector in that market orspecifically in relation to the seller. Any such action or developments orcompliance costs may have a material adverse effect on the seller, the issuer,the servicer, the mortgages trustee, Funding 1, Funding 2 and their respectivebusinesses and operations. This may adversely affect our ability to makepayments in full on the issuer notes when due.

The seller hasgiven or, as applicable, will give warranties to the mortgages trustee in themortgage sale agreement that, among other things, each loan and its relatedsecurity is enforceable (subject to certain exceptions). If a loan or itsrelated security does not comply with these warranties, and if the defaultcannot be or is not cured within 20 London business days, then the seller willbe required to repurchase the loans under the relevant mortgage account andtheir related security from the mortgages trustee.

Prior to N(M), in theUnited Kingdom, self-regulation of mortgage business existed under the MortgageCode (the “CML Code”) issued by the Council of Mortgage Lenders (the “CML”).Halifax subscribed to the CML Code and on and from N(M), as an authorizedperson, has been subject to the FSA requirements in MCOB. Membership of the CMLand compliance with the CML Code were voluntary. The CML Code sets out minimumstandards of good mortgage business practice, from marketing to lendingprocedures and dealing with borrowers experiencing financial difficulties.Since April 30, 1998 lender-subscribers to the CML Code may not acceptmortgage business introduced by intermediaries who were not registered with(before November 1, 2000 until October 31, 2004) the Mortgage CodeRegister of Intermediaries or (on and after November 1, 2000 until October 31,2004) the Mortgage Code Compliance Board. Complaints relating to breach of theCML Code were dealt with by the relevant scheme, such as the Banking OmbudsmanScheme or the Mortgage Code Arbitration Scheme.

**A new European Commissiondirective concerning consumer credit may, if adopted and implemented, have anadverse effect on enforceability of the loans**

In September 2002,the European Commission published a proposal for a directive of the EuropeanParliament and of the Council on consumer credit.

In Its originalform, the proposal applied to certain mortgage loan products. In July 2005,the European Commission published a Green Paper on mortgage credit in which itannounced its intention that loans secured by a land mortgage would be excludedfrom the proposed directive on consumer credit, but will be addressed by theGreen Paper process.

In October 2005,the European Commission published a further amended proposal for a directive onconsumer credit, which applies to loans not exceeding €50,000 (subject tocertain exceptions) but does not apply to loans secured by a land mortgage. Theproposed directive, which may be further substantially amended before it isbrought into effect, is unlikely to be 

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adopted before mid-2006 and member states willthen have a further two years in which to bring national implementinglegislation into force.

Until the finaltext of the directive is decided and the details of the United Kingdomimplementing legislation are published, it is not certain what effect theadoption and implementation of the directive would have on the seller, theissuer, the servicer, the mortgages trustee, Funding 1, Funding 2 and theirrespective businesses and operations. This may adversely affect the issuer’sability to make payments in full on the issuer notes when due.

**Under new distancemarketing regulations, some of the loans may be cancelable, which may have anadverse effect on the Issuer’s ability to make payments on the issuer notes**

The FinancialServices (Distance Marketing) Regulations 2004 apply to, among other things,credit agreements entered into on or after 31 October 2004 by means ofdistance communication (i.e. without any substantive simultaneous physicalpresence of the originator and the borrower). A regulated mortgage contractunder the FSMA, if originated by a UK lender from an establishment in theUnited Kingdom, will not be cancelable under these regulations. Certain othercredit agreements will be cancelable under these regulations if the borrowerdoes not receive prescribed information at the prescribed time. Where thecredit agreement is cancelable under these regulations, the borrower may sendnotice of cancellation at any time before the end of the fourteenth day afterthe day on which the cancelable agreement is made, where all the prescribedinformation has been received, or, if later, the borrower receives the last ofthe prescribed information.

Ifthe borrower cancels the credit agreement under these regulations, then:

(a)                                  theborrower is liable to repay the principal and any other sums paid by theoriginator to the borrower under or in relation to the cancelled agreement,within 30 days beginning with the day of the borrower sending notice ofcancellation or, if later, the originator receiving notice of cancellation;

(b)                                 theborrower is liable to pay interest, or any early repayment charge or othercharge for credit under the cancelled agreement, only if the borrower receivedcertain prescribed information at the prescribed time and if other conditionsare met; and

(c)                                  anysecurity provided in relation to the contract is to be treated as never havinghad effect.

If a significant portionof the loans in the mortgages trust are characterised as being cancellableunder these regulations, then there could be an adverse effect on the issuer’sreceipts in respect of the loans, affecting the issuer’s ability to makepayments on the issuer notes.

**Regulations in the UnitedKingdom could lead to some terms of the loans being unenforceable, which mayadversely affect payments on the issuer notes**

In the UnitedKingdom, the Unfair Terms in Consumer Contracts Regulations 1999 as amended(the “1999 Regulations”), which, together with (in so far as applicable) theUnfair Terms in Consumer Contracts Regulations 1994 (together with the 1999Regulations, the “UTCCR”), apply to agreements made on or after July 1,1995 and affect all or almost all of the loans, provide that:

·                  aconsumer may challenge a standard term in an agreement on the basis that it is “unfair”within the UTCCR and therefore not binding on the consumer; and

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·                  theOFT and any “qualifying body” within the UTCCR (such as the FSA) may seek toenjoin (or in Scotland interdict) a business from relying on unfair terms.

The UTCCR will notgenerally affect “core terms” which define the main subject matter of thecontract, such as the borrower’s obligation to repay the principal, but mayaffect terms that are not considered to be core terms, such as the lender’spower to vary the interest rate.

For example, if aterm permitting the lender to vary the interest rate (as the seller ispermitted to do) is found to be unfair, the borrower would not be liable to payinterest at the increased rate or, to the extent that the borrower has paid it,would be able, as against the lender, or any assignee such as the mortgagestrustee, to claim repayment of the extra interest amounts paid or to set-offthe amount of the claim against the amount owing by the borrower under the loanor any other loan that the borrower has taken. Any such non-recovery, claim or set-offmay adversely affect the issuer’s ability to make payments on the issuer notes.

In February 2000,the OFT issued a guidance note on what the OFT considers to be fair terms andunfair terms for interest variation in mortgage contracts. Where the interestvariation term does not provide for precise and immediate tracking of anexternal rate outside the lender’s control, and if the borrower is locked in,for example by an early repayment charge that is considered to be a penalty,the term is likely to be regarded as unfair under the UTCCR unless the lender (i) notifiesthe affected borrower in writing at least 30 days before the rate change and (ii) permitsthe affected borrower to repay the whole loan during the next three monthsafter the rate change, without paying the early repayment charge. The sellerhas reviewed the guidance note and has concluded that its compliance with itwill have no material adverse effect on the loans or its business. The guidancenote has been withdrawn from the OFT website and is currently under review bythe OFT and FSA, but may remain in effect as the OFT’s view and as a factorthat the FSA may take into account.

The FSA has agreedwith the OFT to take responsibility for the enforcement of the UTCCR inmortgage agreements. In May 2005, the FSA issued a statement of goodpractice on fairness of terms in consumer contracts which is relevant to firmsauthorized and regulated by the FSA in relation to products and services withinthe FSA’s regulatory scope. The statement provides that for locked-inborrowers, a lender may consider drafting the contract to permit a change inthe contract be made only where any lock-in clause is not exercised.

In August 2002,the Law Commission for England and Wales and the Scottish Law Commission issueda joint consultation LCCP No. 166/SLCDP 119 on proposals to rationalizethe UK’s Unfair Contract Terms Act 1977 and the 1999 Regulations into a singlepiece of legislation and a final report, together with a bill on unfair terms,was published in February 2005. It is not proposed that there should beany significant increase in the extent of controls over terms in consumercontracts. Some changes are proposed, however, such as that (a) a consumermay also challenge a negotiated term in agreement on the basis that it is “unfair”and “unreasonable” within the legislation and therefore not binding on theconsumer; and (b) in any challenge by a consumer (but not by the OFT or aqualifying body) of a standard term or a negotiated term, the burden of prooflies on the business to show that the term is fair and reasonable.

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No assurance canbe given that changes enacted in the 1999 Regulations, or any changes adoptedin guidance on interest variation terms, will not have a material adverseeffect on the seller, the issuer, the servicer, the mortgages trustee, Funding1, Funding 2 and their respective businesses and operations. This may adverselyaffect the issuer’s ability to make payments in full on the issuer notes whendue.

**Implementation of theUnfair Commercial Practices Directive**

In May 2005,the European Parliament and the Council adopted a directive on unfairbusiness-to-consumer commercial practices (the “Unfair Practices Directive”).Generally, this directive applies full harmonization, which means that memberstates may not impose more stringent provisions in the fields to which fullharmonization applies. By way of exception, this directive permits memberstates to impose more stringent provisions in the fields of financial servicesand immovable property, such as mortgage loans.

The UnfairPractices Directive provides that enforcement bodies may take administrativeaction or legal proceedings against a commercial practice on the basis that itis “unfair” within the directive. This directive is intended to protect onlycollective interests of consumers, and so is not intended to give any claim,defense or right of set-off to an individual consumer.

InDecember 2005, the DTI published a consultation paper on implementing theUnfair Practices Directive and amending existing consumer legislation. TheDirective must be transposed into UK law by June 12, 2007, and those lawsmust come into force in December 2007 in the UK and other member states.The implementing legislation will be subject to a transitional period until June 12,2013 for applying full harmonization in the fields to which it applies. It istoo early to predict what effect the implementation of the Unfair PracticesDirective would have on the loans.

**Decisionsof the Ombudsman could lead to some terms of the loans being varied, which mayadversely affect payments on the issuer notes**

Under FSMA, theFinancial Ombudsman Service is required to make decisions on, among otherthings, complaints relating to activities and transactions under its jurisdictionon the basis of what, in the Ombudsman’s opinion, would be fair and reasonablein all circumstances of the case, taking into account, among other things, lawand guidance. Transitional provisions exist pursuant to which certaincomplaints relating to breach of the CML Code occurring before N(M) may bedealt with by the Financial Ombudsman Service. Complaints brought before theFinancial Ombudsman Service for consideration must be decided on a case-by-casebasis, with reference to the particular facts of any individual case. Each casewould first be adjudicated by an adjudicator. Either party to the case mayappeal against the adjudication. In the event of an appeal, the case proceedsto a final decision by the Ombudsman.

In January 2002,the Ombudsman made a determination on the seller’s appeal to an earlierdecision by an adjudicator at the Financial Ombudsman Service concerning a caseinvolving HVR 1 and HVR 2. In March 2001, two joint borrowers with acapped rate loan originated when Halifax offered only a single standardvariable base rate contacted Halifax and requested that their loan be linked toHVR 2. Halifax informed the borrowers that, because they were still in theirproduct period, they could either transfer to HVR 2 when their product periodexpired or transfer to HVR 2 immediately and pay the applicable early repaymentfee. The borrowers complained to the Financial Ombudsman Service and, on January 29,2002, on appeal by Halifax, the Ombudsman determined in the borrowers’ favorand recommended that Halifax 

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recalculate the borrowers’ mortgage by reference toHVR 2 from the date when the seller should have granted their request in March 2001,refund any overpayments and pay £150 for any inconvenience caused. HVR 2 waswithdrawn and ceased to be available to new borrowers with effect from February 1,2002.

The Ombudsman’sdecision only applies to the two borrowers and their particular circumstances,though other borrowers may also complain to the Ombudsman. In March 2002,the seller announced that borrowers under loans who were in similarcircumstances and who had asked to be transferred to HVR 2 when it wasavailable would be invited to make a product switch to HVR 2 and to obtain arefund for all overpayments of interest since the date they had asked to betransferred. For each of those loans, the borrowers would also receive £150 forany inconvenience caused. The borrowers under loans who requested to betransferred after HVR 2 was withdrawn and before the announcement in March 2002were not offered a switch or a refund, though the seller has given or will giveeach of these customers an ex gratia payment of £100.

Since then,further decisions by the Ombudsman in similar cases have confirmed thataffected borrowers were only entitled to a refund of overpayments of interestfrom the date when they asked to be transferred to HVR 2 and not from the datewhen HVR 2 first became available, and also that affected borrowers were notentitled to apply to be transferred to HVR 2 after it was withdrawn.

The seller doesnot believe that any Ombudsman’s decision to date or any other decision by anycompetent authority in the future (in respect of the seller’s two variable baserates, HVR 1 and HVR 2) would affect the yield on the loans in such a way as tohave a material adverse effect on our ability to meet our obligations on theissuer notes.

As regards otherborrowers, in the event that a decision (in respect of the seller’s variablebase rate) by the Ombudsman or any other competent authority finds that aborrower’s loan should be linked to HVR 2, then that borrower may set-off theoverpaid sum against the amount owing under his or her loan if the seller doesnot reimburse that borrower. Any such non-recovery, claim or set-off ultimatelymay adversely affect the issuer’s ability to make payments on the issuer notes.

As the FinancialOmbudsman Service is required to make decisions on the basis of, among otherthings, the principles of fairness, it is not possible to predict how anyfuture decision of the Financial Ombudsman Service would affect the ability ofthe issuer to repay the issuer notes.

**Taxpayable by Funding 1 or the issuer may adversely affect the issuer’s ability tomake payments on the issuer notes**

Funding 1 and theissuer will generally be subject to UK corporation tax, currently at a rate of30 per cent., on the profit reflected in their respective profit and lossaccounts as increased by the amount of any non-deductible expenses or losses.If the tax payable by Funding 1 or the issuer is greater than expected because,for example, non-deductible expenses or losses are greater than expected, thefunds available to make payments on the noteholders’ issuer notes will bereduced and this may adversely affect the issuer’s ability to make payments onthe issuer notes.

The UK corporationtax position of the issuer and Funding 1, however, also depends to asignificant extent on the accounting treatment applicable to it. From January 1,2005, the accounts

 

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of the issuer are required to comply with new UKFinancial Reporting Standards reflecting International Financial ReportingStandards (new UK GAAP) or may be required to comply with InternationalFinancial Reporting Standards (“IFRS”) where the issuer chooses to adopt IFRS.Funding 1 may also choose to comply with new UK GAAP or IFRS. There is concernthat companies such as the issuer and Funding 1 might, under either IFRS or newUK GAAP, suffer timing differences that could result in profits or losses for accountingpurposes, and accordingly for tax purposes (unless tax legislation providesotherwise), which bear little or no relationship to the company’s cashposition. However, the Finance Act 2005 requires “securitisation companies” toprepare tax computations for accounting periods beginning on or after January 1,2005 and ending before January 1, 2007 on the basis of UK GAAP asapplicable up to December 31, 2004, notwithstanding the requirement toprepare statutory accounts under IFRS or new UK GAAP. The UK Government hasannounced, in the Pre-Budget Report on December 5, 2005, that the interimregime is to be extended for a further year to December 31, 2007. Theissuer and Funding 1 will each be a “securitisation company” for thesepurposes.

The stated policyof H.M. Revenue & Customs is that the tax neutrality of securitisationspecial purpose companies in general should not be disrupted as a result of thetransition to IFRS or new UK GAAP and that they are working with participantsin the securitisation industry to identify appropriate means of preventing anysuch disruption. The Finance Act 2005 enables regulations to be made toestablish such a regime. However, if measures are not introduced by H.M.Revenue & Customs to deal with the corporation tax position of suchcompanies in respect of accounting periods ending on or after December 31,2007, then profits or losses could arise in the issuer and/or Funding 1 as aresult of the application of IFRS or new UK GAAP which could have tax effectsnot contemplated in the cashflows for the transaction and as such adverselyaffect the issuer and/or Funding 1 and therefore payments on the issuer notes.

**Risksrelated to alternative characterization of the issuer notes as an equityinterest in the issuer for US federal income tax purposes**

The issuer is aspecial purpose company and will be passive. Under current US federal incometax law, the issuer is treated as an association that is taxable as acorporation for US federal income tax purposes. The characterization of theissuer notes as debt or equity for US federal income tax purposes depends onmany factors, including the form of such notes, the terms of the issuer notesand the debt-to-equity ratio of the issuer. Because the issuer may not havesubstantial equity, there is a risk that the United States Internal RevenueService (“IRS”) could assert that the lowest subordinated class of notes or anyother class of notes should be treated as an equity interest in the issuerrather than as debt for US federal income tax purposes. The issuer intends totreat the issuer notes as debt of the issuer for all purposes, including for USfederal income tax purposes.

**Noteholders’interests may be adversely affected by a change of law in relation towithholding tax**

In the event thatamounts due under the issuer notes are subject to withholding tax, the issuerwill not be obliged to pay additional amounts in relation thereto. The issuermay, in certain circumstances, redeem the issuer notes.

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**Noteholders’ interestsmay be adversely affected if the United Kingdom joins the European MonetaryUnion**

If the UnitedKingdom joins the European Monetary Union prior to the maturity of the issuernotes, investors cannot be assured that this would not adversely affectpayments on their issuer notes.

It is possiblethat prior to the maturity of the issuer notes the United Kingdom may become aparticipating member state in the European economic and monetary union and thatthe euro may become the lawful currency of the United Kingdom. In that event, (a) allamounts payable in respect of any issuer notes denominated in sterling maybecome payable in euro; (b) applicable provisions of law may allow orrequire the issuer to re-denominate such issuer notes into euro and takeadditional measures in respect of such issuer notes; and (c) theintroduction of the euro as the lawful currency of the United Kingdom mayresult in the disappearance of published or displayed rates for deposits inpounds sterling used to determine the rates of interest on such issuer notes orchanges in the way those rates are calculated, quoted and published ordisplayed. The introduction of the euro could also be accompanied by a volatileinterest rate environment, which could adversely affect a borrower’s ability torepay its loan as well as adversely affect investors. It cannot be said withcertainty what effect, if any, adoption of the euro by the United Kingdom willhave on investors in the issuer notes.

**Changes of law mayadversely affect noteholders’ interests**

The structure ofthe issue of the issuer notes and the ratings which are assigned to them arebased on English law and (in relation to the Scottish loans) Scots law ineffect as at the date of the prospectus. The issuer cannot provide assurance asto the impact of any possible change to English or Scots law or administrativepractice in the United Kingdom after the date of this Form 20-F.

*InsolvencyAct 2000*. Significant changes to the UK insolvency regimehave been enacted in recent years, including the Insolvency Act 2000. TheInsolvency Act 2000 allows certain “small” companies to seek protection fromtheir creditors for a period of 28 days, for the purposes of putting together acompany voluntary arrangement, with the option for creditors to extend themoratorium for a further two months. A “small” company is defined as one whichsatisfies, in any financial year, two or more of the following criteria: (i) itsturnover is not more than £5.6 million, (ii) its balance sheet total isnot more than £2.8 million and (iii) the number of employees is not morethan 50. Whether or not a company is a “small” company may change from periodto period and consequently no assurance can be given that the issuer, themortgages trustee or Funding 1 will not, at any given time, be determined to bea “small” company. The Secretary of State for Trade and Industry may byregulation modify the eligibility requirements for “small” companies and canmake different provisions for different cases. No assurance can be given thatany such modification or different provisions will not be detrimental to theinterests of the noteholders.

Secondarylegislation has now been enacted which excludes certain special purposecompanies in relation to capital markets transactions from the optionalmoratorium provisions. Such exceptions include (amongst other matters) (i) acompany which is a party to an agreement which is or forms part of a capitalmarket arrangement (as defined in the secondary legislation) under which (a) aparty has incurred or when the agreement was entered into was expected to incura debt of at least £10 million under the arrangement and (b) thearrangement involves the issue of a capital markets investment (also defined,but generally, a rated, listed or traded bond) and (ii) a company which atthe date of filing for a moratorium has incurred a liability (including apresent, future or contingent liability) of at least £10 million. While theissuer, the mortgages trustee and Funding 1 should fall within the exceptions,there is no guidance as to how the legislation will be interpreted and theSecretary of State for Trade and Industry may by regulation 

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modify the exception. No assurance may be given thatany modification of the eligibility requirements for “small” companies and/orthe exceptions will not be detrimental to the interests of the noteholders.

If the issuerand/or the mortgages trustee and/or Funding 1 is determined to be a “small”company and determined not to fall within one of the exceptions (by reason ofmodification of the exceptions or otherwise), then the enforcement of theissuer security by the security trustee may, for a period, be prohibited by theimposition of a moratorium.

*EnterpriseAct 2002*. On September 15, 2003, the corporateinsolvency provisions of the Enterprise Act 2002 came into force, amendingcertain provisions of the Insolvency Act 1986 (as amended, the “Insolvency Act”).These provisions introduced significant reforms to corporate insolvency law. Inparticular the reforms restrict the right of the holder of a floating chargecreated after September 15, 2003 to appoint an administrative receiver(unless an exception applies) and instead gives primacy to collectiveinsolvency procedures (in particular, administration).

The holder of afloating charge created before September 15, 2003 over the whole orsubstantially the whole of the assets of a company (such as the securitytrustee under the Funding 1 deed of charge) retains the ability to block theappointment of an administrator by appointing an administrative receiver, whowill primarily act in the interests of the floating charge holder.

The Insolvency Actcontains provisions that continue to allow for the appointment of anadministrative receiver in relation to certain transactions in the capitalmarkets. The relevant exception provides that the right to appoint anadministrative receiver is retained for certain types of security (such as theissuer security) that form part of a capital markets arrangement (as defined inthe Insolvency Act) that involves indebtedness of at least £50 million (or,when the relevant security document was entered into (being in respect of thetransactions described in the prospectus, relating to the issuer notes and theissued deed of charge), a party to the relevant transaction (such as theissuer) was expected to incur a debt of at least £50 million) and the issue ofa capital markets investment (also defined, but generally a rated, listed ortraded bond). The Secretary of State for Trade and Industry may, by secondarylegislation, modify the capital market exception and/or provide that theexception shall cease to have effect. No assurance can be given that any suchmodification or provision in respect of the capital market exception, or itsceasing to be applicable to the transactions described in this document willnot adversely affect payments on the issuer notes. In addition, as theprovisions of the Enterprise Act have never been considered judicially, noassurance can be given as to whether the Enterprise Act could have a detrimentaleffect on the interests of the noteholders.

The Insolvency Actalso contains a new out-of-court route into administration for a qualifyingfloating charge holder, the directors or the company itself. The relevantprovisions provide for a notice period during which the holder of the floatingcharge can either agree to the administrator proposed by the directors of thecompany or appoint an alternative administrator, although the moratorium willtake effect immediately after notice is given. If the qualifying floatingcharge holder does not respond to the directors’ notice of intention toappoint, the directors’, or as the case may be, the company’s appointee willautomatically take office after the notice period has elapsed. Where the holderof a qualifying floating charge within the context of a capital markettransaction retains the power to appoint an administrative receiver, suchholder may prevent the appointment of an administrator (either by the newout-of-court route or by the court based procedure), by appointing anadministrative receiver prior to the appointment of the administrator beingcompleted.

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The newadministration provisions of the Insolvency Act give primary emphasis to therescue of the company as a going concern. The purpose of realizing property tomake a distribution to one or more secured creditors is subordinated to theprimary purposes of rescuing the company as a going concern or achieving abetter result for the creditors as a whole than would be likely if the companywere wound up. No assurances can be given that the primary purposes of the newprovisions will not conflict with the interests of noteholders were the issuerever subject to administration.

In addition to theintroduction of a prohibition on the appointment of an administrative receiveras set out above, section 176A of the Insolvency Act provides that in relationto floating charges created after September 15, 2003 any receiver(including an administrative receiver), liquidator or administrator of acompany is required to make a “prescribed part” of the company’s “net property”available for the satisfaction of unsecured debts in priority to the claims ofthe floating charge holder. The company’s “net property” is defined as theamount of the chargor’s property which would be available for satisfaction ofdebts due to the holder(s) of any debentures secured by a floating chargeand so refers to any floating charge realizations less any amounts payable tothe preferential creditors or in respect of the expenses of the liquidation oradministration. The “prescribed part” is defined in The Insolvency Act 1986(Prescribed Part) Order 2003 (SI 2003/2097) to be an amount equal to 50 percent. of the first £10,000 of floating charge realizations plus 20 per cent. ofthe floating charge realizations thereafter, provided that such amount may notexceed £600,000.

This obligationdoes not apply if the net property is less than a prescribed minimum and therelevant officeholder is of the view that the cost of making a distribution tounsecured creditors would be disproportionate to the benefits. The relevantofficeholder may also apply to court for an order that the provisions ofsection 176A of the Insolvency Act should not apply on the basis that the costof making a distribution would be disproportionate to the benefits.

Floating chargerealizations upon the enforcement of the issuer security and the securitycreated by the second supplemental Funding 1 deed of charge may be reduced bythe operation of these “ring fencing” provisions.

**The noteholders will notreceive issuer notes in physical form, which may cause delays in distributionsand hamper the noteholders’ ability to pledge or resell the issuer notes**

Unless the globalissuer notes are exchanged for definitive issuer notes, which will only occurunder a limited set of circumstances, the noteholders’ beneficial ownership ofthe issuer notes will only be recorded in book-entry form with The DepositoryTrust Company (“DTC”), Euroclear or Clearstream, Luxembourg. The lack of issuernotes in physical form could, among other things:

·                  resultin payment delays on the issuer notes because the issuer will be sendingdistributions on the issuer notes to DTC, Euroclear or Clearstream, Luxembourginstead of directly to the noteholders;

·                  makeit difficult for the noteholders to pledge the issuer notes if issuer notes inphysical form are required by the party demanding the pledge; and

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·                  hinderthe noteholders’ ability to resell the issuer notes because some investors maybe unwilling to buy issuer notes that are not in physical form.

**If the noteholders have aclaim against the issuer it may be necessary for the noteholders to bring suitagainst the issuer in England to enforce the noteholders’ rights**

The issuer hasagreed to submit to the non-exclusive jurisdiction of the courts of England,and it may be necessary for noteholders to bring a suit in England to enforcetheir rights against the issuer.

**Implementation of theBasel II risk-weighted asset framework may result in changes to therisk-weighting of the issuer notes**

The BaselCommittee on Banking Supervision published the text of the new framework on June 26,2004 under the title “Basel II: International Convergence of CapitalMeasurement and Capital Standards: a Revised Framework”. This new framework(the “Basel II Framework”), which places enhanced emphasis on market disciplineand sensitivity to risk, is the basis for national rule-making and approvalprocesses to continue and for banking organizations to complete their preparationsfor implementation of the Basel II Framework. The Committee has suggested thatthe various approaches under the Basel II Framework will be implemented instages, some from year-end 2006, the most advanced at year-end 2007. Nationalimplementation dates may differ depending on the relevant implementationprocess. As and when implemented (including in respect of EU financialinstitutional investors, through the proposed EU Capital RequirementsDirective), the Basel II Framework could affect the risk-weighting of theissuer notes in respect of certain investors if those investors are subject tothe Basel II Framework following its implementation. Consequently, investorsshould consult their own advisers as to the consequences to and effect on themof the proposed implementation of the Basel II Framework. No predictions can bemade as to the precise effects of potential changes which might result upon theimplementation of the Basel II Framework.

The issuer may,under certain circumstances relating to the statutory implementation of theBasel II Framework in the United Kingdom, require investors to sell theirissuer notes or redeem their issuer notes.

**Item 4. Information on theCompany**

A.*            History and Development of the Company*

Not applicable.

B. *           Business Overview*

Not applicable.

C. *           OrganizationalStructure*

Not applicable.

D. *           Property, Plants andEquipment*

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The issuer

The property ofthe issuer consists primarily of its right to receive payments of interest andprincipal from Funding 1 on the various term advances made under the issuerintercompany loan agreement.

Funding 1

The property ofFunding 1 consists primarily of its interest in the trust property held by themortgages trustee (which entitles Funding 1 to receive certain payments ofprincipal and interest from the trust property according to the terms of themortgages trust deed) and amounts available under a reserve fund.

The mortgagestrustee

The trust propertyincludes the portfolio of loans and their related security assigned to themortgages trustee by the seller on June 14, 2002, and on severalsubsequent dates, any new loans and their new related security assigned to themortgages trustee by the seller after the closing date, any increase in theoutstanding principal balance of a loan due to the borrower taking paymentholidays or making underpayments under a loan or a borrower making a drawingunder any flexible loan, any interest, principal and other amounts (excludingthird party amounts) paid by borrowers on their loans and their related security,the rights under the insurance policies that are assigned to the mortgagestrustee or of which the mortgages trustee has the benefit, and amounts ondeposit and interest earned on the mortgages trustee guaranteed investmentcontract. Any actual losses in relation to the loans, any actual reductionsoccurring in respect of the loans and distributions of principal made from timeto time to the beneficiaries or the mortgages trust will be deducted from thetrust property. The composition of the trust property will fluctuate asdrawings under flexible loans and new loans are added, as borrowers takepayment holidays or make underpayments under a loan and as the loans that werepreviously part of the trust property are repaid, mature, default or are repurchasedby the seller.

**Item 5. Operating and FinancialReview and Prospects**

A.*            Operating Results*

Not applicable.

B. *           Liquidity and CapitalResources*

Not applicable.

C. *           Research andDevelopment, Patents and Licenses, etc.*

Not applicable.

D*.            Trend Information*

Not applicable.

E. *            Off-balance SheetArrangements*

Not applicable.

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F. *            Tabular Disclosure ofContractual Obligations*

Not applicable.

G*.            Safe Harbor*

Not applicable.

**Item 6. Directors, SeniorManagement and Employees**

A. *           Directors and SeniorManagement*

The following setsout the names, business addresses and business occupations of the directors ofthe issuer, Funding 1 and the mortgages trustee. Because each of the issuer,Funding 1 and the mortgages trustee is organized as a special purpose companyand will be largely passive, it is expected that the directors of each entityin that capacity will manage its operations to the extent necessary.

The issuer
| Name                                | ** ** | **Business Address**                                              | ** ** | **Business Occupation**                              |
|-------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------|
| SFM Directors  Limited              |       | 35 Great St. Helen’s  London  EC3A 6AP                       |       | Provision of directors to special purpose companies  |
| SFM Directors  (No. 2) Limited |       | 35 Great St. Helen’s  London  EC3A 6AP                       |       | Provision of directors  to special purpose companies |
| David Balai                         |       | HBOS Treasury Services  plc  33 Old Broad Street  London EC2N 1HZ |       | Director                                             |

 

Funding 1
| Name                                | ** ** | **Business Address**                                              | ** ** | **Business Occupation**                              |
|-------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------|
| SFM Directors  Limited              |       | 35 Great St. Helen’s  London  EC3A 6AP                       |       | Provision of directors to special purpose companies  |
| SFM Directors  (No. 2) Limited |       | 35 Great St. Helen’s  London  EC3A 6AP                       |       | Provision of directors  to special purpose companies |
| David Balai                         |       | HBOS Treasury Services  plc  33 Old Broad Street  London EC2N 1HZ |       | Director                                             |

 

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The mortgagestrustee
| Name                  | ** ** | **Business Address**                                              | ** ** | **Business Occupation** |
|-----------------------|------------|-------------------------------------------------------------------|------------|-------------------------|
| Michael George Best   |       | 47 Esplanade  St. Helier  Jersey JE1 0BD                          |       | Trust Company Director  |
| Peter John Richardson |       | 47 Esplanade  St. Helier  Jersey JE1 0BD                          |       | Trust Company Director  |
| David Balai           |       | HBOS Treasury Services  plc  33 Old Broad Street  London EC2N 1HZ |       | Director                |

 

David Balai is anemployee of a company in the same group of companies as the seller.

B.*           Compensation*

The issuer

In accordance withthe issuer corporate services agreement entered into between the issuer, theseller, the security trustee, the note trustee, Holdings and Structured FinanceManagement Limited (“SFM”), the seller and SFM will each provide directors andother corporate services for the issuer in consideration for a payment of aseparate fee payable by the issuer to SFM. No other remuneration is paid to anydirector or officer in connection with such director’s or officer’s activitieson behalf of the issuer.

Funding 1

In accordance withthe Funding 1 corporate services agreement entered into between Funding 1, theseller, the security trustee, the note trustee, Holdings, Permanent PECOHLimited, SFM, and SFM Corporate Services Limited (“SFM Corporate”), the sellerand SFM will each provide directors and SFM will provide other corporateservices for Funding 1 in consideration for a payment of a separate fee payableby Funding 1 to SFM. No other remuneration is paid to any director or officerin connection with such director’s or officer’s activities on behalf of Funding1.

The mortgagestrustee

In accordance withthe mortgages trustee corporate services agreement entered into between themortgages trustee, the security trustee, the note trustee and SFM OffshoreLimited (“SFM Offshore”), the seller and SFM Offshore will each providedirectors and SFM Offshore will provide other corporate services for themortgages trustee in consideration for a payment of a separate fee payable bythe mortgages trustee to SFM Offshore. No other remuneration is paid to anydirector or officer in connection with such director’s or officer’s activitieson behalf of the mortgages trustee.

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C.            *Board Practices*

Not applicable.

D.            *Employees*

None of theissuer, Funding 1 or the mortgages trustee has any employees.

E.             *Share Ownership*

Not applicable.

**Item 7. Major Shareholders andRelated Party Transactions**

A.            *Major Shareholders*

The issuer andFunding 1 are wholly owned by Permanent Holdings Limited, a companyincorporated under the laws of England and Wales. SFM Corporate holds all ofthe beneficial interest in the issued shares of Holdings on a discretionarytrust for the benefit of The National Society for the Prevention of Cruelty toChildren in the United Kingdom and for other charitable purposes.

SFM Offshore holdsall of the issued shares of the mortgages trustee in trust for charitable purposes.

Neither SFMCorporate nor SFM Offshore is affiliated with Halifax plc.

B.            *Related Party Transactions*

None, other thanwith respect to the making of payments in respect to the securities asdescribed in the Registration Statement and “Item 3.D — Risk Factors.”

C.            *Interests of Experts andCounsel*

Not applicable toannual reports filed on Form 20-F.

**Item 8. Financial Information**

For a discussionof the available financial information, see “Item 3.A — Selected FinancialInformation”.

The issuer,Funding 1 and the mortgages trustee know of no material legal or arbitrationproceedings involving their respective companies that may have significanteffects on the registrants’ financial position or profitability, includinggovernmental proceedings pending or known to be contemplated and any materialproceeding in which any director or affiliate is either a party adverse to aregistrant or has a material interest adverse to a registrant.

**Item 9. The Offer and Listing**

A.*           Offer and ListingDetails*

Not applicable.

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B. *           Plan of Distribution*

Not applicable toannual reports filed on Form 20-F.

C. *           Markets*

The principaltrading market for each class of the issuer notes is the London Stock Exchange.The issuer notes have been listed on the London Stock Exchange since March 23,2005.

D. *           Selling Shareholders*

Not applicable toannual reports filed on Form 20-F.

E. *            Dilution*

Not applicable toannual reports filed on Form 20-F.

F. *            Expenses of the Issue*

Not applicable toannual reports filed on Form 20-F.

**Item 10. Additional Information**

A. *           Share Capital*

Not applicable toannual reports filed on Form 20-F.

B. *           Memorandum and Articlesof Association*

The memorandum andarticles of association for each of the issuer, Funding 1 and the mortgagestrustee are incorporated by reference from the Registration Statement. Pleasealso see the description of the issuer, Funding 1 and the mortgages trustee setforth in the Registration Statement.

C.            *Material Contracts*

Not applicableother than with respect to contracts relating to the issuer notes, which weredescribed in the Registration Statement.

D. *           Exchange Controls*

None.

E. *            Taxation*

**UnitedKingdom Taxation**

The followingsection is a general description of certain UK tax consequences of thepurchase, ownership and disposition of the issuer notes based on current lawand practice in the UK.

 

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In relation to Funding, the summary assumes thatFunding does not draw up its accounts in accordance with UK GAAP reflectingInternational Financial Reporting Standards (**IFRS**)and that the profit in Funding 1’s profit and loss account will not exceed 0.01 percent. of the Funding 1 available revenue receipts.

The Issuer shouldbe regarded as a “securitisation company” for the purposes of section 83 of theFinance Act 2005. On the assumption that the Finance (No.2) Bill 2006 isenacted in its current form, the issuer will prepare its corporation taxreturns, for accounting periods ending before 1 January 2008, on the basisof UK GAAP as applicable up to 31 December 2004 (**OLD UK GAAP**),notwithstanding that the issuer’s actual accounts will be drawn up in accordancewith conformed UK GAAP reflecting IFRS or, if the issuer so elects, IFRS.Consequently, in relation to the issuer, the summary assumes that the profitwhich would be reflected in the issuer’s profit and loss account, were it to bedrawn up in accordance with Old UK GAAP, will not exceed 0.01 per cent. ofthe interest on the issuer term advances under the issuer intercompany loan andany interest earned by the issuer on its share capital proceeds.

The summaryfurther assumes that all payments made pursuant to the final documentation arecalculated on arm’s length terms. The summary does not purport to be a completeanalysis of all tax considerations of the purchase, ownership and dispositionof the issuer notes. It relates to the position of persons who are the absolutebeneficial owners of issuer notes and may not apply to certain classes ofpersons such as dealers or persons connected with the issuer. Noteholders whomay be subject to tax in a jurisdiction other than the UK or who may be unsureas to their tax position should seek their own professional advice.

**Taxationof US residents**

As discussed inmore detail below, no UK withholding tax will be required in relation tointerest payments on the issuer notes provided that the issuer notes are listedon a “recognised stock exchange”, which includes the London Stock Exchange. Ifthe issuer notes cease to be listed on a “recognised stock exchange”, an amountmust be withheld on account of UK income tax at the lower rate (currently 20per cent.), subject to any direction to the contrary from H.M. Revenue andCustoms (**HMRC**) in respect of such relief as maybe available pursuant to the provisions of an applicable double taxationtreaty.

Residents of theUS are generally not subject to tax in the UK on payments on the issuer notesunder the terms of the double taxation treaty between the US and the UK (the **Treaty**), subject to completion of administrativeformalities, except where the issuer notes are effectively connected with apermanent establishment or a fixed base of the noteholder situated in the UK orwhere the amounts paid on the issuer notes exceed the return on comparable debtinstruments, in which event the UK may tax the excess in accordance with UKdomestic law.

 Subject to the opinions set out in thepreceding paragraphs, as discussed in more detail under “—Direct assessment of non-UK resident holdersof the issuer notes to UK tax on interest” below, a noteholder who is residentin the US for US tax purposes and who is not resident in the UK for UK taxpurposes will not be subject to UK tax in respect of any payments on the issuernotes unless they are held by or for a trade, profession or vocation carried onby him through a branch or agency (or, in the case of a noteholder that is acompany, through a permanent establishment) in the UK.

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US resident noteholders will not be liable to UK tax in respect of adisposal of the issuer notes provided they are not within the charge to UKcorporation tax and (i) are not resident or ordinarily resident in the UK,and (ii) do not carry on a trade, profession or vocation through a branchor agency in connection with which interest is received or to which the issuernotes are attributable.

On the basis of the assumptions above, Funding 1 and the issuer willgenerally be subject to UK corporation tax, currently at a rate of 30 per cent,on the profit reflected in their respective applicable profit and loss accountsas increased by the amounts of any non-deductible expenses or losses.

The mortgages trustee will have no liability to UK tax in relation toamounts which it receives on behalf of Funding 1 or the seller under themortgages trust.

**Withholdingtax**

There will be noUK withholding tax in relation to interest payments on the issuer notesprovided that, so far as concerns deduction by the issuer or its paying agents,the issuer notes are listed on a “recognised stock exchange”, as defined insection 841 of the Income and Corporation Taxes Act 1988 (the **Taxes Act**). The London Stock Exchange is currently arecognised stock exchange for this purpose. Under HMRC practice, securitieswill be listed on the London Stock Exchange if they are admitted to theOfficial List by the UK Listing Authority and admitted to trading on the LondonStock Exchange. If the issuer notes cease to be listed on a “recognised stockexchange”, an amount must generally be withheld on account of UK income tax atthe lower rate (currently 20 per cent.) from interest paid on them, subject toany direction to the contrary by HMRC in respect of such relief as may beavailable pursuant to the provisions of an applicable double taxation treaty orto the interest being paid to persons (including companies within the charge toUK corporation tax) and in circumstances specified in section 349A to 349D of theTaxes Act.

Noteholders who areindividuals may wish to note that HMRC has power to obtain information(including the name and address of the beneficial owner of the interest) fromany person in the UK who either pays interest to, or receives interest for thebenefit of, an individual. Information so obtained may, in certaincircumstances, be exchanged by HMRC with the tax authorities of otherjurisdictions.

**Directassessment of non-UK resident holders of the issuer notes to UK tax on interest**

Interest on theissuer notes has a UK source. Accordingly, payments of interest on the issuernotes will in principle be within the charge to UK tax even if paid withoutwithholding or deduction. However, other than where the provisions of theTreaty apply to allow certain interest paid to residents of the US to be taxedin the UK, such payments will not be chargeable to UK tax in the hands of anoteholder (other than certain trustees) who is not resident for tax purposesin the UK unless such noteholder carries on a trade, profession or vocationthrough a branch or agency (or, in the case of a noteholder which is a companywhich carries on a trade through a permanent establishment) in the UK inconnection with which the payments are received or to which the issuer notesare attributable, in which case (subject to exemptions for interest received bycertain categories of agent such as some brokers and investment managers) taxmay be levied on the UK branch or agency or permanent establishment. Theprovisions of an applicable double taxation treaty may also be relevant in suchcircumstances.

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**Taxationof returns: companies within the charge to UK corporation tax**

Ingeneral, noteholders who are within the charge to UK corporation tax (otherthan authorized unit trusts) will normally be subject to tax on all profits andgains, including interest and profit and gains attributable to currencyfluctuations, arising on or in connection with the issuer notes under the loanrelationship rules. Any such profits and gains will generally fall to becalculated in accordance with the statutory accounting treatment of the issuernotes in the hands of the relevant noteholder. Relief may be available inrespect of losses or for related expenses on a similar basis.

**Taxationof returns: other noteholders**

Noteholders who are not within the charge to UK corporation tax and whoare resident or ordinarily resident in the UK for tax purposes or who carry ona trade, profession or vocation in the UK through a branch or agency inconnection with which interest on the issuer notes is received or to which theissuer notes are attributable will generally be liable to UK tax on the amountof any interest received in respect of the issuer notes.

A disposal of issuer notes which are not regarded by HMRC asconstituting “qualifying corporate bonds” (**QCBs**) withinthe meaning of section 117 of the Taxation of Chargeable Gains Act 1992 (**TCGA**) may give rise to a chargeable gain or an allowableloss for the purpose of the UK taxation of chargeable gains.

A disposal of issuer notes which are regarded byHMRC as constituting QCBs within the meaning of section 117 of the TCGA are notexpected to give rise to a chargeable gain or an allowable loss for thepurpose of the UK taxation of chargeable gains.

A disposal of the issuer notes by such noteholders as described abovemay also give rise to a charge to tax on income in respect of an amountrepresenting interest accrued on the issuer notes since the preceding paymentdate. For the issuer notes which constitute variable rate securities, taxationin respect of such a disposal will be computed on the basis that such amount asHMRC considers to be just and reasonable will be treated as accrued income.However, the transferee of a variable rate security will not be entitled to anyrelief on such amount.

**Stampduty and stamp duty reserve tax**

No UK stamp dutyor stamp duty reserve tax is payable on the issue or transfer of the offeredglobal issuer notes or on the issue or transfer of definitive issuer notes.

**UKtaxation of Funding 1 and the issuer**

On the basis ofthe assumptions above, Funding 1 and the issuer will generally be subject to UKcorporation tax, currently at a rate of 30 per cent., on the profitreflected in the respective applicable profit and loss accounts as increased bythe amounts of any non-deductible expenses or losses. In respect of Funding 1,the profit in the profit and loss account will not exceed 0.01 per cent.of the Funding 1 available revenue receipts. In respect of the issuer, theprofit in the profit and loss account drawn up in accordance with Old UK GAAPwill not exceed 0.01 per cent. of the interest on the issuer term advancesunder the issuer intercompany loan and any interest earned by the issuer on itsShare Capital proceeds.

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**UKtaxation of the mortgages trustee**

The mortgagestrustee will have no liability to UK tax in respect of any income, profit orgain arising under these arrangements. Accordingly, the mortgages trustee willhave no liability to UK tax in relation to amounts that it receives on behalfof Funding 1 or the seller under the mortgages trust.

**EUSavings Tax Directive**

Under the EuropeanCouncil Directive 2003/48/EC on the taxation of savings income, each MemberState of the European Union is required, from 1July 2005, to provide to the taxauthorities of another Member State details of payments of interest (or similarincome) paid by a person within its jurisdiction to an individual resident inthat other Member State. However, for a transitional period, Belgium,Luxembourg and Austria are instead required (unless during that period theyelect otherwise) to operate a withholding system in relation to such payments(the ending of such transitional period being dependent upon the conclusion ofcertain other agreements relating to information exchange with certain othercountries). A number of non-European Union countries and territories, includingSwitzerland, have agreed to adopt similar measures (a withholding system in thecase of Switzerland) with effect from the same date.

As part of anagreement reached in connection with the EU Savings Directive on the taxationof savings income in the form of interest payments, in line with steps taken byother relevant third countries. Jersey introduced, with effect from July 1,2005, a retention tax system in respect of payments of interest, or othersimilar income, made to an individual beneficial owner resident in an EU MemberState by a paying agent situated in Jersey (the terms “beneficial owner” and “payingagent” for this purpose are as defined in the EU Savings Tax Directive). Theretention tax system applies for a transitional period prior to theimplementation of a system of automatic communication to EU Member States ofinformation regarding such payments. During this transitional period, such anindividual beneficial owner resident in an EU Member State would be entitled torequest a paying agent not to retain tax from such payments but instead toapply a system by which the details of such payments are communicated to thetax authorities of the EU Member State in which the beneficial owner isresident.

**UnitedStates Federal Income Taxation**

The followingsection summarizes the material US federal income tax consequences of thepurchase, ownership and disposition of the series 2 issuer notes (the “US notes”).In general, the summary assumes that a holder acquires the US notes atoriginal issuance and holds the US notes as capital assets. It does not purportto be a comprehensive description of all the tax considerations thatmay be relevant to a decision to purchase the US notes. In particular, itdoes not discuss special tax considerations that may apply to certaintypes of taxpayers, including, without limitation, the following: (i) financialinstitutions; (ii) insurance companies; (iii) dealers or traders instocks, securities, notional principal contracts or currencies; (iv) tax-exemptentities; (v) regulated investment companies; (vi) persons that willhold the US notes as part of a “hedging” or “conversion” transaction or as aposition in a “straddle” for US federal income tax purposes; (vii) personsthat own (or are deemed to own) 10 per cent. or more of the voting shares ofthe issuer; (viii) persons who hold US notes through partnerships or otherpass-through entities; and (ix) persons that have a “functional currency”other than the US dollar. In addition, this summary does not addressalternative minimum tax consequences, nor does it describe any tax consequencesarising under the laws of any taxing jurisdiction other than the USfederal government.

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This summary isbased on the US Internal Revenue Code of 1986, as amended (the “Code”), USTreasury regulations and judicial and administrative interpretations thereof,in each case as in effect or available on the date of filing of this Form 20-F.All of the foregoing are subject to change, and any change may applyretroactively and could affect the tax consequences described below.

**Investorsshould consult their own tax advisors as to the personal US federal income taxconsequences of the purchase, ownership and disposition of the US notes,including the possible application of state, local, non-US or other tax laws,and other US tax issues affecting the transaction.**

As used in thissection, the term “United States holder” means a beneficial owner of US notesthat is for US federal income tax purposes: (i) a citizen or residentof the United States; (ii) a corporation (or other entity treated as acorporation) or partnership, created or organized in or under the laws of theUnited States or any state thereof (including the District of Columbia); (iii) anyestate the income of which is subject to US federal income tax regardless ofthe source of its income; or (iv) any trust if a court within the UnitedStates is able to exercise primary supervision over the administration of thetrust and one or more United States persons have the authority to control allsubstantial decisions of the trust. If a partnership holds US notes, the taxtreatment of a partner will generally depend upon the status of the partner andupon the activities of the partnership. Partners of partnerships holding USnotes should consult their own tax advisers regarding the personal taxconsequences to them. A “Non-United States holder” is a beneficial owner of USnotes that is not a United States holder.

**Taxstatus of the issuer, Funding 1, the mortgages trustee and the mortgages trust**

Each of theissuer, Funding 1 and the mortgages trustee acting it its capacity as trusteeof the mortgages trust covenants not to engage in any activities in the UnitedStates (directly or through agents), not to derive any income from sourceswithin the United States as determined under US federal income tax principles,and not to hold any property if doing so would cause it to be engaged or deemedto be engaged in a trade or business within the United States as determinedunder US federal income tax principles. Assuming compliance with thesecovenants, none of the issuer, Funding 1 or the mortgages trustee acting in itscapacity as trustee of the mortgages trust will be subject to US federal incometax. No elections will be made to treat the issuer, Funding 1 or the mortgagestrustee or any of their assets as a REMIC (a type of securitisation vehiclehaving a special tax status under the Code).

**Characterization****of the US notes**

Although there isno authority regarding the treatment of instruments that are substantiallysimilar to the US notes, and while it is not free from doubt, the issuerbelieves that the US notes will be treated as debt for US federal income taxpurposes. The issuer intends to treat the US notes as indebtedness of theissuer for all purposes, including US tax purposes. The discussion in the nextsection assumes this result.

The US notes willnot be qualifying real property loans in the hands of domestic savings and loanassociations, real estate investment trusts, or REMICs under sections7701(a)(19)(C), 856(c) or 860G(a)(3) of the Code, respectively.

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**Taxationof United States holders of the US notes**

*QualifiedStated Interest and Original Issue Discount.*The issuerintends to treat interest on the US notes as “qualified stated interest” underUS Treasury regulations relating to original issue discount (hereafter the “OIDregulations”). As a consequence, discount on the US notes arising from anissuance at less than par will only be required to be accrued under the OIDregulations if such discount exceeds a statutorily defined *de minimis*amount. Qualified stated interest, which generally must be unconditionallypayable at least annually, is taxed under a holder’s normal method ofaccounting as ordinary interest income. *Deminimis* original issue discount (“OID”) is included in income on a *pro rata* basis as principal payments are made on the USnotes.

It is possiblethat interest on the US notes that are class B and class C issuer notes couldbe treated as OID because such interest is subject to deferral in certainlimited circumstances. A United States holder of a US note issued with OID mustinclude OID in income over the term of such US note under a constant yieldmethod that takes into account the compounding of interest. Under the Code, OIDis calculated and accrued using prepayment assumptions where payments on a debtinstrument may be accelerated by reason of prepayments of other obligationssecuring such debt instrument. Moreover, the legislative history to theprovisions provide that the same prepayment assumptions used to price a debtinstrument be used to calculate OID, as well as to accrue market discount andamortize premium. Here, prepayment of the mortgage loans is not expected toalter the scheduled principal payments on the US notes that are class B andclass C issuer notes and, accordingly, the issuer intends to assume that such CUS notes will have their principal repaid according to the schedule forpurposes of accruing any OID. No representation is made that the mortgage loanswill pay on the basis of such prepayment assumption or in accordance with anyother prepayment scenario.

As an alternativeto the above treatments, United States holders may elect to include in grossincome all interest with respect to the class B and class C US notes, includingstated interest, acquisition discount, OID, *de minimis* OID,market discount, *de minimis* market discount, andunstated interest, as adjusted by any amortizable bond premium or acquisitionpremium, using the constant yield method described above.

Interest income onthe US notes will be treated as foreign source income for US federal income taxpurposes, which may be relevant in calculating a United States holder’s foreigntax credit limitation for US federal income tax purposes. The limitation onforeign taxes eligible for the US foreign tax credit is calculated separatelywith respect to specific classes of income. The foreign tax credit rules arecomplex, and United States holders should consult their own tax advisersregarding the availability of a foreign tax credit and the application of thelimitation in their particular circumstances.

*Sales andRetirement.* In general, a United States holder of a US notewill have a basis in such US note equal to the cost of the US note to suchholder, and reduced by any payments thereon other than payments of statedinterest. Upon a sale or exchange of the US note, a United States holder willgenerally recognize gain or loss equal to the difference between the amountrealized (less any accrued interest, which would be taxable as such) and theholder’s tax basis in the US note. Such gain or loss will be long-term capitalgain or loss if the United States holder has held the US note for more than oneyear at the time of disposition. **Investors should consulttheir own tax advisors with respect to the treatment of capital gains (whichmay be taxed at lower rates than ordinary income for taxpayers who areindividuals, trusts or estates that**

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**hold the US notes for more than one year) andcapital losses (the deductibility of which is subject to limitations) forinvestors as a consequence of an investment in the issuer notes.**

**Taxationof Non-United States holders of the US Notes**

Subject to thebackup withholding rules discussed below, a Non-United States holdergenerally should not be subject to US federal income or withholding tax on anypayments on a US note and gain from the sale, redemption or other dispositionof a US note unless: (i) that payment and/or gain is effectively connectedwith the conduct by that Non-United States holder of a trade or business in theUnited States; (ii) in the case of any gain realized on the sale orexchange of a US note by an individual Non-United States holder, that holder ispresent in the United States for 183 days or more in the taxable year of thesale, exchange or retirement and certain other conditions are met; or (iii) theNon-United States holder is subject to tax pursuant to provisions of the Codeapplicable to certain expatriates. **Non-United States holdersshould consult their own tax advisors regarding the US federal income and othertax consequences of owning US notes.**

**Alternativecharacterization of the US notes**

The propercharacterization of the arrangement involving the issuer and the holders of theUS notes is not clear because there is no authority on transactions comparableto that contemplated herein. The issuer intends to treat the US notes as debtfor all US federal income tax purposes. Investors should consult their own taxadvisors with respect to the potential impact of an alternativecharacterization of the US notes for US tax purposes.

One possiblealternative characterization is that the US Internal Revenue Service (“IRS”)could assert that the class C or any other class of US notes should be treatedas equity in the issuer for US federal income tax purposes because the issuermay not have substantial equity. If the class C or any other class of US noteswere treated as equity, United States holders of such notes would be treated asowning equity in a passive foreign investment company (“PFIC”) which, dependingon the level of ownership of such United States holder and certain other factors,might also constitute an interest in a controlled foreign corporation (“CFC”)for such United States holder. A US note that is treated as an equity interestin a PFIC or CFC rather than a debt instrument would have certain timing andcharacter consequences to a United States holder and could require certainelections and disclosures that would need to be made shortly after acquisitionto avoid potentially adverse US tax consequences.

If a United Statesholder were treated as owning an equity interest in a PFIC, unless a UnitedStates holder makes a “QEF election” or “mark to market election”, a UnitedStates holder will be subject to a special tax regime (i) in respect ofgains realized on the sale or other disposition of the relevant notes, and (ii) inrespect of distributions on the relevant notes held for more than one taxableyear to the extent those distributions constitute “excess distributions”.Although not free from doubt, the PFIC rules should not apply to gainrealized in respect of any notes disposed of during the same taxable year inwhich such notes are acquired. An excess distribution generally includesdividends or other distributions received from a PFIC in any taxable year tothe extent the amount of such distributions exceeds 125 per cent. of theaverage distributions for the three preceding years (or, if shorter, theinvestor’s holding period). Because the US notes pay interest at a floatingrate, it is possible that a US holder will receive “excess distributions” as aresult of fluctuations in the rate of USD-LIBOR over the term of the US notes.In general, under PFIC rules, a United States holder will be required toallocate such excess distributions and any gain realized on a sale of its notesto each day during the United States 

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holder’s holding period for the notes, and will betaxable at the highest rate of taxation applicable to the notes for the year towhich the excess distribution or gain is allocable (without regard to theUnited States holder’s other items of income and loss for such taxable year)(the “deferred tax”). The deferred tax (other than the tax on amounts allocableto the year of disposition or receipt of the distribution) will then beincreased by an interest charge computed by reference to the rate generallyapplicable to underpayments of tax (which interest charge generally will benon-deductible interest expense for individual taxpayers).

The issuer doesnot intent to provide information that would enable a holder of a US note tomake a QEF election, and the mark to market election will only be availableduring any period in which the US notes are traded on a qualifying exchange ormarket. The issuer encourages persons considering the purchase or ownership of10 per cent., or more of any class of US notes (or combination of classes) thatis treated as equity for US federal income tax purposes to consult their owntax advisors regarding the personal US tax consequences resulting from such anacquisition under the special rules applicable to CFCs under the code.

**Backupwithholding and information reporting**

Backup withholding and information reporting requirements may apply tocertain payments on the US notes and proceeds of the sale or redemption of theUS notes to United States holders. The issuer, its agent, a broker, orany paying agent, as the case may be, may be required to withhold tax from anypayment that is subject to backup withholding if the United States holder failsto furnish the United States holder’s taxpayer identification number (usuallyon IRS Form W-9), to certify that such United States holder is notsubject to backup withholding, or to otherwise comply with the applicablerequirements of the backup withholding rules. Certain United States holders (including, among others,corporations) are not subject to the backup withholding and informationreporting requirements. Non-United States holders may be required to complywith applicable certification procedures (usually on IRS Form W-8BEN)to establish that they are not United States holders in order to avoid theapplication of such information reporting requirements and backup withholding.

Payments ofprincipal or interest made to or through a foreign office of a custodian,nominee or other agent acting on behalf of a beneficial owner of a US note generallywill not be subject to backup withholding. However, if such custodian, nomineeor other agent is (i) a United States person (as defined in section7701(a)(30) of the Code), (ii) a controlled foreign corporation (asdefined in section 957(a) of the Code), (iii) a foreign person 50 percent. or more of whose gross income is effectively connected with a US trade orbusiness for a specified three-year period, or (iv) a foreign partnershipif (A) at any time during its tax year, one or more of its partners areUnited States persons (as defined in applicable Treasury regulations) who inthe aggregate hold more than 50 per cent. of the income or capital interest inthe partnership or (B) at any time during its taxable year, it is engagedin a US trade or business (each of (i) through (iv), a “US ConnectedHolder”), such custodian, nominee or other agent may be subject to certaininformation reporting requirements with respect to such payment unless it hasin its records documentary evidence that the beneficial owner is not a UnitedStates holder and certain conditions are met or the beneficial owner otherwiseestablishes an exemption. Principal and interest paid by the US office of acustodian, nominee or agent will be subject to both backup withholding and informationreporting unless the beneficial owner certifies its non-US status underpenalties of perjury or otherwise establishes an exemption. Payments ofproceeds on the sale of a US note made to or through a foreign office of abroker will not be subject to backup withholding. However, if such broker is aUS Connected Holder, information reporting will be required unless the brokerhas in its records documentary evidence that the beneficial owner is 

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not a United States holder and certain conditions aremet or the beneficial owner otherwise establishes an exemption. Payments ofproceeds on the sale of a US note made to or through the US office of a brokerwill be subject to backup withholding and information reporting unless thebeneficial owner certifies, under penalties of perjury, that it is not a USholder or otherwise establishes an exemption.

Backup withholdingis not an additional tax. Any amounts withheld under the backup withholding rules willbe refunded or credited against the United States holder’s US federal incometax liability, provided that the required information is furnished to the IRS. **Holders of US notes should consult their tax advisors as to theirqualification for exemption from backup withholding and the procedure forobtaining an exemption.**

**MaterialJersey (Channel Islands) Tax Considerations**

The mortgagestrustee is resident in Jersey for taxation purposes and will be liable toincome tax in Jersey at a rate of 20 per cent. in respect of the profits itmakes from acting as trustee of the mortgages trust. The mortgages trustee willnot be liable for any income tax in Jersey in respect of any income it receivesin its capacity as mortgages trustee on behalf of the beneficiaries of themortgages trust.

F.             *Dividends and PayingAgents*

Not applicable toannual reports filed on Form 20-F.

G.            *Statement by Experts*

Not applicable toannual reports filed on Form 20-F.

H.            *Documents on Display*

The issuer,Funding 1 and the mortgages trustee are subject to the information requirementsof the U.S. Securities Exchange Act of 1934, as amended, and are thereforerequired to file reports, including annual reports on Form 20-F, andother information with the SEC. These materials, including this annual reportand the exhibits thereto, may be inspected and copied at the SEC’s publicreference rooms in Washington, DC, New York, NY and Chicago, IL. Please callthe SEC at +1-800-732-0330 for further information on thepublic reference rooms. Any filings made by the issuer, Funding 1 or themortgages trustee will be made available to the public over the Internet at theSEC’s web site at http://www.sec.gov.

I.              *Subsidiary Information*

Not applicable toannual reports filed on Form 20-F.

**Item 11. Quantitative andQualitative Disclosures About Market Risk**

Funding 1 hasentered into the Funding 1 swap agreement with Halifax plc as the Funding 1swap provider and the security trustee. The issuer has entered into issuerswaps with the issuer swap providers and the security trustee. In general, theswaps are designed to do the following:

·                  Funding1 swap: to hedge against the possible variance between the mortgages trusteevariable base rate payable on the variable rate loans, the rates of interestpayable on the tracker rate loans and the fixed rates of interest payable onthe fixed rate loans and a LIBOR based rate for three-month sterling deposits;

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·                  issuerdollar currency swaps: to protect the issuer against changes in the sterling toUS dollar exchange rate following the closing date and the possible variancebetween a LIBOR based rate for three-month sterling deposits and a LIBOR basedrate for three-month dollar deposits, applicable to the series 2 issuer notes ,and to address the difference in periodicity between the interest payment datesin respect of the intercompany loans, which occur quarterly. and

·                  issuereuro currency swaps: to protect the issuer against changes in the sterling toeuro exchange rate following the closing date and the possible variance betweena LIBOR based rate for three-month sterling deposits and a EURIBOR based ratefor three-month euro deposits applicable to the series 4 class A1 issuer notes, the series 4 class B issuer notes, theseries 4 class C issuer notes.

**TheFunding 1 swap**

Some of the loansin the portfolio pay a variable rate of interest for a period of time which mayeither be linked to the mortgages trustee variable base rate or linked to avariable interest rate other than the mortgages trustee variable base rate,such as a rate set by the Bank of England or linked to the flexible variablerate.. Other loans pay a fixed rate of interest for a period of time. However,the interest rate payable by Funding 1 with respect to the issuer term advancesis calculated as a margin over LIBOR for three-month sterling deposits. To providea hedge against the possible variance between:

(1)                                  themortgages trustee variable base rate payable on the variable rate loans, therates of interest payable on the tracker rate loans and the fixed rates ofinterest payable on the fixed rate loans; and

(2)                                  aLIBOR based rate for three-month sterling deposits,

Funding 1, the Funding 1swap provider and the security trustee have entered into the Funding 1 swap asamended and restated on March 22, 2006. The Funding 1 swap:

·                  hasa notional amount that is sized to hedge against any potential interest ratemismatches in relation to the current issues outstanding; and

·                  providesfor the notional amount to be increased as appropriate to hedge against similarpotential interest rate mismatches in relation to any new issues.

Under the Funding1 swap, on each calculation date, the following amounts will be calculated:

·                  theamount produced by applying LIBOR for three-month sterling deposits (asdetermined in respect of the corresponding interest period under the intercompanyloans) plus a spread for the relevant calculation period to the notional amountof the

 

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Funding 1 swap as described later in thissection (known as the “calculation period swap provider amount”); and

·                  the amount produced by applying a rate equal to the weighted averageof:

         (i)  the average of the standard variable mortgagerates or their equivalent charged to existing borrowers on residential mortgageloans as published from time to time, after excluding the highest and thelowest rate, of Abbey National plc, HSBC Bank plc, Cheltenham &Gloucester, National Westminster Bank Plc, Nationwide Building Society,Northern Rock plc and Woolwich plc (and where those banks have more than onestandard variable rate, the highest of those rates);

      (ii)  the rates of interest payable on the trackerrate loans; and

   (iii)  the rates of interest payable on the fixedrate loans,

for therelevant calculation period to the notional amount of the Funding 1 swap (knownas the “calculation period Funding 1 amount”). “Calculation date” is defined asthe first day (or if not a London Business Day, the next succeeding LondonBusiness Day) of each month and any other day on which Funding 1 acquires afurther interest in the trust property from and including the calculation dateimmediately preceding the effective date. “London Business Day” is defined as aday (other than a Saturday or Sunday) on which banks are generally open forbusiness in London.

On eachFunding 1 interest payment date the following amounts will be calculated:

·                  the sum of each of the calculation period swap provider amountscalculated during the preceding interest period; and

·                  the sum of each of the calculation period Funding 1 amountscalculated during the preceding interest period.

Afterthese two amounts are calculated in relation to a Funding 1 interest paymentdate, the following payments will be made on that Funding 1 interest paymentdate:

·                  if the first amount is greater than the second amount, then theFunding 1 swap provider will pay the difference to Funding 1;

·                  if the second amount is greater than the first amount, then Funding1 will pay the difference to the Funding 1 swap provider; and

·                  if the two amounts are equal, neither party will make a payment tothe other.

If apayment is to be made by the Funding 1 swap provider, that payment will beincluded in the Funding 1 available revenue receipts and will be applied on therelevant Funding 1 interest payment date according to the relevant order ofpriority of payments of Funding 1. If a payment is to be made by Funding 1, itwill be made according to the relevant order of priority of payments of Funding 1.

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Thenotional amount of the Funding 1 swap in respect of a calculation period willbe an amount in sterling equal to:

·                  the aggregate principal amount outstanding of all intercompany loanson the first day of the relevant calculation period, less

·                  the balance of the principal deficiency ledger attributable to allintercompany loans on the first day of the relevant calculation period, less

·                  the amount of the principal receipts in the Funding 1 GIC accountattributable to all intercompany loans on the first day of the relevantcalculation period.

In theevent that the Funding 1 swap is terminated prior to the service of any issuerintercompany loan acceleration notice or final repayment of any intercompanyloan, Funding 1 shall enter into a replacement Funding 1 swap on termsacceptable to the rating agencies, with the security trustee and with a swapprovider whom the rating agencies have previously confirmed in writing toFunding 1, the issuer and the security trustee will not cause the then currentratings of the issuer notes to be downgraded, withdrawn or qualified. IfFunding 1 is unable to enter into a replacement Funding 1 swap on termsacceptable to the rating agencies, this may affect amounts available to payinterest on the intercompany loans.

**Theissuer currency swaps**

Theissuer intercompany loan is denominated in sterling, and interest payable byFunding 1 to the issuer under the issuer term advances is calculated as amargin over LIBOR for three-month sterling deposits. However, some of theissuer notes are denominated in US dollars and accrue interest at either aLIBOR based rate for one-month US dollar deposits or a LIBOR based rate forthree-month US dollar deposits. In addition, the series 3 notes are denominated in euro and accrue interest at aEURIBOR based rate for three-month euro deposits. To deal with the potentialinterest rate and currency mismatch between (i) its receipts andliabilities in respect of the issuer intercompany loan and (ii) itsreceipts and liabilities under the issuer notes, the issuer has, pursuant tothe terms of the issuer currency swaps, swapped its receipts and liabilities inrespect of the issuer intercompany loans on terms that match the issuer’sobligations under the US dollar denominated issuer notes or the eurodenominated issuer notes, as applicable.

Thecurrency amount of each issuer currency swap is the principal amountoutstanding under the term advance for the issuer notes to which the relevantissuer currency swap relates. Subject, in the case of the class B and C issuerswaps, to certain deferral of interest provisions that will apply when paymentof interest under the corresponding offered issuer notes is deferred inaccordance with the terms and conditions of such offered issuer notes, theissuer swap providers will pay to the issuer amounts in US dollars or euro, asapplicable, that are equal to the amounts of interest to be paid on each of theclasses of the offered issuer notes and the issuer will to the issuer swapproviders the sterling interest amounts received on the issuer term advancescorresponding to the class of the offered issuer notes. In order to allow forthe effective currency amount of each issuer currency swap to amortize at thesame rate as the relevant series and class of issuer notes, each issuercurrency swap agreement provides that as and when the issuer notes amortize, acorresponding portion of the relevant issuer currency swap so terminated willbe swapped from sterling into US dollars at the relevant dollar currencyexchange rate or into euro at the euro currency exchange rate, as applicable.On the final maturity date of each class of offered issuer notes or, ifearlier, the date on which such notes are redeemed in full, the issuer will payto the relevant issuer swap provider an amount in sterling equal to theprincipal amount outstanding 

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under the relevant issuer notes and therelevant issuer swap provider will pay an equivalent amount in US dollars oreuro, as applicable, or, if less, the amount of principal available for paymentto the relevant issuer swap provider pursuant to the cash management agreement,in either case converted by reference to the dollar currency exchange rate oreuro currency exchange rate, as applicable.

Thepayment obligations of the series 1 issuer swap provider are guaranteed by theUBS issuer swap guarantor pursuant to a guarantee (the “UBS issuer swapguarantee”).

Thepayment obligations of the series 2 issuer swap provider under the relevantissuer currency swaps are guaranteed by the Swiss Re issuer swap guarantorpursuant to a guarantee (the “Swiss Re issuer swap guarantee”).

In theevent that any issuer currency swap is terminated prior to the service of anissuer note acceleration notice or the final redemption of the relevant US dollardenominated or euro denominated issuer notes, as applicable, the issuer shallenter into a replacement issuer currency swap in respect of that class andseries of issuer notes. Any replacement issuer currency swap must be enteredinto on terms acceptable to the rating agencies, the issuer and the securitytrustee and with a replacement issuer currency swap provider whom the ratingagencies have previously confirmed in writing to the issuer and the securitytrustee will not cause the then current ratings of the issuer notes to bedowngraded, withdrawn or qualified. If the issuer is unable to enter into anyreplacement issuer currency swaps on terms acceptable to the rating agencies,this may affect amounts available to pay amounts due under the issuer notes.

If anissuer currency swap agreement is terminated and the issuer is unable to enterinto a replacement swap as described above, then any payments received by theissuer from Funding 1 on each Funding 1 interest payment date shall bedeposited in the issuer bank account (or such other account opened for thispurpose) and applied by the issuer to repay the issuer notes on each interestpayment date after exchanging at the “spot” rate, the relevant proceeds fromsterling into US dollars or euros as required.

**Ratingsdowngrade of swap providers**

Undereach of the swap agreements, in the event that the relevant rating(s) of aswap provider, or its respective guarantor, as applicable, is or are, asapplicable, downgraded by a rating agency below the rating(s) specified inthe relevant swap agreement (in accordance with the requirements of the ratingagencies) for such swap provider, and, as a result of the downgrade, the thencurrent ratings of the current notes, in respect of the Funding 1 swap, or theissuer notes corresponding to the relevant issuer swap in respect of therelevant issuer swap, would or may, as applicable, be adversely affected, therelevant swap provider will, in accordance with the Funding 1 swap or therelevant issuer swap, as applicable, be required to take certain remedialmeasures, which may include providing collateral for its obligations under therelevant swap, arranging for its obligations under the relevant swap to betransferred to an entity with rating(s) required by the relevant ratingagency as specified in the relevant swap agreement (in accordance with therequirements of the rating agency), procuring another entity with rating(s) requiredby the relevant rating agency as specified in the relevant swap agreement (inaccordance with the requirements of the rating agency), to become co-obligor orguarantor as applicable, in respect of its obligations under the relevant swap,or taking such other action as it may agree with the relevant rating agency.

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**Terminationof the swaps**

TheFunding 1 swap will terminate on the date on which the aggregate principalamount outstanding under all intercompany loans is reduced to zero.

Eachissuer swap other than the series 2 class A issuer swap and the series 3 classA issuer swap will terminate on the earlier of the interest payment datefalling in June 2042 and the date on which all of the relevant class andseries of issuer notes are redeemed in full. The series 2 class A issuer swapwill terminate on the earlier of the interest payment date falling in December 2011and the date on which the series 2 class A issuer notes are redeemed in full.The series 3 class A issuer swap will terminate on the earlier of the interestpayment date falling in September 2032 and the date on which the series 3 classA issuer notes are redeemed in full.

Anyswap may also be terminated in any of the following circumstances, eachreferred to as a “swap early termination event”:

·                  at the option of one party to the swap agreement, if there is afailure by a party to pay any amounts due under that swap and any applicablegrace period has expired;

·                  in respect of the issuer swaps, at the option of the relevant swapprovider, if an event of default under the relevant class of issuer notesoccurs and the security trustee serves an issuer note acceleration notice;

·                  in respect of the Funding 1 swap, at the option of the Funding 1swap provider, if an event of default under any intercompany loan occurs andthe security trustee serves an intercompany loan acceleration notice;

·                  in respect of the issuer swaps, if a redemption or purchase of therelevant class of issuer notes occurs pursuant to number 5(F) (Redemptionor purchase following a regulatory event).

·                  in respect of the issuer swaps, at the option of the issuer, and inrespect of the Funding 1 swap, at the option of Funding 1, if certain taxrepresentations by the relevant swap provider prove to have been untrue ormisleading in any material respect;

·                  in respect of the issuer swaps, at the option of the relevant issuerswap provider, and in respect of the Funding 1 swap, at the option of Funding1, if certain insolvency events occur with respect to the issuer or Funding 1;

·                  at the option of the issuer (in respect of the issuer swaps) orFunding 1 (in respect of the Funding 1 swap) upon the occurrence of aninsolvency of the relevant swap provider, or its guarantor, as applicable, orthe merger of the relevant swap provider without an assumption of theobligations under the relevant swap agreement, or if a material misrepresentationis made by the swap provider under the relevant swap agreement or a default bythe relevant swap provider under an over-the-counter derivatives transactionunder another agreement between the issuer and such swap provider; or if abreach of a provision of the relevant swap agreement by the swap provider isnot remedied within the applicable grace period, or, if applicable, the 

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guarantor of the relevant swap providerfails to comply with its obligations under the guarantee;

·                  if a change in law resulting in the obligations of one of theparties becoming illegal;

·                  at the option of the relevant swap provider but subject to obtainingthe consent of the security trustee (in the case of the issuer swaps) or thenote trustee (in the case of the Funding 1 swap) (which if certain conditionsare satisfied, shall be given), if withholding taxes are imposed on paymentsmade by the relevant swap provider under the relevant swap due to a change inlaw; and

·                  if the relevant swap provider or its guarantor, as applicable, isdowngraded and fails to comply with the requirements of the ratings downgradeprovision contained in the relevant swap agreement.

Uponthe occurrence of a swap early termination event, the issuer or the relevantissuer swap provider may be liable to make a termination payment to the otherparty (in the case of an issuer swap) and/or Funding 1 or the Funding 1 swapprovider may be liable to make a termination payment to the other party (in thecase of the Funding 1 swap). This termination payment will be calculated andmade in sterling. The amount of any termination payment will be based on themarket value of the terminated swap as determined on the basis of quotationssought from leading dealers as to the cost of entering into a swap with thesame terms and conditions that would have the effect of preserving the economicequivalent of the respective full payment obligations of the parties (or basedupon a good faith determination of total losses and costs (or gains) if aninsufficient number of quotations can be obtained or if basing the valuation onquotations would not produce a commercially reasonable result). Any suchtermination payment could be substantial.

If anyissuer swap is terminated early and a termination payment is due by the issuerto an issuer swap provider, then, pursuant to its obligations under the issuerintercompany loan, Funding 1 shall pay to the issuer an amount equal to thetermination payment due to the relevant issuer swap provider less any amountreceived by the issuer under any replacement issuer swap agreement. Thesepayments will be made by Funding 1 only after paying interest amounts due onthe issuer term advances and after providing for any debit balance on theprincipal deficiency ledger. The issuer shall apply amounts received fromFunding 1 under the issuer intercompany loan in accordance with the issuerpre-enforcement revenue priority of payments or, as the case may be, the issuerpost-enforcement priority of payments. The application by the issuer of terminationpayments due to an issuer swap provider may affect the funds available to payamounts due to noteholders.

If theissuer receives a termination payment from an issuer currency swap provider,then the issuer shall use those funds towards meeting its costs in effectingcurrency exchanges at the spot rate of exchange until a replacement issuercurrency swap is entered into and/or to acquire a replacement issuer currencyswap.

Noteholderswill not receive extra amounts (over and above interest and principal payableon the issuer notes) as a result of the issuer receiving a termination payment.

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**Transferof the swaps**

Eachswap provider may, subject to certain conditions specified in the relevant swapagreement, including (without limitation) the satisfaction of certainrequirements of the rating agencies, transfer its obligations under any of theswaps to another entity.

**Taxation**

NeitherFunding 1 nor the issuer is obliged under any of the swaps to gross up paymentsmade by them if withholding taxes are imposed on payments made under theFunding 1 swap or the issuer swaps.

Eachswap provider will generally be obliged to gross up payments made by it toFunding 1 or the issuer, as appropriate, if withholding taxes are imposed onpayments made under the Funding 1 swap or the issuer swaps. However, if a swapprovider is required to gross up a payment under a swap due to a change in law,the relevant swap provider may, subject to obtaining the consent of thesecurity trustee (in the case of the issuer swaps) or the note trustee (in thecase of the Funding 1 swap), terminate the relevant swap.

**Item 12. Description ofSecurities Other than Equity Securities**

Notapplicable to annual reports filed on Form 20-F.

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**PART II**

**Item 13. Defaults,Dividend Arrearages and Delinquencies**

None.

**Item 14. MaterialModifications to the Rights of Security Holders and Use of Proceeds**

None.

**Item 15. Controls andProcedures**

Notapplicable.

**Item 16. [Reserved]**

**Item 16A. Audit CommitteeFinancial Expert**

Notapplicable.

**Item 16B. Code of Ethics**

Notapplicable.

**Item 16C. PrincipalAccountant Fees and Services**

Notapplicable.

**Item 16D. Exemptions fromthe Listing Standards for Audit Committees**

Notapplicable.

**Item 16E. Purchases ofEquity Securities by the Issuer and Affiliated Purchasers**

Not applicable.

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**PART III**

**Item 17. FinancialStatements**

Notapplicable.

**Item 18. FinancialStatements**

Notapplicable.

**Item 19. Exhibits**

Thefollowing documents are filed as part of the Annual Report on Form 20-F:

Exhibit 1:a copy of the Memorandum and Articles of Association of each of the issuer,Funding 1 and the mortgages trustee is incorporated by reference from theRegistration Statement.

Exhibit 2:instruments defining the rights of the security holders as described in theRegistration Statement are incorporated by reference from the RegistrationStatement.

Exhibit 12:Section 302 certification.

Exhibit 15.1:Investor’s Report for the month of March 2005 (incorporated by referencefrom the Form 6-K previously filed on April 20, 2004).

Exhibit 15.2:Investor’s Report for the month of April 2005(incorporated by referencefrom the Form 6-K previously filed on May 12, 2005).

Exhibit 15.3:Investor’s Report for the month of May 2005(incorporated by reference fromthe Form 6-K previously filed on June 27, 2005).

Exhibit 15.4:Investor’s Report for the month of June 2005(incorporated by referencefrom the Form 6-K previously filed on July 21, 2005).

Exhibit 15.5:Investor’s Report for the month of July 2005(incorporated by referencefrom the Form 6-K previously filed on August 19, 2005).

Exhibit 15.6:Investor’s Report for the month of August 2005(incorporated by referencefrom the Form 6-K previously filed on September 27, 2005).

Exhibit 15.7:Investor’s Report for the month of September 2005(incorporated byreference from the Form 6-K previously filed on October 27,2005).

Exhibit 15.8:Investor’s Report for the month of October 2005(incorporated by referencefrom the Form 6-K previously filed on November 23, 2005).

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Exhibit 15.9:Investor’s Report for the month of November 2005(incorporated by referencefrom the Form 6-K previously filed on December 12, 2005).

Exhibit 15.10:Investor’s Report for the month of December 2005(incorporated by referencefrom the Form 6-K previously filed on January 20, 2006).

Exhibit 99.1:Annual Compliance Certificate for year end December 31, 2005.

Exhibit 99.2:Report of Independent Accountants.

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**SIGNATURES**

Eachregistrant hereby certifies that it meets all of the requirements for filing onForm 20-F and that it has duly caused and authorized the undersignedto sign this annual report on its behalf.

 
|                           | PERMANENT FINANCING (NO. 7) PLC     |
|---------------------------|-------------------------------------|
|                      |                                |
|                      | By:                                 | /s/ David Balai |
|                      | Name:                               | David Balai |
|                      | Title:                              | Director |
|                      |                                |
|                      | PERMANENT FUNDING (NO. 1) LIMITED   |
|                      |                                |
|                      | By:                                 | /s/ David Balai |
|                      | Name:                               | David Balai |
|                      | Title:                              | Director |
|                      |                                |
|                      | PERMANENT MORTGAGES TRUSTEE LIMITED |
|                      |                                |
|                      | By:                                 | /s/ David Balai |
| Date:  June 26, 2006 | Name:                               | David Balai |
|                      | Title:                              | Director |

 

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