**As filedwith the Securities and Exchange Commission on June 30, 2005**

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 20-F**

 

**(Mark One)**

 

**o****                      ****Registration statement pursuantto Section 12(b) or 12(g) of the Securities Exchange Act of 1934**

 

**or**

 

**ý****                      ****Annual report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**For thefiscal year ended December 31, 2004**

 

**or**

 

**o****                      ****Transition report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**For the transition period from                     to                     **

 

**Commissionfile number:   333-109144**

 

**PERMANENT FINANCING (NO. 3) PLC**

(Exact Name of Registrant 1 asspecified in its charter)

 

**UnitedKingdom**

(Jurisdiction of Incorporationor Organization)

 

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

(Address of Principal ExecutiveOffices)

 

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

(Exact Name of Registrant 2 asspecified in its charter)

 

**UnitedKingdom**

(Jurisdiction of Incorporationor Organization)

 

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

(Address of Principal ExecutiveOffices)

 

**PERMANENT MORTGAGES TRUSTEELIMITED**

(Exact Name of Registrant 3 asspecified in its charter)

 

**Jersey,Channel Islands**

(Jurisdiction of Incorporationor Organization)

 

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

(Address of Principal ExecutiveOffices)

 

Securitiesregistered or to be registered pursuant to Section 12(b) of the Act:                          **None.**

 

Securitiesregistered or to be registered pursuant to Section 12(g) of the Act:                          **None.**

 

Securities forwhich there is a reporting obligation pursuant to Section 15(d) of theAct:

 

Title of eachclass

 

$1,700,000,000series 2 class A notes due September 2010

 

$59,000,000series 2 class B notes due June 2042

 

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

 

$1,500,000,000series 3 class A notes due September 2033

 

$52,000,000series 3 class B notes due June 2042

 

$52,000,000series 3 class C notes due June 2042

 

Series 2 termAAA advance(1)

 

Series 2 termAA advance(1)

 

Series 2 termBBB advance(1)

 

Series 3 termAAA advance(1)

 

Series 3 termAA advance(1)

 

Series 3 termBBB advance(1)

 

Funding 1interest in the mortgages trust(1)

 

Indicate the number of outstanding shares ofeach of the issuer’s classes of capital or common stock as of the close of theperiod covered by the annual report.

 

**Not applicable.**

 

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

 

Yes ýNo o

 

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

 

**Not applicable.**

 

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(1)  Theseitems have not been offered directly to investors. Permanent Mortgages TrusteeLimited is the registrant for the Funding 1 interest in the mortgages trust andis holding the Funding interest in the mortgages trust on behalf of PermanentFunding (No. 1) Limited. The Funding 1 interest in the mortgages trust is theprimary source of payments on the term advances listed. Permanent Funding (No.1) Limited is the registrant for the term advances and has issued the termadvances to Permanent Financing (No. 3) PLC. The term advances are the primarysource of payments on the series 2 notes and the series 3 notes. PermanentFinancing (No. 3) PLC is the registrant for the series 2 notes and the series 3notes.

 

 

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**PRESENTATIONOF INFORMATION**

 

This annual report on Form 20-F relates toPermanent Financing (No. 3) PLC (the “issuer”) and the following securities(the “issuer notes”), which were issued pursuant to a trust deed dated November 25,2003 (the “issuer trust deed”), between the issuer and The Bank of New York, asnote trustee (the “note trustee”):

 

•                  $1,700,000,000series 2 class A notes due September 2010

•                  $59,000,000series 2 class B notes due June 2042

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

•                  $1,500,000,000series 3 class A notes due September 2033

•                  $52,000,000series 3 class B notes due June 2042

•                  $52,000,000series 3 class C notes due June 2042

 

This annual report on Form 20-F also relates to the followingadvances made pursuant to the intercompany loan agreement dated November 25,2003 (the “issuer intercompany loan agreement”), between the issuer, PermanentFunding (No. 1) Limited (“Funding 1”), The Bank of New York, as security trustee(the “security trustee”) and Citibank, N.A., as agent bank:

 

•                  £1,018,000,000series 2 term AAA advance

•                  £35,400,000series 2 term AA advance

•                  £35,400,000series 2 term BBB advance

•                  £898,250,000series 3 term AAA advance

•                  £31,200,000series 3 term AA advance

•                  £31,200,000series 3 term BBB advance

 

This annual report on Form 20-F furtherrelates to Funding 1’s interest in the mortgages trust, comprising, among otherthings, the initial portfolio of loans and their related security assigned toPermanent Mortgages Trustee Limited (the “mortgages trustee”) by Halifax plc(the “seller”) on June 14, 2002, and on several subsequent dates any newloans and their new related security assigned to the mortgages trustee by theseller after November 25, 2003 (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 relatedsecurity, the rights under the insurance policies that are assigned to themortgages trustee or of which the mortgages trustee has the benefit, andamounts on deposit and interest earned on the mortgages trustee guaranteedinvestment contract. The mortgages trustee guaranteed investment contract, orGIC, account is the bank account in which the mortgages trustee holds any cashthat is part of the trust property until it is distributed to thebeneficiaries. 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 used herein and not definedhave the same meaning ascribed to such terms in the Registration Statementfiled on Form S-11 (the “Registration Statement”) relating to the securities(file number 333-109144).

 

Certain items in Form 20-F are not applicableto annual reports filed on Form 20-F.Therefore, as used in this filing, “Notapplicable to annual reports filed on Form 20-F” means that the response to thereferenced item is omitted in reliance on the instructions to Form 20-Fpublished by the United States Securities and Exchange Commission (the “SEC”)as of the date of this annual report that specifically state that the item isinapplicable to annual reports filed on Form 20-F.

 

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Certain items in Form 20-F are not applicableto the issuer, Funding 1 or the mortgages trustee. Therefore, as used in thisfiling, “Not applicable” means the response to the reference item is omitted inreliance on the procedures outlined in numerous no-action letters issued by thestaff of the SEC with respect to issuers of substantially similar asset-backedsecurities that file annual reports on Form 10-K, or that the referenced itemis otherwise not applicable.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This annual report includes forward-lookingstatements including, but not limited to, statements made under the “RiskFactors” section. These forward-looking statements can be identified by the useof forward-looking terminology, such as the words “believes”, “expects”, “may”,“intends”, “should” or “anticipates”, or the negative or other variations ofthose terms. These statements involve known and unknown risks, uncertaintiesand other important factors that could cause the actual results and performanceof the issuer notes, the seller or the UK residential mortgage industry todiffer materially from any future results or performance expressed or impliedin the forward-looking statements. These risks, uncertainties and other factorsinclude, among others: general economic and business conditions in the UK;currency exchange and interest fluctuations; government, statutory, regulatoryor administrative initiatives affecting the seller, changes in businessstrategy, lending practices or customer relationships and other factors thatmay be referred to in this annual report.

 

Some of the most significant of these risks,uncertainties and other factors are discussed in the section of thisannual report entitled “Risk Factors”. Investors are encouraged to carefullyconsider those factors prior to making an investment decision regarding theissuer notes.

 

**INCORPORATIONOF CERTAIN DOCUMENTS BY REFERENCE**

 

Each of the issuer, Funding 1 and themortgages trustee incorporates by reference its periodic filings on Form 6-K,which contain all financial information relating to the securities relevant tothe holders of the issuer notes.

 

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**PART I**

 

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

 

Not applicable to annual reports filed onForm 20-F.

 

**Item 2. Offer Statistics and Expected Timetable**

 

Not applicable to annual reports filed onForm 20-F.

 

**Item 3. Key Information**

 

A.*            SelectedFinancial Data*

 

Each of the issuer, Funding 1 and themortgages trustee incorporates by reference and attaches hereto as exhibits thefollowing reports, filed on Form 6-K, which include all financial informationrelating to the securities that is relevant to holders of the issuer notes:

 

•                  Investor’sReport for the month of January 2004

•                  Investor’sReport for the month of February 2004

•                  Investor’sReport for the month of March 2004

•                  Investor’sReport for the month of April 2004

•                  Investor’sReport for the month of May 2004

•                  Investor’sReport for the month of June 2004

•                  Investor’sReport for the month of July 2004

•                  Investor’sReport for the month of August 2004

•                  Investor’sReport for the month of September 2004

•                  Investor’sReport for the month of October 2004

•                  Investor’sReport for the month of November 2004

•                  Investor’sReport for the month of December 2004

 

B.*            Capitalizationand Indebtedness*

 

Not applicable to annual reports filed onForm 20-F.

 

C.*            Reasonsfor the Offer and Use of Proceeds*

 

Not applicable to annual reports filed onForm 20-F.

 

D*.**            RiskFactors*

 

*This section describes the principal riskfactors associated with an investment in the issuer notes. Investorsconsidering purchasing the issuer notes should carefully read and think aboutall the information contained in this document, including the risk factors setout here, prior to making any investment decision.*

 

**Noteholders cannot rely on any person otherthan the issuer to make payments on the issuer notes**

 

The issuer notes do not represent anobligation and are not the responsibility of any of Halifax plc or any of itsaffiliates, underwriters, managers, the mortgages trustee, the note trustee orany other party to the transaction other than the issuer.

 

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**The issuer has a limited set of resourcesavailable to it to make payments on the issuer notes**

 

The issuer’s ability to make payments ofprincipal and interest on the issuer notes and to pay its operating andadministrative expenses will depend primarily on the funds being received underthe issuer intercompany loan. In addition, the issuer will rely on the issuerdollar currency swaps and the issuer euro currency swaps to provide payments onthe issuer notes denominated in US dollars and euro, respectively and on theissuer interest rate swap to provide payments of interest on the series 5 classA notes until the interest payment date falling in December 2010.

 

Noteholders should note that there is noliquidity facility directly available to the issuer, although Funding 1 has thebenefit of a liquidity facility to pay interest on the issuer term advancescorresponding to the issuer notes and to pay principal on issuer term advancescorresponding to the series 1 class A issuer notes, the series 2 class A issuernotes, the series 3 class A issuer notes and the series 4 class A issuer notes.In the event that the seller suffers certain ratings downgrades, Funding 1 willbe required to fund the liquidity reserve fund, though there can be noassurance that Funding 1 will have sufficient resources to do so at such time,and Funding 1 may draw money from the liquidity reserve fund, to the extent ithas been funded, to pay amounts due to the issuer. The ability of Funding 1 todraw on the Funding 1 liquidity facility is subject to satisfying certainconditions precedent. The Funding 1 liquidity facility will be available torepay principal due on the issuer term advance corresponding to the series 3class A issuer notes and the series 4 class A issuer notes on their finalmaturity date only.

 

In addition to the issuer, all relevantissuers (including the previous issuer and, as they are established, each newissuer) have or will have an indirect interest in the Funding 1 liquidityfacility (the Funding 1 liquidity facility will be available to meet interestand principal obligations of Funding 1 to the previous issuer and new issuers,subject to certain conditions precedent). If a drawing is made under theFunding 1 liquidity facility to enable Funding 1 to meet its obligations to theprevious issuer or to new issuers, then that may affect the amount of fundsavailable to Funding 1 to meet its obligations to the issuer.

 

The issuer will not have any othersignificant sources of funds available to meet its obligations under the issuernotes and/or any other payments ranking in priority to the issuer notes.

 

**Funding 1 is not obliged to make payments onthe issuer term advances if it does not have enough money to do so, which couldadversely affect payments on the issuer notes**

 

Funding 1’s ability to pay amounts due on theissuer term advances will depend upon:

 

•                  Funding1 receiving enough funds from its entitlement to the trust property on orbefore each Funding 1 interest payment date;

 

•                  Funding1 receiving the required funds from the Funding 1 swap provider;

 

•                  theamount of funds credited to the general reserve fund;

 

•                  theamount of funds credited to the liquidity reserve fund;

 

•                  Funding1 making drawings as permitted under the Funding 1 liquidity facility; and

 

•                  theallocation of funds between the issuer term advances, the previous termadvances and any new term advances.

 

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According to the terms of the mortgages trustdeed, the mortgages trustee is obliged to pay to Funding 1 the Funding 1 sharepercentage of revenue receipts on the loans by crediting those amounts to theFunding 1 GIC account on each distribution date. The mortgages trustee isobliged to pay Funding 1 principal receipts on the loans by crediting thoseamounts to the Funding 1 GIC account as and when required pursuant to the termsof the mortgages trust deed.

 

Funding 1 will be obliged to pay revenuereceipts due to the issuer under the issuer intercompany loan only to theextent that it has revenue receipts left over after making payments ranking inpriority to the issuer, such as payments of certain fees and expenses ofFunding 1 and payments on certain higher ranking new term advances under newintercompany loans.

 

Funding 1 will be obliged to pay principalreceipts due to the issuer under the issuer intercompany loan only to the extentthat it has principal receipts available for that purpose after repayingamounts ranking in priority to the issuer (including repaying any higherranking Previous term advances or new term advances).

 

If there is a shortfall between the amountspayable by Funding 1 to the issuer under the issuer intercompany loan agreementand the amounts payable by the issuer on the issuer notes, the noteholders may,depending on what other sources of funds are available to the issuer and toFunding 1, not receive the full amount of interest and/or principal which wouldotherwise be due and payable on the issuer notes.

 

**Failure by Funding 1 to meet its obligationsunder the issuer intercompany loan agreement would adversely affect payments onthe issuer notes**

 

If Funding 1 does not make payments due andpayable on the issuer intercompany loan, then the issuer may not have enoughmoney to make payments on the issuer notes, and in addition the issuer willhave only limited recourse to the assets of Funding 1. If Funding 1 does notpay amounts under the issuer intercompany loan because it does not have enoughmoney available, those amounts will be deemed not to be due and payable, sothere will not be an event of default under the issuer intercompany loan, andthe issuer will not have recourse to the assets of Funding 1 in that instance.

 

**On the final repayment date of the issuerintercompany loan any outstanding amounts in respect of the issuer term AAadvances and the issuer term BBB advances will be extinguished, which wouldcause a loss on any class B issuer notes and any class C issuer notes stilloutstanding**

 

The transaction has been structured in theexpectation that on the final repayment date of the issuer intercompany loan inJune 2042, the interest and principal due and payable on the issuer termAA advances and the issuer term BBB advances will be in an amount equal to thesum available to pay all outstanding interest and/or principal (includinginterest and/or principal deferred and unpaid) on the issuer term AA advancesand the issuer term BBB advances (after paying amounts of a higher order ofpriority as required by the Funding 1 priority of payments).

 

If there is a shortfall between the amountavailable to pay the interest and/or principal and the amount required to payall outstanding interest and/or principal on the issuer term AA advances andthe issuer term BBB advances, then the shortfall will be deemed to be not dueand payable under the issuer intercompany loan agreement and the issuer willnot have any claim against Funding 1 for the shortfall.

 

If there is a shortfall in interest and/orprincipal payments under the issuer intercompany loan agreement, thenoteholders may not receive the full amount of interest and/or principal whichwould otherwise be due and payable on the class B issuer notes or the class Cissuer notes outstanding.

 

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**Enforcement of the issuer security is theonly remedy for a default in the issuer’s obligations, and the proceeds of thatenforcement may not be enough to make payments on the issuer notes**

 

The only remedy for recovering amounts on theissuer notes is through the enforcement of the issuer security. The issuer hasno recourse to the assets of Funding 1 unless Funding 1 has also defaulted onits obligations under the issuer intercompany loan and the Funding 1 securityhas been enforced.

 

If the security created as required by theissuer deed of charge is enforced, the proceeds of enforcement may beinsufficient to pay all principal and interest due on the issuer notes.

 

**The transaction has been structured in theexpectation that the series 2 issuer notes will be redeemed before the series 3issuer notes and so on**

 

The transaction has been structured in theexpectation that:

 

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

 

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

 

•                  theseries 4 issuer notes will be redeemed in full prior to the redemption of theseries 5 issuer notes.

 

This means, among other things, that theseries 2 class B issuer notes and the series 2 class C issuer notes areexpected to be redeemed before the series 3 class A issuer notes, the series 4class A issuer notes and the series 5 class A issuer notes, even though theseries 3 class A issuer notes, the series 4 class A issuer notes and the series5 class A issuer notes have a higher rating that the series 2 class B issuernotes and the series 2 class C issuer notes. Similarly, the series 3 class Bissuer notes and the series 3 class C issuer notes are expected to be redeemedbefore the series 4 class A issuer notes and the series 5 class A issuer notes,and so on for each series of issuer notes.

 

However, there is no assurance that theseries 2 issuer notes will be redeemed in full before the series 3 issuernotes, the series 4 issuer notes and the series 5 issuer notes or that theseries 3 issuer notes will be redeemed in full before the series 4 issuer notesand the series 5 issuer notes or that the series 4 issuer notes will beredeemed in full before the series 5 issuer notes. In each case, redemption of theissuer notes is ultimately dependent on, among other things, repayment andredemptions on the loans and on the term advance rating of the issuer termadvances.

 

Further, if on any interest payment date,amounts are due and payable in respect of the class A issuer notes of anyseries and amounts are payable in respect of the class B issuer notes of anyseries and/or the class C issuer notes of any series, then payments ofprincipal will be made on the class A issuer notes in priority to payments ofprincipal on the class B issuer Notes and the class C issuer notes. Similarly,if on any interest payment date, amounts are payable in respect of the class Bissuer notes of any series and the class C issuer notes of any series, thenpayments of principal will be made on the class B issuer notes in priority topayments of principal on the class C issuer notes.

 

**There may be conflicts between thenoteholders’ interests and the interests of any of the issuer’s other securedcreditors, and the interests of those secured creditors may prevail over thenoteholders’ interests**

 

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The issuer deed of charge requires thesecurity trustee to consider the interests of each of the issuer securedcreditors in the exercise of all of its powers, trusts, authorities, duties anddiscretions, but requires the security trustee, in the event of a conflictbetween the noteholders’ interests and the interests of any of the other issuersecured creditors, to consider only the noteholders’ interests. In certaincircumstances, the security trustee can make amendments to the documentswithout the noteholders’ prior consent.

 

**The security trustee may agree modificationsto the issuer transaction documents without the noteholders’ prior consent,which may adversely affect the noteholders’ interests**

 

Pursuant to the terms of the Funding 1 deedof charge and the issuer deed of charge, the security trustee may, without theconsent or sanction of Funding 1’s secured creditors or the issuer’s secured creditors,concur with any person in making or sanctioning any modifications to thetransaction documents:

 

•                  whichin the opinion of the security trustee it may be expedient to make, providedthat the security trustee is of the opinion that the 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, the secured creditorhas given its written consent to the modification; or

 

•                  whichin the opinion of the security trustee is made to correct a manifest error oran error established as such to the satisfaction of the security trustee or isof a formal, minor or technical nature.

 

The security trustee will be entitled toassume that the exercise of its discretion will not be materially prejudicialto the noteholders’ interests if each of the rating agencies has confirmed thatthe then current rating by it of the notes would not be adversely affected bysuch exercise.

 

In addition, the security trustee will giveits consent to any modifications to the mortgage sale agreement, the servicingagreement, the cash management agreement, the Funding 1 deed of charge, theFunding 1 liquidity facility agreement, the Funding 1 swap agreement, theintercompany loan terms and conditions, the bank account agreement and themaster definitions and construction schedule, that are requested by Funding 1or the cash manager, provided that Funding 1 or the cash manager certifies tothe security trustee in writing that the modifications are required in order toaccommodate:

 

i)                 the entry byFunding 1 into new intercompany loan agreements and/or the issue of new typesof notes by new issuers and/or the addition of other relevant creditors to thetransaction;

 

ii)              the inclusion ofPermanent Funding (No. 2) PLC (“Funding 2”) as a beneficiary of the mortgagestrust;

 

iii)           the issue of new notesby Funding 2;

 

iv)          the sale of new types ofloans to the mortgages trustee;

 

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

 

vi)          changes to be made tothe definitions of asset trigger event and non-asset trigger event; and

 

vii)       the inclusion of anadditional Funding 1 liquidity facility;

 

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and provided further that:

 

•                  inrespect of the matters listed in paragraphs (i) to (iv), the relevantconditions precedent have been satisfied; and

 

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

 

The modifications required to give effect tothe matters listed in paragraphs (i) to (vii) above may include, *inter alia*, amendments to the provisions of the Funding 1deed of charge relating to the application of monies. Accordingly, there can beno assurance that the effect of the modifications to the transaction documentswill not ultimately adversely affect noteholders’ interests. Any modificationsto the documents described above will require the actual consent of the Funding1 liquidity facility provider, the Funding 1 swap provider and each of theissuer swap providers (in respect of each document to which they are a party),as applicable, such consent not to be unreasonably withheld and to be deemedgiven if no response (affirmative or negative) is given within ten businessdays after the request for consent is sent to each such party.

 

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

 

The issuer trust deed and the terms of theissuer notes provide that the note trustee is to have regard to the interestsof the holders of all the classes of issuer notes. There may be circumstances,however, where the interests of one class of noteholders conflict with theinterests of another class or classes of noteholders. The issuer trust deed andthe terms of the issuer notes provide that where, in the opinion of the notetrustee, there is a conflict, then:

 

•                  thenote trustee is to have regard only to the interests of the class A noteholdersin the event of a conflict between the interests of the class A noteholders onthe one hand and the class B noteholders and the class C noteholders on theother hand; and

 

•                  thenote trustee is to have regard only to the interests of the class B noteholdersin the event of a conflict between the interests of the class B noteholders onthe one hand and the class C noteholders on the other hand.

 

**There may be a conflict between the interestsof the holders of each series of the class A issuer notes, the holders of eachseries of the class B issuer notes and the holders of each series of the classC issuer notes, and the interests of one series of noteholders may prevail overthe interests of other series of noteholders**

 

There may also be circumstances where theinterests of the class A noteholders of one series of the issuer notes conflictwith the interests of the class A noteholders of another series of the issuer notes.Similarly, there may be circumstances where the interests of the class Bnoteholders of one series of the issuer notes conflict with the interests ofthe class B noteholders of another series of the issuer notes or the interestsof the class C noteholders of one series of the issuer notes conflict with theinterests of the class C noteholders of another series of the issuer notes.

 

The issuer trust deed and the terms of theissuer notes will provide that where, in the sole opinion of the note trustee,there is a conflict, then a resolution directing the note trustee to take anyaction must be passed at separate meetings of the holders of each series of theclass A issuer notes, or, as applicable, each series of the class B issuernotes or each series of the class C issuer notes. A

 

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resolution may only be passed at a single meeting of noteholders ofeach series of the relevant class if the note trustee is, in its absolutediscretion, satisfied that there is no conflict between them.

 

Similar provisions will apply in relation torequests in writing from holders of a specified percentage of the principalamount outstanding of the issuer notes of each class within each series (theprincipal amount outstanding being converted into sterling for the purposes ofmaking the calculation). Noteholders should note that, as a result ofrepayments of principal first to the series 2 issuer notes, then to the series3 issuer notes, then to the series 4 issuer notes and then to the series 5issuer notes, the principal amount outstanding of each series of the issuernotes will change after the closing date.

 

**Permanent Holdings Limited (“Holdings”) hasestablished another company, Funding 2, which may become an additional beneficiaryunder the mortgages trust**

 

Holdings has established a separate entity,Funding 2, which may issue new notes from time to time and use the proceeds topay for a direct interest in the trust property rather than lending theproceeds to Funding 1. Simultaneously with the acquisition by Funding 2 of aninterest in the trust property, the seller and Funding 1, as existingbeneficiaries of the mortgages trust, would be required to agree to a decreasein their beneficial interests in the trust property (which would require apartial release of security by Funding 1 over its share in the trust property).

 

The seller, Funding 1 and Funding 2 wouldeach have a joint and undivided interest in the trust property but theirentitlement to the proceeds from the trust property would be in proportion totheir respective shares of the trust property. On each distribution date themortgages trustee would distribute interest and principal receipts to one, twoor all three beneficiaries, depending on the terms of the mortgages trust.

 

It is anticipated that Funding 2 will issuenotes directly or indirectly to investors from time to time backed by its shareof the trust property. Noteholders would not have a direct or indirect interestin Funding 2’s share of the trust property.

 

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

 

•                  themortgage sale agreement to enable the purchase by Funding 2 of interests in thetrust property;

 

•                  themortgages trust deed (i) to establish Funding 2 as a beneficiary of the trust,(ii) to enable the acquisition by Funding 2 of an interest in the trustproperty from time to time and (iii) to regulate the distribution of interestand principal receipts in the trust property to Funding 2 and the otherbeneficiaries;

 

•                  thecash management agreement to regulate the application of monies to Funding 2;

 

•                  theservicing agreement to ensure that Funding 2 receives the benefit of theservicers duties under that agreement; and

 

•                  themaster definitions and construction agreement.

 

In addition, Funding 1, Funding 2 and theseller may enter into new agreements to regulate the making of decisionsbetween them.

 

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There may be conflicts of interest betweenFunding 1 and Funding 2, in which case it is expected that the mortgagestrustee will follow the directions given by the relevant beneficiary (excludingthe seller) that has the largest share of the trust property at that time. Theinterests of Funding 1 may not prevail, which may adversely affect thenoteholders’ interests.

 

Noteholders’ prior consent to the inclusionof Funding 2 as a beneficiary of the mortgages trust and the subsequentamendments to the documents and/or release of security by Funding 1 will not beobtained. Before becoming a beneficiary of the mortgages trust, however,Funding 2 will be required to satisfy a number of conditions, including:

 

•                  obtaininga written 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 will occuras 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 no assurance that the inclusionof Funding 2 as a beneficiary of the mortgages trust would not affect cashflowsavailable to pay amounts due on the noteholders’ issuer notes and thereforeadversely affect the noteholders’ interests.

 

**If Funding 1 enters into new intercompanyloan agreements, then the new term advances may rank ahead of issuer termadvances as to payment, and accordingly new notes may rank ahead of the issuernotes as to payment**

 

Since the closing date, Holdings hasestablished new issuers to issue new notes to investors, and it is likely thatHoldings will establish additional new issuers in the future. The proceeds ofeach new issue will be used by the new issuer to make a new intercompany loanto Funding 1. Funding 1 will use the proceeds of the new intercompany loaneither to:

 

•                  paythe seller in relation to the initial consideration for new loans and theirrelated security to be assigned to the mortgages trustee;

 

•                  paythe seller for a portion of the seller share of the trust property, which willresult in an increase in Funding 1’s share of the trust property;

 

•                  refinancein whole or in part an intercompany loan or intercompany loans outstanding atthat time (and if the issuer’s intercompany loan to Funding 1 is refinanced,noteholders could be repaid early); and/or

 

•                  depositsome of those proceeds in the general reserve fund.

 

The payment and security priorities of theissuer notes relative to each other as set out in the issuer deed of charge andthe issuer cash management agreement will not be affected as a result of anissue of new notes by a new issuer, because that new issue will be separatelydocumented. However, Funding 1 may be required to repay to a new issuer amountsowing under a new term advance ahead of or in the same order of priority asamounts owing to the issuer on the issuer term advances, depending on the termadvance rating, the scheduled repayment date of that new term advance and

 

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certain other rules regarding the repayment of principal by Funding 1.If this is the case, then the relevant new noteholders will be paid before thenoteholders.

 

If Holdings establishes new issuers to makenew intercompany loans to Funding 1, the noteholders will not have any right ofprior review or consent with respect to those new intercompany loans or thecorresponding issuance by new issuers of new notes. Similarly, the terms of theFunding 1 transaction documents (including the mortgage sale agreement, themortgages trust deed, the Funding 1 deed of charge, the definitions of thetrigger events, the criteria for the sale of new loans to the mortgages trusteeand the amount available to be drawn under the Funding 1 liquidity facility) maybe amended to reflect the new issue. Noteholders’ consent to these changes willnot be required. There can be no assurance that these changes will not affectthe cashflows available to pay amounts due on the issuer notes.

 

However, before issuing new notes, a newissuer will be required to satisfy a number of conditions, including:

 

•                  obtaininga written 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.

 

**Funding 1 has entered into other intercompanyloan agreements with other issuers, and some of the term advances in the otherintercompany loans rank ahead of some of the issuer term advances in the issuerintercompany loan as to payment, and accordingly some of the notes issued bythe other issuers rank ahead of some of the issuer notes as to payment**

 

The otherissuers issued notes to investors, the equivalent net issue proceeds of whichwere used by the other issuers to make intercompany loans to Funding 1. Funding1 used most of the proceeds of these intercompany loans to pay the seller forthe initial loans (together with their related security) that it assigned tothe mortgages 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 paymentand security priorities of the issuer notes relative to each other as set outin the issuer deed of charge and the issuer cash management agreement are notaffected as a result of the issue of notes by the other issuers, because theother issues were separately documented. However, Funding 1 may be required topay to the other issuers amounts that are owing under one or more term advancesahead of or in the same order of priority as amounts owing to the issuer on theissuer term advances, depending on the term advance rating, the scheduledrepayment date of that term advance and other rules regarding the payment ofinterest and the repayment of principal by Funding 1. If this is the case thenthe other note holders will be paid before the holders of the issuer notes.

 

**Other creditors will share in the samesecurity granted by Funding 1 to the issuer, and this may adversely affectpayments on the issuer notes**

 

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If Funding 1 enters into a new intercompanyloan agreement, then if required it will also enter into a new start-up loanagreement with new start-up loan providers and the security trustee.

 

If required bythe rating agencies, Funding 1 will use part of the proceeds of the newstart-up loan to fund further the general reserve fund. Similarly, ifnecessary, Funding 1 will also enter into a new Funding 1 swap with either theFunding 1 swap provider or a new Funding 1 swap provider and the securitytrustee.

 

The new issuer, any new start-up loanprovider and any new Funding 1 swap provider will become party to the Funding 1deed of charge and will be entitled to share in the security granted by Funding1 for its benefit (and the benefit of the other Funding 1 secured creditors)under the Funding 1 deed of charge. In addition, the liabilities owed to theFunding 1 liquidity facility provider and the Funding 1 swap provider which aresecured by the Funding 1 deed of charge may increase each time that Funding 1enters into a new intercompany loan agreement. Those factors could ultimatelycause a reduction in the payments noteholders receive on the issuer notes.Noteholders’ consent to the requisite changes to the transition documents willnot be required.

 

**There may be conflicts between the issuer andany new issuers, and the issuer’s interests may not prevail, which mayadversely affect payments on the issuer notes**

 

The security trustee will exercise its rightsunder the Funding 1 deed of charge only in accordance with directions given bythe issuers (which could be the issuer and, if Funding 1 enters into newintercompany loans, any new issuer) that have the highest-ranking outstandingterm advances, provided that the security trustee is indemnified and/or securedto its satisfaction.

 

If the security trustee receives conflictingdirections, it will follow the directions given by the relevant issuersrepresenting the largest principal amount outstanding of relevant termadvances. If the issuer is not in the group representing that largest principalamount, then its interests may not prevail. This could ultimately cause areduction in the payments the noteholders receive on the issuer notes.

 

**As new loans are sold to the mortgagestrustee, the characteristics of the trust property may change from thoseexisting at the closing date, and those changes may adversely affect paymentson the issuer notes**

 

There is no guarantee that any new loans soldto the mortgages trustee will have the same characteristics as the loans in theinitial portfolio as of the closing date. In particular, new loans may havedifferent payment characteristics than the loans in the initial portfolio as ofthe closing date. The ultimate effect of this could be to delay or reduce thepayments the noteholders receive on the issuer notes.

 

**The yield to maturity of the issuer notes maybe adversely affected by prepayments or redemptions on the loans**

 

The yield to maturity of the issuer notes ofeach class will depend mostly on (a) the amount and timing of payment ofprincipal on the loans and (b) the price paid by noteholders of each class ofissuer notes. The yield to maturity of the issuer notes of each class may beadversely affected by a higher or lower than anticipated rate of prepayments onthe loans.

 

No assurance can be given that Funding 1 willaccumulate sufficient funds during the cash accumulation period relating to theissuer series 2 term AAA advance, each scheduled amortization installment underthe issuer series 3 term AAA advance and/or each scheduled amortizationinstallment under the issuer series 4 term AAA advance to enable it to repaythese issuer term advances to the issuer so that the corresponding classes ofissuer notes will be redeemed in their entirety on their scheduled redemption dates.

 

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During the cash accumulation period for theissuer term advances and scheduled amortization installments, repayments ofprincipal will only be made on the issuer series 5 term AAA advance, the issuerterm AA advances or the issuer term BBB advances that are due and payable ifthe quarterly CPR of the loans in the trust property is greater than 15 percent. and certain other conditions are met. This means that there may be nocorresponding repayments of principal on the series 5 class A issuer notes, theclass B issuer notes or the class C issuer notes.

 

The extent to which sufficient funds aresaved by Funding 1 during a cash accumulation period or received by it from itsshare in the mortgages trust on a scheduled repayment date will depend onwhether the actual principal prepayment rate of the loans is the same as theassumed principal prepayment rate. If Funding 1 is not able to save enoughmoney during a cash accumulation period or does not receive enough money fromits share in the mortgages trust on a scheduled repayment date to repay therelevant issuer term AAA advance (and if it is unable to make a drawing on theFunding 1 liquidity facility or the reserve fund to make good the shortfall) sothat the issuer can redeem the class A issuer notes of the corresponding serieson 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.

 

**The issuer’s ability to redeem the series 2class A issuer notes, the series 3 class A issuer notes and/or the series 4class A issuer notes on their scheduled redemption dates is affected by therate of prepayment on the loans**

 

The rate of prepayment of loans is influencedby a wide variety of economic, social and other factors, including prevailingmortgage market interest rates, the availability of alternative financingprograms, local and regional economic conditions and homeowner mobility. Forinstance, prepayments on the loans may be due to borrowers refinancing theirloans and sales of properties by borrowers (either voluntarily or as aresult of enforcement action taken). In addition, if theseller is required to repurchase a loan or loans under a mortgageaccount and their related security because, for example, one of the loansdoes not comply with the loan warranties in the mortgage sale agreement, thenthe payment received by the mortgages trustee will have the same effect as a prepaymentof all of the loans under the mortgage account. Because these factors are notwithin its control or the control of Funding 1 or the mortgages trustee, theissuer cannot give any assurances as to the level of prepayments that theportfolio may experience.

 

Variation in the rate of prepayments ofprincipal on the loans may affect each class of the issuer notes differentlydepending upon amounts already repaid by Funding 1 to the issuer under theissuer intercompany loan and whether a trigger event has occurred, or a loan issubject to a product switch or a further advance or the security granted by theissuer under the issuer deed of charge has been enforced. If prepayments on theloans occur less frequently than anticipated, then there may not be sufficientfunds available to redeem the series 2 class A issuer notes and/or the series 3class A issuer notes and/or the series 4 class A issuer notes in full on theirrespective scheduled redemption dates.

 

**The seller may change the lending criteriarelating to loans that are subsequently assigned to the mortgages trustee,which could affect the characteristics of the trust property and which mayadversely affect payments on the issuer notes**

 

Each of the loans was originated inaccordance with the seller’s lending criteria at the time of origination. Theselending criteria consider a variety of factors such as a potential borrower’scredit history, employment history and status and repayment ability, as well asthe value of the property to be mortgaged. In the event of the sale of any newloans and new related security to the mortgages

 

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trustee, the seller will warrant that those new loans and new relatedsecurity were originated in accordance with the seller’s lending criteria atthe time of their origination. However, the seller retains the right to reviseits lending criteria as determined from time to time, and so the lendingcriteria applicable to any loan at the time of its origination may not be orhave been the 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.

 

**The seller hasadopted procedures relating to investigations and searches for remortgageswhich could affect the characteristics of the trust property and which mayadversely affect payments on the issuer notes**

 

The seller does not require a solicitor,licensed conveyancer or (in Scotland) qualified conveyancer to conduct a fullinvestigation of the title to a property in all cases. Where the borrower isremortgaging there will be a limited investigation to carry out some but notall of the searches and investigations which would normally be carried out by asolicitor conducting a full investigation of the title to a property.Properties which have undergone such a limited investigation may be subject tomatters which would have been revealed by a full investigation of title andwhich may have been remedied or, if incapable of remedy, may have resulted inthe properties not being accepted as security for a loan had the matters beenrevealed, though to mitigate against this risk search indemnity insurance isobtained in respect of the properties. The introduction of loans secured by theproperties into the trust property could result in a change of thecharacteristics of the trust property. This could lead to a delay or areduction in the payments received on the issuer notes.

 

**The timing and amount of payments on theloans could be affected by various factors that may adversely affect paymentson the issuer notes**

 

The loans are affected by credit, liquidity andinterest rate risks. Various factors influence mortgage delinquency rates,prepayment rates, repossession frequency and the ultimate payment of interestand principal, such as changes in the national or international economicclimate, regional economic or housing conditions, changes in tax laws, interestrates, inflation, the availability of financing, yields on alternativeinvestments, political developments and government policies. Other factors inborrowers’ individual, personal or financial circumstances may affect theability of borrowers to repay loans. Loss of earnings, illness, divorce andother similar factors may lead to an increase in delinquencies by andbankruptcies of borrowers, and could ultimately have an adverse impact on theability of borrowers to repay loans.

 

In addition, the ability of a borrower tosell a 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.

 

Further, the mortgage loan industry in theUnited Kingdom is highly competitive. This competitive environment may affectthe rate at which the seller originates new loans and may also affect the levelof attrition of the seller’s existing borrowers.

 

The principal source of income for repaymentof the issuer notes by the issuer is the issuer intercompany loan. Theprincipal source of income for repayment by Funding 1 of the issuerintercompany loan is its interest in the loans held on trust by the mortgagestrustee for Funding 1 and the seller. If the timing and payment of the loans isadversely affected by any of the risks described in this section, the paymentson the issuer notes could be reduced or delayed.

 

**The occurrence of trigger events andenforcement of the issuer security may adversely affect the scheduledredemption dates of the series 2 class A issuer notes, series 3 class A issuernotes and/or series 4 class A issuer notes**

 

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If no trigger event has occurred and theissuer security has not been enforced in accordance with the terms of theissuer deed of charge, then payments of principal will not occur on the series2 class A issuer notes and/or series 3 class A issuer notes and/or series 4class A issuer notes before their respective scheduled redemption dates.

 

If a trigger event occurs or the issuersecurity is enforced in accordance with the issuer deed of charge prior to thescheduled redemption dates for the series 2 class A issuer notes and/or series3 class A issuer notes and/or series 4 class A issuer notes, then the relevantclasses of issuer notes outstanding will not be repaid on their scheduled redemptiondates but will be repaid on each interest payment date from monies receivedfrom Funding 1 on the issuer term AAA advances of the corresponding series asdescribed in the following three risk factors.

 

**If an asset trigger event occurs, any series2 class A issuer notes, series 3 class A issuer notes, and/or series 4 class Aissuer notes then outstanding will not be repaid on their scheduled redemptiondates**

 

When an asset trigger event has occurred, themortgages trustee will distribute principal receipts on the loans to Funding 1and the seller proportionally and equally based on their percentage shares ofthe trust property (that is, the Funding 1 share percentage and the sellershare percentage). When an asset trigger event has occurred, Funding 1 willrepay (after making requisite payments to the Funding 1 liquidity facilityprovider and to replenish the reserve fund):

 

*first*, the issuerterm AAA advances in respect of the issuer intercompany loan, the previousintercompany loans and any new intercompany loans, until all of those term AAAterm advances are fully repaid;

 

*then*, the issuerterm AA advances in respect of the issuer intercompany loan, the previousintercompany loans and any new intercompany loans, until all of those term AAterm advances are fully repaid;

 

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

 

*finally*, the issuerterm BBB advances in respect of the issuer intercompany loan, the previousintercompany loans and any new intercompany loans, until all of those term BBBterm advances are fully repaid.

 

If an asset trigger event occurs, any series2 class A issuer notes and/or series 3 class A issuer notes and/or series 4class A issuer notes then outstanding will not be repaid on their scheduledredemption dates, and there is also a risk that they will not be repaid bytheir final maturity dates.

 

**If a non-asset trigger event occurs, anyseries 2 class A issuer notes, series 3 class A issuer notes and/or series 4class A issuer notes then outstanding will not be repaid on their scheduledredemption dates**

 

If a non-asset trigger event has occurred,but an asset trigger event has not occurred, the mortgages trustee willdistribute all principal receipts to Funding 1 until the Funding 1 sharepercentage of the trust property is zero. When a non-asset trigger event hasoccurred, Funding 1 will repay (after making requisite payments to the Funding1 liquidity facility provider and to replenish the reserve funds):

 

*first*, the term AAAadvance with the earliest final repayment date, then to repay the term AAAadvance with the next earliest final repayment date, and so on until the termAAA advances in

 

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respect of the issuer intercompany loan, the previous issuerintercompany loan and any new issuer intercompany loans are fully repaid;

 

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

 

*then*, the term Aadvances in respect of, the previous issuer intercompany loans and any newissuer intercompany loans, until each of those term AA advances is fullyrepaid; and

 

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

 

If a non-asset trigger event occurs, anyseries 2 class A issuer notes, series 3 class A issuer notes and/or series 4class A issuer notes then outstanding will not be repaid on their scheduledredemption dates.

 

**If the issuer security is enforced, anyseries 2 class A issuer notes, series 3 class A issuer notes and/or series 4class A issuer notes then outstanding will not be repaid on their scheduledredemption dates**

 

If the issuer security is enforced, then themortgages trustee will distribute funds as required under the terms of thetransaction agreements. In these circumstances, any series 2 class A issuernotes, series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates and there isalso a risk that those class A issuer notes may not be repaid by their finalmaturity dates.

 

**Loans subject to further advances will berepurchased by the seller from the mortgages trustee, which will affect theprepayment rate of the loans, and this may affect the yield to maturity of theissuer notes**

 

If the servicer at its discretion decides togrant a borrower a further advance under a loan which has been assigned to themortgages trustee, then the seller will be required to repurchase that loan underthe relevant mortgage account and its related security from the mortgagestrustee save for any loan in arrears at a price equal to the outstandingprincipal balance of those loans together with any accrued and unpaid interestand expenses to the date of purchase. The yield to maturity of the issuer notesmay be affected by the repurchase of loans subject to further advances.

 

**In limited circumstances, loans subject toproduct switches will be repurchased by the seller from the mortgages trustee,which will affect the prepayment rate of the loans, and this may affect theyield to maturity of the issuer notes**

 

Loans subject to product switches will not berepurchased unless on any distribution date, the seller is in breach of theconditions precedent to the sale of new loans to the mortgages trustee. Fromand including that date to but excluding the date when those conditionsprecedent have been satisfied, the seller will be required to repurchase anyloans and their related security that are subject to product switches. Theseller will be required to repurchase the relevant loan or loans under therelevant mortgage account and their related security from the mortgages trusteeat a price equal to the outstanding principal balance of those loans together withany accrued and unpaid interest and expenses to the date of purchase.

 

A loan will be subject to a product switch ifthe borrower and the seller agree on or the servicer offers a variation in thefinancial terms and conditions applicable to the relevant borrower’s loan,other than:

 

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•                  anyvariation agreed with a borrower to control or manage arrears on the loan;

 

•                  anyvariation to the interest rate as a result of a borrower being linked to HVR 2;

 

•                  anyvariation in the maturity date of the loan unless, while the issuerintercompany loan is outstanding, it is extended beyond June 2040;

 

•                  anyvariation imposed by statute;

 

•                  anyvariation of the rate of interest payable in respect of the loan where thatrate is offered to the borrowers of more than 10 per cent. by outstandingprincipal amount of loans comprised in the trust property in any interestperiod; or

 

•                  anyvariation in the frequency with which the interest payable in respect of theloan is charged.

 

The yield to maturity of the issuer notes maybe affected by the repurchase of loans subject to product switches.

 

**Ratings assigned to the issuer notes may belowered or withdrawn after the noteholders purchase the issuer notes, which maylower the market value of the issuer notes**

 

The ratings assigned to each class of theissuer notes address the likelihood of full and timely payment to thenoteholders of all payments of interest on each interest payment date underthose classes of the issuer notes. The ratings also address thelikelihood of “ultimate” payment of principal on the finalmaturity date of each class of the issuer notes. Any ratingagency may lower its rating or withdraw its rating if, in the sole judgment ofthe rating agency, the credit quality of the issuer notes has declined or is inquestion. If any rating assigned to the issuer notes is lowered or withdrawn,the market value of the issuer notes may be reduced.

 

A change to the ratings assigned to eachclass of the issuer notes will not affect the term advance ratings assigned toeach issuer term advance in the intercompany loans.

 

**Subordination of the other note classes maynot protect noteholders from all risk of loss**

 

The class B issuer notes and class C issuernotes are subordinated in right of payment of interest to the class A issuernotes. The class C issuer notes are subordinated in right of payment ofinterest to the class B issuer notes. However, the transaction has beenstructured in the expectation that the series 2 issuer notes will be repaid infull prior to the redemption of the series 3 class A issuer notes, the series 4class A issuer notes, the series 5 class A issuer notes.

 

Accordingly, there is no assurance that thesesubordination rules will protect the holders of class A issuer notes or theholders of class B issuer notes from all risk of loss.

 

**Principal payments onthe original pass-through notes will be deferred in some circumstances**

 

Principal repaymentson the issuer term AA advances and/or the issuer term BBB advances will bedeferred in the following circumstances:

 

If on a Funding 1interest payment date;

 

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•                  thereis a debit balance on the BBB principal deficiency sub-ledger, the A principaldeficiency sub-ledger or the AA principal deficiency sub-ledger afterapplication of the Funding 1 available revenue receipts on that Funding 1interest payment date; or

 

•                  theadjusted general reserve fund level is less than the reserve fund threshold; or

 

•                  theaggregate outstanding principal balance of loans in the mortgages trust, inrespect to which the aggregate amount in arrears is more than three times themonthly payment then due, is more than 5 per cent. of the aggregate outstandingprincipal balance of loans in the mortgages trust;

 

then to the extent that any term AAA advance remains outstanding(whether or not such term AAA advance is then due and payable) after theallocation of principal on that Funding 1 interest payment date to those termadvances, the issuer term AA advances and issuer term BBB advances will not beentitled to principal repayments until the relevant circumstance as describedabove has been remedied or otherwise ceases to exist. In addition, if any termAA advance remains outstanding (whether or not such term AA advance is then dueand payable) after the allocation of principal on that Funding 1 interestpayment date to those term advances, the issuer term BBB advances will not beentitled to principal repayments until the relevant circumstance as describedabove has been remedied or otherwise ceases to exist and if any term A advanceremains outstanding (whether or not such term A advance is then due and payableafter the allocation of principal on that Funding 1 interest payment date to thoseterm advances, the issuer term BBB advance will not be entitled to principalrepayments until the relevant circumstances as described above have beenremedied or otherwise cease to exist. This means that payments of principal onthe class C issuer notes of all series and, as applicable, the class B issuernotes of all series will be deferred until the earlier of the time when therelevant circumstance described in this risk factor has been remedied (if ever)and the final maturity date of the relevant notes.

 

Furthermore, if, on a Funding 1 interestpayment date prior to the issuer step-up date:

 

•                  oneor more bullet term advances and/or scheduled amortization installments arethen in a cash accumulation period;

 

•                  thequarterly CPR is less than 15 per cent.; and

 

•                  thereis a cash accumulation shortfall at that time;

 

then, on or before their step-up dates, the issuer term advances thatare original pass-through term advances will be entitled to principalrepayments only to the extent permitted under the pass-through repaymentrestrictions.

 

**Series 2 issuernotes, series 3 issuer notes, series 4 issuer notes and series 5 issuer notesmay be subject to risk if the trust property deteriorates after repayment ofprevious series of the issuer notes**

 

If the loans comprising the trust property donot perform as expected at any time after the repayment in full of the series 1issuer notes and/or the series 2 issuer notes, then the series 2 issuer notesand/or the series 3 issuer notes and/or the series 4 issuer notes and/or theseries 5 issuer notes may not be repaid in full.

 

**Noteholders may be subject to exchange raterisks on the series 2 issuer notes, the series 3 issuer notes, the series 4class A1 issuer notes, the series 4 class B issuer notes, the series 4 class Cissuer notes, the series 5 class B issuer notes and the series 5 class C issuernotes**

 

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Repayments of principal and payments ofinterest on the series 2 issuer notes and the series 3 issuer notes will bemade in US dollars and on the series 4 class A1 issuer notes, series 4 class Bissuer notes, series 4 class C issuer notes, series 5 class B issuer notes andthe series 5 class C issuer notes will be made in euro, but the issuer termadvances made by the issuer to Funding 1 and repayments of principal andpayments of interest by Funding 1 to the issuer under the issuer intercompanyloan will be in sterling.

 

To hedge its currency exchange rate exposure,including the interest rate exposure connected with that currency exposure, theissuer has entered into the issuer dollar currency swaps for the series 2issuer notes and the series 3 issuer notes with the issuer dollar currency swapproviders and the issuer euro currency swaps for the series 3 issuer notes andthe series 4 class A1 issuer notes, series 4 class B issuer notes, series 4class C issuer notes, series 5 class B issuer notes and the series 5 class Cissuer notes with the issuer euro currency swap providers.

 

If the issuer fails to make timely paymentsof amounts due under an issuer swap, then the issuer will have defaulted underthat issuer swap. Each issuer swap provider is obliged only to make paymentsunder an issuer swap as long as the issuer make payments under the same. If anissuer swap provider is not obliged to make payments, or if it exercises anyright to terminate that it may have under the relevant issuer swap, or if itdefaults in its obligations to make payments of amounts in US dollars or euro,as applicable, 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 andin the associated interest rates on these currencies. Unless a replacementissuer swap is entered into, the issuer may have insufficient funds to makepayments due on the issuer notes of any class and any series that are thenoutstanding.

 

Each issuer swap provider will be obliged togross up payments made by it to the issuer if withholding taxes are imposed onpayments under the relevant issuer swap and the AIG issuer swap guarantor willbe obliged to gross up payments made by it to the issuer if withholding taxesare imposed on payments under the AIG issuer swap guarantee. However, if such agross up is required, the relevant swap provider may subject to obtaining theconsent of the security trustee, terminate the relevant issuer currency swap.If it does terminate the relevant issuer currency swap, the issuer will beexposed to changes in currency exchange rates and in the associated interestrates on these currencies. Unless a replacement issuer currency swap is enteredinto, the issuer may have insufficient funds to make payments due on the issuernotes of any class and any series that are then outstanding.

 

# **Noteholders may besubject to interest rate risk on the series 5 class A issuer notes**

# ** **

The issuer will pay investors a fixed rate ofinterest on the series 5 class A notes until the interest payment date fallingin December 2010 but Funding 1 will pay the issuer a LIBOR based rate ofinterest for three-month sterling deposits on the advances the issuer madeunder the issuer intercompany loan. To hedge the issuer interest rate exposureagainst possible adverse floating rate interest movements, the issuer hasentered into the issuer interest rate swap for the series 5 class A issuernotes with the issuer interest rate swap provider.

 

If the issuer fails to make timely paymentsof amounts due under the issuer interest rate swap, then the issuer will havedefaulted under the issuer interest rate swap. The issuer interest rate swapprovider is obliged only to make payments under the issuer interest rate swapif and for so long as the issuer makes payments under the same. If the issuerinterest rate swap provider is not obliged to make payments, or if it defaultsin its obligations to make payments of amounts equal to the full amount to bepaid by it on the payment dates under the issuer interest rate swap (which arethe same dates as the interest payment dates in respect of the series 5 class Aissuer notes), the issuer will be exposed to any difference between the amountpayable to them by Funding 1 on the issuer series 5 term AAA advance and theamount of interest payable by the issuer to investors on the series 5 class Aissuer notes. Unless a replacement issuer interest rate swap is entered into,the issuer may have insufficient

 

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funds to make payments of interest due on the issuer notes of any classor series that are then outstanding.

 

**The mortgages trusteeGIC provider or the Funding 1 GIC provider may cease to satisfy certaincriteria to provide the mortgages trustee GIC account or the Funding 1 GICaccount**

 

The mortgages trustee GIC provider and theFunding 1 GIC provider are required to satisfy certain criteria (includingcertain criteria and/or permissions set or required by the Financial ServicesAuthority (the”FSA”) from time to time) in order to continue to receivedeposits in the mortgages trustee GIC account and the Funding 1 GIC accountrespectively. If either the mortgages trustee GIC provider or the Funding 1 GICprovider ceases to satisfy those criteria then the relevant account may betransferred to another entity that does satisfy those criteria. In thesecircumstances the new GIC provider may not offer a GIC on terms as favorable asthose provided by the mortgages trustee GIC provider or the Funding 1 GICprovider.

 

The criteria referred to above include arequirement that the short-term, unguaranteed and unsecured ratings of themortgages trustee GIC provider or the Funding 1 GIC provider, as the case maybe, are at least A-1+ by Standard & Poor’s, F1+ by Fitch and P-1 by Moody’s,unless each rating agency confirms that its then current rating of the noteswould not be adversely affected as a result of such ratings falling below theseminimum ratings.

 

**Termination payments on the issuer swaps mayadversely affect the funds available to make payments on the issuer notes**

 

If any of the issuer swaps terminate, theissuer may as a result be obliged to make a termination payment to the relevantissuer swap provider. The amount of the termination payment will be based onthe cost of entering into a replacement issuer swap. Under the issuerintercompany loan agreement, Funding 1 will be required to pay the issuer anamount equal to any termination payment due by the issuer to the relevantissuer swap provider. Funding 1 will also be obliged to pay the issuer anyextra amounts that the issuer may be required to pay to enter into areplacement swap.

 

The issuer cannot give noteholders anyassurance that Funding 1 will have the funds available to make that payment orthat the issuer will have sufficient funds available to make any terminationpayment under any of its issuer swaps or to make subsequent paymentsto noteholders in respect of the relevant series and class of the issuernotes. Nor can the issuer give noteholders any assurance that it will be ableto enter into a replacement issuer swap, or, if oneis entered into, that the credit rating of thereplacement issuer swap provider will be sufficiently high to prevent adowngrading of the then current ratings of the issuer notes by the ratingagencies.

 

Except where the relevant issuer swap provider has caused therelevant issuer swap to terminate by its own default, any termination paymentdue by the issuer will rank equally not only with payments due to the holdersof the series and class of the issuer notes which rank equally with the series and class ofissuer notes to which the relevant swap relates but also with payments dueto the holders of any other series and class of issuer notes to which therelevant swap relates. Any additional amounts required to be paid by the issuerfollowing termination of the relevant issuer swap (including any extra costsincurred (for example, from entering into “spot” currency or interest rateswaps) if the issuer cannot immediately enter into a replacement swap) willalso rank equally not only with payments due to the holders of the series andclass of the issuer notes to which the relevant issuer swap relates but alsowith payments due to the holder of any other series and class of the issuernotes which rank equally with the series and class of the issuer notes to whichthe relevant issuer swap relates. Furthermore, any termination payment oradditional payment or additional amounts required to be paid by the issuerfollowing termination of an issuer swap will rank ahead of payments due to theholders of any series and class of the issuer notes which ranks below theseries and class of the issuer notes to which the relevant issuer swap relates.Therefore, if the issuer is obliged to make a

 

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termination payment to the relevant issuer swapprovider or to pay any other additional amount as a result of the terminationof the relevant issuer swap, this may affect the funds which the issuer hasavailable to make payments on the issuer notes of any class and any series.

 

**Risks associated with the Funding 1 swap**

 

To provide a hedge against (a) the mortgagestrustee variable base rate payable on the variable rate loans, the rates ofinterest payable on the tracker rate loans and the fixed rates of interestpayable on the fixed rate loans; and (b) the rate of interest payable byFunding 1 on the intercompany loans, Funding 1 has entered into the Funding 1swap agreement. If Funding 1 fails to make timely payments under the Funding 1swap, it will have defaulted under the Funding 1 swap. The Funding 1 swapprovider is obliged only to make payments under the Funding 1 swap if and forso long as Funding 1 makes payments under the same. If the Funding 1 swapprovider is not obliged to make payments, or if it exercises any right toterminate that it may have under the Funding 1 swap, or if it defaults in itsobligation to make payments under the Funding 1 swap, Funding 1 will be exposedto the variance between the rates of interest payable on the loans and the rateof interest payable by it under the intercompany loans unless a replacementFunding 1 swap is entered into. If the Funding 1 swap terminates, Funding 1 mayas a result be obliged to make a termination payment to the Funding 1 swapprovider. Any variance between the rates of interest payable on the loans andthe rate of interest payable by Funding 1 under the intercompany loans and anytermination payment payable by it to the Funding 1 swap provider may adverselyaffect the ability of Funding 1 to meet its obligations under the issuerintercompany loan agreement.

 

Funding 1 will receive interest on thevariable rate loans, which is based on HVR 1 or HVR 2. The paymentobligations of Funding 1 under the Funding 1 swap will, among other things, bebased on the average of the standard variable mortgage rates or theirequivalent charged to existing borrowers on residential mortgage loans aspublished from time to time, after excluding the highest and the lowest rate,of Abbey National plc, HSBC Bank plc, Cheltenham & Gloucester plc, NationalWestminster Bank Plc, Nationwide Building Society, Northern Rock plc andWoolwich plc (and where those banks have more than one standard variable rate,the highest of those rates). While it is anticipated that the average rate willbroadly track both HVR 1 and HVR 2, the variance between the average rate andHVR 1 and HVR 2, respectively, may affect the ability of Funding 1 to meet itspayment obligations under the Funding 1 swap agreement.

 

**The issuer relies on third parties to performservices in relation to the issuer notes, and the noteholders may be adverselyaffected if they fail to perform their obligations**

 

The issuer is a party to contracts with anumber of other third parties that have agreed to perform services in relationto the issuer notes. For example, the issuer swap providers have agreed toprovide their respective issuer swaps, the corporate services provider has agreedto provide corporate services and the paying agents and the agent bank haveagreed to provide payment and calculation services in connection with theissuer notes. In the event that any of these parties were to fail to performtheir obligations under the respective agreements to which they are a party,the noteholders may be adversely affected.

 

**The issuer may be unable to pay, in full orat all, interest due on the issuer notes if there is an income or principaldeficiency**

 

If, on any Funding 1 interest payment date,revenue receipts available to Funding 1 (including the reserve fund) areinsufficient to enable Funding 1 to pay interest on the issuer term advancesand any new term advances and other expenses of Funding 1 ranking higher inseniority to interest due on these term advances, then Funding 1 may useprincipal receipts on the loans received by it in the mortgages trust to makeup the shortfall.

 

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Funding 1 will use principal receipts thatwould have been applied to repay the term advances with the lowest term advancerating to pay interest on those other term advances and senior expensesdescribed in the preceding paragraph where there is a shortfall of monies topay those amounts. At the closing date, the relevant term advances with thelowest term advance rating 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.

 

Funding 1 will be obliged to keep a ledgerthat records any principal applied to pay interest and senior expenses (as wellas any losses on the loans causing a principal deficiency). When the amountrecorded on the ledger is equal to the principal amount outstanding of the termBBB advances, then Funding 1 will use principal receipts that would have beenapplied to repay the term advance with the next lowest ranking term advancerating to pay interest on the term advances and senior expenses where there isa shortfall of money to pay those amounts. When the amount recorded on theprincipal deficiency ledger exceeds the principal amount outstanding on theterm A advances, Funding 1 will use principal that would have been applied torepay the term AA advances to pay those amounts. When the amount recorded onthe principal deficiency ledger exceeds the principal amount outstanding on theterm AA advances, Funding 1 will use principal receipts that would have beenapplied to repay the term AAA advances to pay those amounts.

 

During the term of the transaction, however,it is expected that any principal deficiencies will be recouped from subsequentexcess revenue receipts and amounts standing to the credit of the reserve fund.The revenue receipts and the reserve fund monies will be applied first to coverany principal deficiency in respect of the term advances with the highest termadvance rating, and then the term advances with the next highest ranking termadvance rating, and so on down to the term advances with the lowest termadvance rating.

 

If there are insufficient funds availablebecause of income or principal deficiencies, then one or more of the followingconsequences may occur:

 

•                  theinterest and other net income of Funding 1 may not be sufficient, after makingthe payments to be made in priority, to pay, in full or at all, interest due onthe issuer term BBB advances and the issuer term AA advances;

 

•                  theremay be insufficient funds to repay any of the issuer term BBB advances and theissuer term AA advances prior to their final repayment dates unless the othernet income of Funding 1 is sufficient, after making other prior rankingpayments, to reduce any principal deficiency in respect of the term BBBadvances, term A advances and term AA advances;

 

•                  ifthe amount of principal deficiencies exceeds the principal amount outstandingof any of the term advances (and the principal deficiencies cannot be coveredby the other income of Funding 1), then the issuer may not receive the fullprincipal amount of any or all of the issuer term advances and, accordingly,the noteholders may not receive the full face value of the class C issuernotes, the class B issuer notes and the class A issuer notes, as the case maybe; and/or

 

•                  theissuer may be unable to pay, in full or at all, interest due on the issuernotes.

 

**The seller share of the trust property doesnot provide credit enhancement for the issuer notes**

 

Any losses from loans included in the trustproperty will be allocated to Funding 1 and the seller proportionally on eachdistribution date in accordance with the Funding 1 share percentage and theseller share percentage of the trust property. The seller’s share of the trustproperty therefore does

 

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not provide credit enhancement for the Funding 1 share of the trustproperty or the issuer notes. Losses on the loans in the trust property areallocated proportionately between the seller and Funding 1 depending on theirrespective shares in the trust property.

 

**The issuer will only have recourse to theseller if there is a breach of warranty by the seller, but otherwise the seller’sassets will not be available to the issuer as a source of funds to makepayments on the issuer notes**

 

After an issuer intercompany loanacceleration notice under the issuer intercompany loan is given, the securitytrustee may, but shall not be obliged to, sell the Funding 1 share of the trustproperty. There is no assurance that a buyer would be found or that a sale wouldrealize enough money to repay amounts due and payable under the issuerintercompany loan agreement.

 

The issuer, Funding 1 and the mortgages trustee will not haveany recourse to the seller of the loans, other than in respect of a breach ofwarranty under the mortgage sale agreement.

 

The issuer, Funding 1, the mortgages trusteeand the security trustee will not undertake any investigations, searches orother actions on any loan or its related security and each of them will relyinstead on the warranties given in the mortgage sale agreement by the seller.

 

If any of the warranties made by the seller(a) in the case of each loan in the portfolio, was materially untrue on thedate the loan was assigned to the mortgages trustee or (b) in the case of eachnew loan, is materially untrue on the date the new loan is assigned to themortgages trustee, then the seller will be required to remedy the breach within20 London business days of the seller becoming aware of the same or of receiptby it of a notice from the mortgages trustee.

 

If the seller fails to remedy the breachwithin 20 London business days, then the seller will be required to repurchasethe loan or loans under the relevant mortgage account and their relatedsecurity at their outstanding principal balance as of the date of repurchasetogether with any arrears of interest and accrued and unpaid interest andexpenses. There can be no assurance that the seller will have the financialresources to repurchase the loan or loans under the relevant mortgage accountand their related security. However, if the seller does not repurchase thoseloans and their related security when required, then the seller’s share of thetrust property will be deemed to be reduced by an amount equal to the principalamount outstanding of those loans together with any arrears of interest andaccrued and unpaid interest and expenses.

 

Other than as described here, neither thenoteholders nor the issuer will have any recourse to the assets of the seller.

 

**There can be no assurance that a borrowerwill repay principal at the end of the term on an interest-only loan, which mayadversely affect repayments on the issuer notes**

 

Each loan in the portfolio is repayableeither on a principal repayment basis or an interest-only basis. Of the loansin the portfolio as at January 1, 2005, approximately 33.27 per cent.were interest-only loans. For interest-only loans, because the principal isrepaid in a lump sum at the maturity of the loan, the borrower is recommendedto have some repayment mechanism such as an investment plan in place which isintended to provide sufficient funds repay the principal at the end of theterm. However, the seller does not ensure that a repayment mechanism is inplace in all cases and does not take security over these repayment mechanisms.The borrower is also recommended to take out a life insurance policy inrelation to the loan but, as with repayment mechanisms, the seller does nottake security over these life insurance policies.

 

The ability of a borrower to repay theprincipal on an interest-only loan at maturity depends on the borrower’sresponsibility to ensure that sufficient funds are available from an investmentplan

 

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or another source, such as ISAs, pension policies, personal equityplans or endowment policies, as well as the financial condition of theborrower, tax laws and general economic conditions at the time.

 

There can be no assurance that the borrowerwill have the funds required to repay the principal at the end of the term. Ifa borrower cannot repay the loan and a loss occurs on the loan, then this mayaffect repayments of principal on the issuer notes if that loss cannot be curedby amounts standing to the credit of the reserve fund or the application ofexcess Funding 1 available revenue receipts.

 

**There may be risks associated with the factthat the mortgages trustee has no legal title to the loans and their relatedsecurity, which may adversely affect payments on the issuer notes**

 

The sale by the seller to the Englishmortgages trustee of the mortgages will take effect in equity only. The sale bythe seller to the mortgages trustee of the Scottish mortgages has been giveneffect by a Scottish declaration of trust by the seller (and any sale of Scottishmortgages in the future will be given effect by further Scottish declarationsof trust) by which the beneficial interest in the Scottish mortgages has beenor will be transferred to the mortgages trustee. In each case this means thatlegal title to the loans in the trust property remains with the seller, but themortgages trustee has all the other rights and benefits relating toownership of each loan and its related security (which rights and benefits aresubject to the trust in favor of the beneficiaries). The mortgages trustee hasthe right to demand that the seller give it legal title to the loans and therelated security in certain circumstances and until then the mortgages trusteewill not give notice of the sale of the English mortgages to any borrower orapply to the Land Registry or the Central Land Charges Registry to register orrecord its equitable interest in the English mortgages or take any steps tocomplete or perfect its title to the Scottish mortgages.

 

Because the mortgages trustee has notobtained legal title to the loans or their related security, there are risks,as follows:

 

•                  first,if the seller wrongly sold a loan which has already been assigned to themortgages trustee to another person, and that person acted in good faith and didnot have notice of the interests of the mortgages trustee or the beneficiariesin the loan, 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,the rights 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 a borrower exercises any set-offrights, then an amount equal to the amount set off will reduce the total amountof the seller share of the trust property only, and the minimum seller sharehas been sized in an amount expected to cover this risk, although there is noassurance that it will. If the minimum seller share is exhausted, then theamount of any set-offs would be applied to reduce the Funding 1 share of thetrust property.

 

Once notice has been given to borrowers ofthe transfer of the loans and their related security to the mortgages trustee,independent set-off rights which a borrower has against the seller willcrystallize (such as, for example, set-off rights associated with borrowersholding deposits with the

 

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seller) and further rights of independent set-off would cease to accruefrom that date and no new rights of independent set-off could be assertedfollowing that notice. Set-off rights arising under transaction set-off (whichare set-off claims arising out of a transaction connected with the loan) willnot be affected by that notice.

 

**Set-off risks in relation to flexible loansand delayed cashbacks may adversely affect the funds available to the issuer torepay the issuer notes**

 

The seller has made, and in the future maymake, an equitable assignment of the relevant loans and their related security,or in the case of Scottish loans a transfer of the beneficial interest in therelevant loans and their related security, with legal title being retained bythe seller. Therefore, the rights of the mortgages trustee may be subject tothe direct rights of the borrowers against the seller, including rights ofset-off existing prior to notification to the borrowers of the sale of the mortgages.Although the mortgages trustee does not currently include flexible loans ordelayed cashbacks, those loans may be added to the mortgages trust in thefuture. Set-off rights (including analogous rights in Scotland) may occur ifthe seller fails to advance to a borrower a drawing or permit the borrower tomake an underpayment or to take a payment holiday under a flexible loan or ifthe seller fails to pay to a borrower any delayed cashback which the seller hadagreed to pay to that borrower after completion of the relevant loan.

 

If the seller fails to advance the drawing orpermit the borrower to make an underpayment or take a payment holiday or paythe delayed cashback, then the relevant borrower may set off any damages claim(or exercise analogous rights in Scotland) arising from the seller’s breach ofcontract against the seller’s (and, as assignee or holder of the beneficialinterest in the loans and their related security, the mortgages trustee’s)claim for payment of principal and/or interest under the loan as and when itbecomes due. These set-off claims will constitute transaction set-off asdescribed in the immediately preceding risk factor.

 

The amount of the claim in respect of adrawing will, in many cases, be the cost to the borrower of finding analternative source of finance although, in the case of flexible loans ordelayed cashbacks which are Scottish, it is possible that the borrower’s rightof 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 circumstancescommunicated by the borrower to the seller at the time the mortgage was takenout or which otherwise were reasonably foreseeable. In either case, the damagesclaim will be limited by general legal principles concerning remoteness of lossand mitigation. These include (i) the principle that something, which is a realpossibility but would only occur in a small minority of cases, will not usuallyfall within the contractual measure of damages, and (ii) the borrower’s duty tomitigate his loss.

 

In respect of a delayed cashback,underpayment or payment holiday, the claim is likely to be in an amount equalto the amount due under the delayed cashback together with interest andexpenses and consequential losses (if any).

 

A borrower may also attempt to set offagainst his or her mortgage payments an amount greater than the amount of his orher damages claim (or exercise analogous rights in Scotland). In that case, theservicer will be entitled to take enforcement proceedings against the borroweralthough the period of non-payment by the borrower is likely to continue untila judgment is obtained.

 

The exercise of set-off rights by borrowerswould reduce the incoming cashflow to the mortgages trustee during theexercise. However, the amounts set off will be applied to reduce the sellershare of the trust property only.

 

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Further there may be circumstances in whichcertain drawings may rank behind security created by a borrower after the dateupon which the borrower entered into its mortgage with the seller.

 

The minimum seller share has been sized in anamount expected to cover this risk, although there is no assurance that itwill. If the minimum seller share is not sufficient in this respect then thereis a risk that noteholders may not receive all amounts due on the issuer notesor that payments may not be made when due.

 

**If the servicer is removed, there is noguarantee that a substitute servicer would be found, which could delaycollection of payments on the loans and ultimately could adversely affectpayments on the issuer notes**

 

The seller has been appointed by themortgages trustee and the beneficiaries as servicer to service the loans. Ifthe servicer breaches the terms of the servicing agreement, then the mortgagestrustee, Funding 1 and/or the security trustee will be entitled to terminatethe appointment of the servicer and appoint a new servicer in its place.

 

There can be no assurance that a substitute servicer withsufficient experience of administering mortgages of residential propertieswould be found who would be willing and able to service the loans on the termsof the servicing agreement. In addition, as described below, any substituteservicer may be required to be authorized under FSMA (as defined below in orderto administer loans that constitute regulated mortgage contracts). The abilityof a substitute servicer fully to perform the required services would depend,among other things, on the information, software and records available at thetime of the appointment. Any delay or inability to appoint a substituteservicer may affect payments on the loans and hence the issuer’s ability tomake payments when due on the issuer notes.

 

The noteholders should note that the servicerhas no obligation itself to advance payments that borrowers fail to make in atimely fashion.

 

**Funding 1 may not receive the benefit of anyclaims made on the buildings insurance which could adversely affect payments onthe issuer notes**

 

No assurance can be given that Funding 1 willalways receive the benefit of any claims made under any applicable insurancecontracts. This could reduce the principal receipts received by Funding 1according to the Funding 1 share percentage and could adversely affect theissuer’s ability to redeem the issuer notes. The noteholders should note thatbuildings insurance is renewed annually.

 

**Regulatory changes by the Office of FairTrading, the Financial Services Authority and other regulatory authorities mayhave an impact on the seller, the issuer, the servicer, the mortgages trustee,Funding 1, Funding 2 and/or the loans and may adversely affect the issuer’sability to make payments when due on the issuer notes**

 

In the United Kingdom, the Office of FairTrading (the “OFT”) is responsible for the issue of licenses under, and thesuperintendence of the working and the enforcement of, the Consumer Credit Act(the “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, a credit agreement is regulated bythe CCA where: (a) the borrower is or includes an individual; (b) the amount of“credit” as defined in the CCA does not exceed the financial limit, which is£25,000 for credit agreements made on or after May 1, 1998, or lower amountsfor credit agreements made before that date; and (c) the credit agreement isnot an exempt agreement under the CCA, for example, a regulated mortgagecontract under the FSMA (as defined below).

 

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Any credit agreement that is wholly or partlyregulated by the CCA or to be treated as such has to comply with requirementsunder the CCA as to licensing of lenders and brokers, documentation andprocedures of credit agreements, and (in so far as will be applicable)pre-contract disclosure. If it does not comply with those requirements, then tothe extent that the credit agreement is regulated by the CCA or to be treatedas such, it is unenforceable against the borrower: (a) without an order of theOFT, if the lender or any broker does not hold the required license at therelevant time; (b) totally, if the form to be signed by the borrower is notsigned by the borrower personally or omits or mis-states a ‘‘prescribed term’’;or (c) without a court order in other cases and, in exercising its discretionwhether to make the order, the court would take into account any prejudicesuffered by the borrower and any culpability of the lender.

 

Any credit agreement for a loan or furtheradvance might be wholly or partly regulated by the CCA or treated as suchbecause of technical rules on: (a) determining whether any credit under the CCAarises, or whether the financial limit of the CCA is exceeded; (b) determiningwhether the credit agreement is an exempt agreement under the CCA; and (c)changes to credit agreements.

 

A court order under section 126 of theCCA is necessary to enforce a land mortgage securing a credit agreement to theextent that the credit agreement is regulated by the CCA or to be treated assuch. In dealing with such application, the court has the power, if it appearsjust to do so, to amend the credit agreement or to impose conditions upon itsperformance or to make a time order (for example, giving extra time for arrearsto be cleared).

 

Under section 75 of the CCA in certaincircumstances: (a) the lender is liable to the borrower in relation tomisrepresentation and breach of contract by a supplier in a transactionfinanced by the lender, where the related credit agreement is or is treated asentered into under pre-existing arrangements, or in contemplation of futurearrangements, between the lender and the supplier; and (b) the lender has anindemnity from the supplier against such liability, subject to any agreementbetween the lender and the supplier.

 

In November 2002, the UK Department ofTrade and Industry (the “DTI”) announced its intention that a credit agreementwill be regulated by the CCA where, for credit agreements made after thischange is implemented: (a) the borrower is or includes an individual, save forpartnerships of four or more partners; (b) irrespective of the amount of credit(although in July 2003, the DTI announced its intention that the financiallimit will remain for certain business-to-business lending); and (c) the creditagreement is not an exempt agreement. In December 2003, the DTI publisheda White paper proposing amendments to the CCA and to secondary legislation madeunder it.

 

In June 2004, secondary legislation wasmade on: (a) amending requirements as to documentation of credit agreements,coming into force on May 31, 2005, or August 31, 2005 for agreements givento the borrower for signature but not made before May 31, 2005; (b)pre-contract disclosure, coming into force on May 31, 2005; and (c) replacingthe formula for calculating the maximum amount payable on early settlement witha formula more favorable to the borrower, coming into force on May 31, 2005 fornew agreements or on May 31, 2007 or May 31, 2010 (depending on the term of theagreement) for agreements existing before May 31, 2005.

 

In December 2004, the UK Parliamentpublished a consumer Credit Bill proposing to amend the CCA by, among otherthings: (a) changing the definition of a credit agreement regulated by the CCAto that announced by the DTI as described above; and (b) repealing the rulethat, to the extent that a credit agreement is regulated by the CCA or treatedas such, it may be unenforceable totally. If these changes are enacted, thenany credit agreement made or changed such that a new contract is entered intoafter this time, other than a regulated mortgage contract under the FSMA orother exempt 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.

 

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This consumer Credit Bill also proposes toamend the CCA by: (a) strengthening the licensing regime; (b) reforming the lawon extortionate credit, with the retrospective effect on existing agreements;and (c) extending the jurisdiction of the Ombudsman (as described below) tolicense holders under the CCA. Further proposals to amend the CCA and secondarylegislation made under it are expected at an unspecified time.

 

The seller has interpreted certain technicalrules under the CCA in a way common with many other lenders in the mortgagemarket. If such an interpretation were held to be incorrect by a court or theOmbudsman, then a credit agreement, to the extent that it is regulated by theCCA or treated as such, would be unenforceable as described above. If suchinterpretation were challenged by a significant number of borrowers, then thiscould lead to significant disruption and shortfall in income of the mortgagestrustee. Court decisions have been made on technical rules under the CCAagainst certain mortgage lenders, but such decisions are very few and aregenerally county court decisions not binding on other courts.

 

The seller has given or, as applicable, willgive warranties to the mortgages trustee in the mortgage sale agreement that,among other things, each loan and its related security is enforceable (subjectto certain exemptions). If a loan or its related security does not comply withthese warranties, and if the default cannot be or is not cured within 20 Londonbusiness days, then the seller will be required to repurchase the loans underthe relevant mortgage account and their related security from the mortgagestrustee.

 

In the United Kingdom, regulation ofresidential mortgage business by the FSA under the Financial Services andMarkets Act 2000 (the “FSMA”) came into force on October 31, 2004, thedate known as “N(M)”. Entering into, arranging, advising on and administeringregulated mortgage contracts, and agreeing to do any of these things, are(subject to applicable exemptions) regulated activities under the FSMA.

 

A credit agreement is a regulated mortgagecontract under the FSMA if, at the time it is entered into on or after N(M):(a) the borrower is an individual or trustee; (b) the contract provides for theobligation of the borrower to repay to be secured by a first legal mortgage or,in Scotland, a first ranking standard security on land (other than timeshareaccommodation) in the UK; and (c) at least 40 per cent. of that land is used,or is intended to be used, as or in connection with a dwelling by the borroweror (in case of credit provided to trustees) by an individual who is abeneficiary of the trust, or by a related person.

 

The main effects are that, unless anexclusion or exemption applies: (a) each entity carrying on a regulatedmortgage activity has to hold authorization and permission from the FSA tocarry on that activity; and (b) generally, each financial promotion in respectof an agreement relating to a qualifying credit has to be issued or approved bya person holding authorization and permission from the FSA. If requirements asto authorization and permission of lenders and brokers or as to issue andapproval of financial promotions are not complied with, a regulated mortgagecontract will be unenforceable against the borrower except with the approval ofa court. An unauthorized person who administers a regulated mortgage contractentered into on or after N(M) may commit a criminal offence, but this will notrender the contract unenforceable against the borrower.

 

Any credit agreement intended to be aregulated mortgage contract under the FSMA might instead be wholly or partlyregulated by the CCA or treated as such, or unregulated, because of technicalrules on: (a) determining whether the credit agreement falls within thedefinition of “regulated mortgage contract”; and (b) changes to creditagreements.

 

The seller is required to holdauthorisization and permission to enter into and to administer and, whereapplicable, to advise on regulated mortgage contracts. Subject to anyexemption, brokers

 

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will be required to hold authorization and permission to arrange and,where applicable, to advise on regulated mortgage contracts.

 

The issuer and mortgagestrustee are not and do not propose to be authorized persons under the FSMA. Theissuer and mortgages trustee will not require authorization in order to acquirelegal or beneficial title to a regulated mortgage contract. The issuer andmortgages trustee do not carry on the regulated activity of administering inrelation to regulated mortgage contracts by having them administered pursuantto an administration agreement by an entity having the required FSAauthorization and permission. If such administration agreement terminates,however, the issuer and mortgages trustee will have a period of not more thanone month in which to arrange for mortgage administration to be carried out bya replacement administrator having the required FSA authorization andpermission. In addition, from N(M) no variation has been or will be made to theloans and no further advance has been or will be made to a loan, where it willresult in the issuer, Funding 1, Funding 2 or the mortgages trustee arranging,advising on, administering or entering into a regulated mortgage contract oragreeing to carry on any of these activities, if the issuer Funding 1, Funding2 or the mortgages trustee would be required to be authorized under the FSMA todo so.

 

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*, certainpre-origination matters, such as financial promotion and pre-applicationillustrations, pre-contract and start of contract and post-contract disclosure,contract changes, charges, arrears and repossessions. FSA rules forprudential and authorization requirements for mortgage firms and insuranceintermediaries, and for extending the appointed representatives regime cameinto force on October 31, 2004 for mortgages and on January 14, 2005for general insurance.

 

Aborrower who is a private person is entitled to claim damages for loss sufferedas a result of any contravention by an authorized person of an FSA rule, andmay set-off the amount of the claim against the amount owing by the borrowerunder the loan or any other loan that the borrower has taken (or exerciseanalogous rights in Scotland). Any such set-off may adversely affect the issuer’sability to make payments on the issuer notes.

 

So as to avoid dualregulation it is intended that regulated mortgage contracts will not beregulated by the CCA. This exemption only affects credit agreements made on orafter N(M), and credit agreements made before N(M) but subsequently changedsuch that a new contract is entered into on or after N(M) and constitutes aregulated mortgage contract. A court order under section 126 of the CCAis, however, necessary to enforce a land mortgage securing a regulated mortgagecontract that would, apart from this exemption, be regulated by the CCA or betreated as such.

 

No assurance can be giventhat additional regulations from the OFT, the FSA or any other regulatoryauthority will not arise with regard to the mortgage market in the UnitedKingdom 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 issuerand/or the servicer and their respective businesses and operations. This mayadversely affect our ability to make payments in full on the issuer notes whendue.

 

Prior to M(N), 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) the Mortgage Code Register of Intermediaries or(on and after November 1, 2000 until October 31, 2004) the MortgageCode Compliance Board.

 

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In September 2002,the European Commission published a proposal for a directive of the EuropeanParliament and of the Council on the harmonization of the laws, regulations andadministrative provisions of the member states concerning credit for consumersand surety agreements entered into by consumers. In its original form, theproposal does not include a financial limit for regulated agreements (unlikethe existing Directive 87/102/EEC, as amended, which provides that (subject tocertain exceptions) loans not exceeding euro 20,000 are regulated by such Directive)and requires specified requirements to be met in respect of certain mortgageloan products (including new credit agreements for further drawings undercertain flexible mortgages and for further advances and amortization tables forrepayment mortgages). If the proposal comes into force in its original form,mortgage loans which do not comply with these requirements may beunenforceable. Significantly, in its original form, the proposal provides thatit does not apply retrospectively (subject to certain exceptions including inrespect of new drawings or further advances made in respect of existingagreements) and does not apply to residential mortgage loans except those whichinclude an equity release component.

 

There has beensignificant opposition from the European Parliament to the original form of theproposed directive. On February 13, 2004, the Committee of Legal Affairsand the Internal Market published the European Parliament’s amendments to theproposed draft. These amendments provide that (subject to certain exceptions)loans not exceeding euro 100,000 will be regulated, but that the proposeddirective will not apply to any loan secured by a land mortgage or, inScotland, a standard security, and will not apply to any credit agreement orsurety agreement made before national implementing legislation comes intoforce. In October 2004, the European Commission published an amended formof the proposed directive. In this amended form, the proposed directiveprovides that (subject to certain exceptions) loans not exceeding euro 100,000will be regulated, and that it will indeed apply to any loan secured by a landmortgage or, in Scotland a standard security that includes an equity releasecomponent, but it is unclear whether it will apply to any credit agreement orsurety agreement made before national implementing legislation comes intoforce. There are differences in opinion as to the extent to which mortgageloans should be included in the scope of the proposed directive, which may besubstantially further amended before it is ultimately brought into effect.

 

The proposal is unlikelyto come into force before 2006 as the co-decision procedure of the EuropeanParliament and of the Council, from the publication of the proposal to thecoming into force of the new consumer credit directive, is likely to take atleast two years and member states will then have a further two years in whichto bring national implementing legislation into force. The DTI has consultedwith consumer and industry organizations in relation to this proposal and in February 2005published a consultation paper on the form of the proposed directive publishedby the European Commission in October 2004.

 

Until the final text ofthe directive is decided and the details of the United Kingdom implementinglegislation are published, it is not certain what effect the adoption andimplementation of the directive would have on the seller, the issuer, theservicer, the mortgages trustee, Funding1, Funding 2 and their respectivebusinesses and operations. This may adversely affect the issuer’s ability tomake payments in full on the issuer notes when due.

 

**Regulationsin the United Kingdom could lead to some terms of the loans beingunenforceable, which may adversely affect payments on the issuer notes**

 

In the United Kingdom,the Unfair Terms in Consumer Contracts Regulations 1999 as amended (the “1999Regulations”), which, together with (in so far as applicable) the Unfair Termsin Consumer Contracts Regulations 1994 (together with the 1999 Regulations, the“UTCCR”), apply to agreements made on or after July 1, 1995 and affect allor 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 a termpermitting the lender to vary the interest rate (as the seller is permitted todo) is found to be unfair, the borrower will not be liable to pay the increasedrate or, to the extent that she or he has paid it, will be able, as against thelender, or any assignee such as the mortgages trustee, to claim repayment ofthe extra interest amounts paid or to set-off the amount of the claim againstthe amount owing by the borrower under the loan or any other loan that theborrower has taken. Any such non-recovery, claim or set-off may adverselyaffect 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. The FSA has agreed with the OFT to take responsibility for theenforcement of the UTCCR in mortgage agreements. It is expected that the FSAwill issue guidance on interest variation terms shortly.

 

In August 2002, theLaw Commission for England and Wales and the Scottish Law Commission issued ajoint consultation LCCP No. 166/SLCDP 119 on proposals to rationalize theUK’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. The Law Commissions have a duty under section 3of the UK’s Law Commissions Act 1965 to keep the law under review for a numberof purposes, including its simplification. The proposals are primarily tosimplify the legislation on unfair terms. It is not proposed that there shouldbe any 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. It is tooearly to tell how the proposals, if enacted, would affect the loans.

 

No assurance can be giventhat changes in the UTCCR, if enacted, or changes to guidance on interestvariation terms, if adopted, will not have a material adverse effect on theseller, the issuer, the servicer, the mortgages trustee, Funding 1, Funding 2 andtheir respective businesses and operations. This may adversely affect theissuer’s ability to make payments in full on the issuer notes when due.

 

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

 

Under FSMA, the FinancialOmbudsman Service is required to make decisions on, among other things,complaints relating to activities and transactions under its jurisdiction onthe basis of what, in the Ombudsman’s opinion, would be fair and reasonable inall circumstances of the case, taking into account, among other things, law andguidance. Complaints brought before the Financial

 

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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, theOmbudsman made a determination on the seller’s appeal to an earlier decision byan adjudicator at the Financial Ombudsman Service concerning a case involvingHVR 1 and HVR 2. In March 2001, two joint borrowers with a capped rateloan originated when Halifax offered only a single standard variable base ratecontacted Halifax and requested that their loan be linked to HVR 2. Halifaxinformed the borrowers that, because they were still in their product period,they could either transfer to HVR 2 when their product period expired ortransfer to HVR 2 immediately and pay the applicable early repayment fee. Theborrowers 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 recalculate the borrowers’ mortgage by referenceto HVR 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’s decisiononly applies to the two borrowers and their particular circumstances, thoughother borrowers may also complain to the Ombudsman. In March 2002, theseller announced that borrowers under loans who were in similar circumstancesand who had asked to be transferred to HVR 2 when it was available would beinvited to make a product switch to HVR 2 and to obtain a refund for alloverpayments of interest since the date they had asked to be transferred. Foreach of those loans, the borrowers would also receive £150 for anyinconvenience caused. The borrowers under loans who requested to be transferredafter HVR 2 was withdrawn and before the announcement in March 2002 werenot offered a switch or a refund, though the seller has given or will give eachof these customers an *ex gratia*payment of £100.

 

Since then, furtherdecisions by the Ombudsman in similar cases have confirmed that affectedborrowers were only entitled to a refund of overpayments of interest from thedate when they asked to be transferred to HVR 2 and not from the date when HVR2 first became available, and also that affected borrowers were not entitled toapply to be transferred to HVR 2 after it was withdrawn.

 

The seller does notbelieve 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 the issuerwill generally be subject to UK corporation tax, currently at a rate of 30 percent. on the profit reflected in their respective profit and loss accounts asincreased by the amount of any non-deductible expenses or losses. If the taxpayable by Funding 1 or the issuer is greater than expected because, forexample, non-deductible expenses or losses are greater than

 

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expected, the funds available to make payments on the noteholders’issuer notes will be reduced and this may adversely affect the issuer’s abilityto make payments on the issuer notes.

 

The UK corporation taxposition of the issuer and Funding 1, however, also depends to a significantextent on the accounting treatment applicable to it. From January 1, 2005,the accounts of the issuer are required to comply with International FinancialReporting Standards (“IFRS”) or with new UK Financial Reporting Standardsreflecting IFRS (“new UK GAAP”). Funding 1 may also choose to comply with IFRS.There is concern that companies such as the issuer and Funding 1 might, undereither IFRS or new UK GAAP, suffer timing differences that could result inprofits or losses for accounting purposes, and accordingly for tax purposes(unless tax legislation provides otherwise), which bear little or norelationship to the company’s cash position. However, the Finance Act 2005requires “securitisation companies” to prepare tax computations for accountingperiods beginning on or after January 1, 2005 and ending before January 1,2007 on the basis of UK GAAP as applicable up to December 31, 2004,notwithstanding the requirement to prepare statutory accounts under IFRS or newUK GAAP. The issuer and Funding 1 will each be a “securitisation company” forthese purposes.

 

The stated policy of H.M.Revenue & Customs is that the tax neutrality of securitisation specialpurpose 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 January 1,2007, 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.

 

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

 

In the event that amountsdue under the issuer notes are subject to withholding tax, the issuer will notbe obliged to pay additional amounts in relation thereto. The issuer may, incertain circumstances, redeem the issuer notes.

 

**Noteholders’interests may be adversely affected if the United Kingdom joins the EuropeanMonetary Union**

 

If the United Kingdomjoins the European Monetary Union prior to the maturity of the issuer notes,investors cannot be assured that this would not adversely affect payments ontheir issuer notes.

 

It is possible that priorto 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.

 

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**Changesof law may adversely affect noteholders’ interests**

 

The structure of theissue of the issuer notes and the ratings which are assigned to them are basedon English law and (in relation to the Scottish loans) Scots law in effect asat the date of this prospectus. The issuer cannot provide assurance as to theimpact 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 past 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.

 

Secondary legislation hasnow been enacted which excludes certain special purpose companies in relationto capital markets transactions from the optional moratorium provisions. Suchexceptions include (amongst other matters) (i) a company which is a partyto an agreement which is or forms part of a capital market arrangement (asdefined in the secondary legislation) under which (a) a party has incurredor when the agreement was entered into was expected to incur a debt of at least£10 million under the arrangement and (b) the arrangement involves theissue of a capital markets investment (also defined, but generally a rated,listed or traded bond) and (ii) a company which at the date of filing fora moratorium has incurred a liability (including a present, future orcontingent liability) of at least £10 million. While the issuer, the mortgagestrustee and Funding 1 should fall within the exceptions, there is no guidanceas to how the legislation will be interpreted and the Secretary of State forTrade and Industry may by regulation modify the exception. No assurance may begiven that any modification of the eligibility requirements for “small”companies and/or the exceptions will not be detrimental to the interests of thenoteholders.

 

If the issuer and/or themortgages trustee and/or Funding 1 is determined to be a “small” company anddetermined not to fall within one of the exceptions (by reason of modificationof the exceptions or otherwise), then the enforcement of the issuer security bythe security trustee may, for a period, be prohibited by the imposition of amoratorium.

 

*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 a floatingcharge created before September 15, 2003 over the whole or substantiallythe whole of the assets of a company (such as the security trustee under theFunding 1 deed of charge) retains the ability to block the appointment of anadministrator by appointing an administrative receiver, who will primarily actin 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 the issuersecurity) that form part of a capital markets arrangement (as defined in theInsolvency Act) that involves indebtedness of at least £50 million (or, whenthe relevant security

 

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document was entered into (being in respect of the transactionsdescribed in the prospectus, relating to the issuer notes and the issued deedof charge), a party to the relevant transaction (such as the issuer) wasexpected to incur a debt of at least £50 million) and the issue of a capitalmarkets investment (also defined, but generally a rated, listed or tradedbond). 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 adetrimental effect on the interests of the noteholders.

 

The Insolvency Act alsocontains a new out-of-court route into administration for a qualifying floatingcharge holder, the directors or the company itself. The relevant provisionsprovide for a notice period during which the holder of the floating charge caneither agree to the administrator proposed by the directors of the company orappoint an alternative administrator, although the moratorium will take effectimmediately after notice is given. If the qualifying floating charge holderdoes not respond to the directors’ notice of intention to appoint, thedirectors’, or as the case may be, the company’s appointee will automaticallytake office after the notice period has elapsed. Where the holder of aqualifying floating charge within the context of a capital market transactionretains the power to appoint an administrative receiver, such holder mayprevent the appointment of an administrator (either by the new out-of-courtroute or by the court based procedure), by appointing an administrativereceiver prior to the appointment of the administrator being completed.

 

The new administrationprovisions of the Insolvency Act give primary emphasis to the rescue of thecompany as a going concern. The purpose of realizing property to make adistribution to one or more secured creditors is subordinated to the primarypurposes of rescuing the company as a going concern or achieving a betterresult for the creditors as a whole than would be likely if the company werewound 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 inrelation to 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 charge andso refers to any floating charge realizations less any amounts payable to thepreferential 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 obligation does notapply if the net property is less than a prescribed minimum and the relevantofficeholder is of the view that the cost of making a distribution to unsecuredcreditors would be disproportionate to the benefits. The relevant officeholdermay also apply to court for an order that the provisions of section 176Aof the Insolvency Act should not apply on the basis that the cost of making adistribution 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.

 

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**Thenoteholders will not receive issuer notes in physical form, which may causedelays in distributions and hamper the noteholders’ ability to pledge or resellthe issuer notes**

 

Unless the global issuernotes are exchanged for definitive issuer notes, which will only occur under alimited set of circumstances, the noteholders’ beneficial ownership of theissuer notes will only be recorded in book-entry form with DTC, Euroclear orClearstream, Luxembourg. The lack of issuer notes in physical form could, amongother 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

 

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

 

**If thenoteholders have a claim against the issuer it may be necessary for thenoteholders to bring suit against the issuer in England to enforce thenoteholders’ rights**

 

The issuer has agreed tosubmit to the non-exclusive jurisdiction of the courts of England, and it maybe necessary for noteholders to bring a suit in England to enforce their rightsagainst the issuer.

 

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

 

The Basel Committee onBanking 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 “Framework”), which places enhanced emphasis on market discipline andsensitivity to risk, will serve as the basis for national rule-making andapproval processes to continue and for banking organizations to complete theirpreparations for implementation of the Framework. The Committee confirmed thatit is currently intended that the various approaches under the Framework willbe implemented in stages, some from year-end 2006, the most advanced atyear-end 2007. As and when implemented (including through the EU CapitalRequirements Directive), the Framework could affect the risk–weighting of theissuer notes in respect of certain investors if those investors are subject tothe Framework following its implementation. Consequently, investors shouldconsult their own advisers as to the consequences to and effect on them of theproposed implementation of the Framework. No predictions can be made as to theprecise effects of potential changes which might result upon the implementationof the Framework.

 

The issuer may, undercertain circumstances relating to implementation of the New Basel CapitalAccord in the United Kingdom require investors to sell their issuer notes orredeem their issuer notes.

 

**Item 4.   Information on the Company**

 

A.*            History and Development of theCompany*

 

Not applicable.

 

B.*            Business Overview*

 

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Not applicable.

 

C.*            Organizational Structure*

 

Not applicable.

 

D.*            Property, Plants and Equipment*

 

The issuer

 

The property of theissuer 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 of Funding 1consists primarily of its interest in the trust property held by the mortgagestrustee (which entitles Funding 1 to receive certain payments of principal andinterest from the trust property according to the terms of the mortgages trustdeed) 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 relatedsecurity, the rights under the insurance policies that are assigned to themortgages trustee or of which the mortgages trustee has the benefit, andamounts on deposit and interest earned on the mortgages trustee guaranteedinvestment contract. 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, asborrowers take payment holidays or make underpayments under a loan and as theloans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

**Item 5.  Operating and Financial Review and Prospects**

 

A.*            Operating Results*

 

Not applicable.

 

B.*            Liquidity and Capital Resources*

 

Not applicable.

 

C.*            Research and Development, Patentsand Licenses, etc.*

 

Not applicable.

 

D*.            Trend Information*

 

Not applicable.

 

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E.*             Off-balance Sheet Arrangements*

 

Not applicable.

 

F.*             Tabular Disclosure of ContractualObligations*

 

Not applicable.

 

G*.            Safe Harbor*

 

Notapplicable.

 

**Item 6.  Directors, Senior Management and Employees**

 

A.*            Directors and Senior Management*

 

The following sets outthe names, business addresses and business occupations of the directors of theissuer, 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 |       | Head of Mortgage  Securitisation and Covered Bonds   |

 

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 |       | Head of Mortgage  Securitisation and Covered Bonds   |

 

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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 |       | Head of Mortgage  Securitisation and Covered Bonds |

 

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

 

B.*            Compensation*

 

The issuer

 

In accordance with theissuer 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 with theFunding 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 corporate servicesfor Funding 1 in consideration for a payment of a separate fee payable byFunding 1 to SFM. No other remuneration is paid to any director or officer inconnection with such director’s or officer’s activities on behalf of Funding 1.

 

The mortgagestrustee

 

In accordance with themortgages 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.

 

C.            *Board Practices*

 

Not applicable.

 

D.            *Employees*

 

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

 

E.             *Share Ownership*

 

Not applicable.

 

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**Item 7.  Major Shareholders and Related PartyTransactions**

 

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 holds all ofthe issued shares of the mortgages trustee in trust for charitable purposes.

 

Neither SFM Corporate norSFM Offshore is affiliated with Halifax plc.

 

B.            *Related Party Transactions*

 

None, other than withrespect to the making of payments in respect to the securities as described inthe Registration Statement and “Item 3.D — Risk Factors”.

 

C.            *Interests of Experts andCounsel*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 8.  Financial Information**

 

For a discussion of theavailable financial information, see “Item 3.A — Selected Financial Information”.

 

The issuer, Funding 1 andthe mortgages trustee know of no material legal or arbitration proceedingsinvolving their respective companies that may have significant effects on theregistrants’ financial position or profitability, including governmentalproceedings pending or known to be contemplated and any material proceeding inwhich any director or affiliate is either a party adverse to a registrant orhas a material interest adverse to a registrant.

 

**Item 9.  The Offer and Listing**

 

A.*            Offer and Listing Details*

 

Not applicable.

 

B.*            Plan of Distribution*

 

Not applicable to annualreports filed on Form 20-F.

 

C.*            Markets*

 

The principal tradingmarket for each class of the issuer notes is the London Stock Exchange.  The issuer notes have been listed on theLondon Stock Exchange since November 25, 2003.

 

D.*            Selling Shareholders*

 

Not applicable to annualreports filed on Form 20-F.

 

E.*             Dilution*

 

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Not applicable to annualreports filed on Form 20-F.

 

F.*             Expenses of the Issue*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 10.  Additional Information**

 

A.*            Share Capital*

 

Not applicable to annualreports filed on Form 20-F.

 

B.*            Memorandum and Articles ofAssociation*

 

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 applicable other thanwith respect to contracts relating to the issuer notes, which were described inthe Registration Statement.

 

D.*            Exchange Controls*

 

None.

 

E.*             Taxation*

 

**UnitedKingdom Taxation**

 

The following section summarizesthe material UK tax consequences of the purchase, ownership and disposition ofthe issuer notes based on current law and practice in the UK. The summaryassumes that the profit in Funding 1’s profit and loss account will not exceed0.01 per cent. of the Funding 1 available revenue receipts and that theprofit in the issuer’s profit and loss account will not exceed 0.01 percent. of the interest on the issuer term advances under the issuer intercompanyloan and any interest earned by the issuer on its share capital proceeds arecorrect. It further assumes that all payments made pursuant to the finaldocumentation are calculated on arm’s length terms. The summary does notpurport to be a complete analysis of all tax considerations of the purchase,ownership and disposition of the issuer notes. It relates to the position ofpersons who are the absolute beneficial owners of issuer notes and may notapply to certain classes of persons such as dealers or persons connected withthe issuer. Noteholders who may be subject to tax in a jurisdiction other thanthe UK or who may be unsure as to their tax position should seek their ownprofessional advice.

 

**Taxationof US residents**

 

As discussed in more detailbelow, no UK withholding tax will be required in relation to interest paymentson the issuer notes provided that the issuer notes are listed on a “recognised stock exchange”, whichincludes the London Stock Exchange. If the issuer notes cease to be listed on a“recognised stock exchange”, an amount must be withheld on account of UK incometax at the lower rate (currently 20 per cent.), subject to any direction to thecontrary from H.M. Revenue & Customs in respect of such relief as maybe available pursuant to the provisions of an applicable double taxationtreaty.

 

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Residents of the US aregenerally not subject to tax in the UK on payments on the issuer notes underthe terms of the double taxation treaty between the US and the UK (the “Treaty”),subject to completion of administrative formalities, except where the issuernotes are effectively connected with a permanent establishment or a fixed baseof the noteholder situated in the UK or where the amounts paid on the issuernotes not exceed the return on comparable debt instruments, in which event theUK may tax the excess in accordance with UK domestic law.

 

Subject to the opinionsset out in the preceding 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.

 

USresident noteholders will not be liable to UK tax in respect of a disposal ofthe issuer notes provided they are not within the charge to UK corporation taxand (i) are not resident or ordinarily resident in the UK, and (ii) donot carry on a trade, profession or vocation carried on by him through a branchor agency in connection with which interest is received or to which the issuernotes are attributable.

 

Funding1 and the issuer will generally be subject to UK corporation tax, currently ata rate of 30 per cent, on the profit reflected in their respective profit andloss accounts as increased by the amounts of any non-deductible expenses orlosses.

 

Themortgages trustee will have no liability to UK tax in relation to amounts whichit receives on behalf of Funding 1 or the seller under the mortgages trust.

 

**Withholdingtax**

 

There will be no UKwithholding tax in relation to interest payments on the issuer notes providedthat, so far as concerns deduction by the issuer or its paying agents, theissuer notes are listed on a “recognised stock exchange”, as defined in Section 841of the Income and Corporation Taxes Act 1988 (“ICTA”). The London StockExchange is currently a recognised stock exchange for this purpose. If theissuer 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.) from interest paid on them, subject to any direction to the contraryby H.M. Revenue & Customs 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 349Dof the ICTA.

 

Noteholders who are individualsmay wish to note that H.M. Revenue & Customs has power to obtaininformation (including the name and address of the beneficial owner of theinterest) from any person in the UK who either pays interest to, or receivesinterest for the benefit of, an individual. Information so obtained may, incertain circumstances, be exchanged by H.M. Revenue & Customs with thetax authorities of other jurisdictions.

 

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

 

Interest on the issuernotes has a UK source. Accordingly, payments of interest on the issuer noteswill 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 who is not resident for tax purposes in the UK unless suchnoteholder carries on a trade, profession or vocation through a branch oragency (or, in the case of a noteholder which is a

 

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company which carries on a trade through a permanent establishment) inthe UK in connection with which the payments are received or to which theissuer notes are attributable, in which case (subject to exemptions forinterest received by certain categories of agent such as some brokers andinvestment managers) tax may be levied on the UK branch or agency or permanentestablishment.

 

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

 

In general, noteholderswho are within the charge to UK corporation tax (other than authorized unittrusts) will normally be subject to tax on all profits and gains, includinginterest and profit and gains attributable to currency regulations, arising onor in connection with the issuer notes under the loan relationship rules. Anysuch profits and gains will generally fall to be calculated in accordance withthe statutory accounting treatment of the issuer notes in the hands of therelevant noteholder, and will generally be charged to tax as income in respectof each accounting period to which they are allocated, in accordance with thataccounting treatment. Relief may be available in respect of losses or forrelated expenses on a similar basis.

 

**Taxationof returns: other noteholders**

 

Noteholders who are notwithin the charge to UK corporation tax and who are resident or ordinarilyresident in the UK for tax purposes or who carry on a trade, profession orvocation in the UK through a branch or agency in connection with which intereston the issuer notes is received or to which the issuer notes are attributablewill generally be liable to UK tax on the amount of any interest received in respectof the issuer notes. As the series 1 issuer notes, series 2 issuer notes andseries 3 issuer notes are denominated in US dollars and the series 4 class A1issuer notes, series 4 class B issuer notes, series 4 class C issuer notes,series 5 class B issuer notes and series 5 class C issuer notes are denominatedin euro, they will not be regarded by H.M. Revenue & Customs asconstituting “qualifying corporate bonds” within the meaning of Section 117of the Taxation of Chargeable Gains Act 1992. Accordingly, a disposal of any ofthese issuer notes may give rise to a chargeable gain or an allowable loss forthe purpose of the UK taxation of chargeable gains.

 

It is expected that theseries 5 class A issuer notes and the series 4 class A2 issuer notes will beregarded by H.M. Revenue & Customs as constituting “qualifyingcorporate bonds” within the meaning of Section 117 of the Taxation ofChargeable Gains Act 1992. Accordingly, a disposal of any of these issuer notesis not expected to give rise to a chargeable gain or an allowable loss for thepurpose of the UK taxation of chargeable gains.

 

Adisposal of the issuer notes by such noteholders as described above may alsogive rise to a charge to tax on income in respect of an amount representinginterest accrued on the issuer notes since the preceding payment date. For theissuer notes which constitute variable rate securities, taxation in respect ofsuch a disposal will be computed on the basis that such amount as H.M. Revenue &Customs 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. All of the issuer notes will constitute variable rateissuer notes for this purpose.

 

**Stampduty and stamp duty reserve tax**

 

No UK stamp duty or stampduty reserve tax is payable on the issue or transfer of the offered globalissuer notes or on the issue or transfer of definitive issuer notes.

 

**UKtaxation of Funding 1 and the issuer**

 

Funding 1 and the issuerwill 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 amounts of any non-deductible expenses or losses.In respect of Funding 1, the profit in the profit and

 

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loss account will not exceed 0.01 per cent. of the Funding 1available revenue receipts. In respect of the issuer, the profit in the profitand loss account will not exceed 0.01 per cent. of the interest on theissuer term advances under the issuer intercompany loan and any interest earnedby the issuer on its Share Capital proceeds.

 

**UKtaxation of the mortgages trustee**

 

The mortgages trusteewill have no liability to UK tax in respect of any income, profit or gainarising under these arrangements. Accordingly, the mortgages trustee will haveno liability to UK tax in relation to amounts that it receives on behalf ofFunding 1 or the seller under the mortgages trust.

 

**EUSavings Directive**

 

On June 3, 2003, theEuropean Union (“EU”) Council of Economics and Finance Ministers adopted adirective on the taxation of savings income in the form of interest payments(the “EU Savings Tax Directive”). It is proposed that, subject to a number ofimportant conditions being met, each EU Member State will, from July 1,2005, be required to provide to the tax authorities of another EU Member Statedetails of payments of interest (or other similar income) paid by a personwithin its jurisdiction to or for the benefit of an individual resident in thatother EU Member State. However, Austria, Belgium and Luxembourg will instead(unless during that period they elect otherwise) apply a withholding system fora transitional period in relation to such payments (the ending of suchtransitional period being dependent upon the conclusion of certain otheragreements relating to information exchange with certain other countries).

 

Jersey is not a member ofthe EU and therefore is not required to implement the EU Savings Tax Directive.However, the Policy & Resources Committee of the States of Jersey hasannounced that, in keeping with Jersey’s policy of constructive internationalengagement, Jersey, in line with steps proposed by other relevant thirdcountries, proposes to introduce a retention tax system in respect of paymentsof interest, or other similar income, made to an individual beneficial ownerresident in an EU Member State by a paying agent situated in Jersey (the terms “beneficialowner” and “paying agent” for this purpose are as defined in the EU Savings TaxDirective). The retention tax system would apply for a transitional periodprior to the implementation of a system of automatic communication to EU MemberStates of information regarding such payments. During this transitional period,such an individual beneficial owner resident in an EU Member State would beentitled to request a paying agent not to retain tax from such payments butinstead to apply a system by which the details of such payments arecommunicated to the tax authorities of the EU Member State in which thebeneficial owner is resident.

 

**UnitedStates Federal Income Taxation**

 

The following section summarizesthe material US federal income tax consequences of the purchase, ownership anddisposition of the series 2 issuer notes and the series 3 issuer notes (the “USnotes”). In general, the summary assumes that a holder acquires the USnotes at original issuance and holds the US notes as capital assets. It doesnot purport to be a comprehensive description of all the taxconsiderations that may be relevant to a decision to purchase the USnotes. In particular, it does not discuss special tax considerations thatmay apply to certain types of taxpayers, including, without limitation,the following: (i) financial institutions; (ii) insurance companies; (iii) dealersor traders in stocks, 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 is based onthe US Internal Revenue Code of 1986, as amended (the “Code”), US Treasuryregulations and judicial and administrative interpretations thereof, in eachcase 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 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 usedin this section, the term “United States holder” means a beneficial owner of USnotes that is for US federal income tax purposes: (i) a citizenor resident of the United States; (ii) a corporation (or other entitytreated as a corporation) or partnership, created or organized in or under thelaws of the United States or any state thereof (including the District ofColumbia); (iii) any estate the income of which is subject to US federalincome tax regardless of the source of its income; or (iv) any trust if acourt within the United States is able to exercise primary supervision over theadministration of the trust and one or more United States persons have theauthority to control all substantial decisions of the trust. If a partnershipholds US notes, the tax treatment of a partner will generally depend upon thestatus of the partner and upon the activities of the partnership. Partners ofpartnerships holding US notes should consult their own tax advisers. A “Non-UnitedStates holder” is a beneficial owner of US notes that is not a United Statesholder.

 

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

 

Each of the issuer,Funding 1 and the mortgages trustee acting it its capacity as trustee of themortgages trust covenants not to engage in any activities in the United States(directly or through agents), not to derive any income from sources within theUnited States as determined under US federal income tax principles, and not tohold any property if doing so would cause it to be engaged or deemed to beengaged in a trade or business within the United States as determined under USfederal income tax principles. Assuming compliance with these covenants, noneof the issuer, Funding 1 or the mortgages trustee acting in its capacity astrustee of the mortgages trust will be subject to US federal income tax. Noelection will be made to treat the issuer, Funding 1 or the mortgages trusteeor any of their assets as a REMIC (a type of securitization vehicle having aspecial tax status under the Code).

 

**Characterizationof the US notes**

 

Although there is noauthority regarding the treatment of instruments that are substantially similarto the US notes, and while it is not free from doubt, the issuer believes thatthe US notes will be treated as debt for US federal income tax purposes. Theissuer intends to treat the US notes as indebtedness of the issuer for allpurposes, including US tax purposes. The discussion in the next section assumesthis result.

 

The US notes will not bequalifying 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.

 

**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

 

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must be unconditionally payable at least annually, is taxed under aholder’s normal method of accounting as ordinary interest income. *De minimis* original issue discount (“OID”)is included in income on a *pro rata* basisas principal payments are made on the US notes.

 

It is possible thatinterest on the US notes that are class B and class C issuer notes could betreated as OID because such interest is subject to deferral in certain limitedcircumstances. A United States holder of a US note issued with OID must includeOID in income over the term of such US note under a constant yield method thattakes into account the compounding of interest. Under the Code, OID iscalculated 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 suchUS 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 alternative to theabove treatments, United States holders may elect to include in gross incomeall interest with respect to the US notes, including stated 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 on the USnotes 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 tax 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 hold the US notes for more than one year)and capital losses (the deductibility of which is subject to limitations).**

 

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

 

Subject to the backupwithholding rules discussed below, a Non-United States holder generallyshould not be subject to US federal income or withholding tax on any paymentson a US note and gain from the sale, redemption or other disposition of a USnote unless: (i) that payment and/or gain is effectively connected withthe 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

 

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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 alternative characterizationof the US notes for US tax purposes.

 

One possible alternativecharacterization is that the US Internal Revenue Service (“IRS”) could assertthat the class C or any other class of US notes should be treated as equity inthe issuer for US federal income tax purposes. If the class C or any otherclass of US notes were treated as equity, United States holders of such noteswould be treated as owning equity in a passive foreign investment company (“PFIC”)which, depending on the level of ownership of such United States holder andcertain other factors, might also constitute an interest in a controlledforeign corporation for such United States holder. This would have certaintiming and character consequences for United States holders and could requirecertain elections and disclosures that would need to be made shortly afteracquisition to avoid potentially adverse US tax consequences.

 

If a United States holderwere treated as owning an equity interest in a PFIC, unless a United Statesholder makes a “QEF election” or “mark to market election”, a United Statesholder will be subject to a special tax regime (i) in respect of gainsrealized 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 the 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 holder’s holding period for the notes, andwill be taxable at the highest rate of taxation applicable to the notes for theyear to which the excess distribution or gain is allocable (without regard tothe United States holder’s other items of income and loss for such taxableyear) (the “deferred tax”). The deferred tax (other than the tax on amountsallocable to the year of disposition or receipt of the distribution) will thenbe increased 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).

 

**Backupwithholding and information reporting**

 

Backupwithholding and information reporting requirements may apply to certainpayments on the US notes and proceeds of the sale or redemption of the US notesto United States holders. The issuer, its agent, a broker, or any payingagent, as the case may be, may be required to withhold tax from any paymentthat is subject to backup withholding if the United States holder fails to furnishthe United States holder’s taxpayer identification number (usually on IRS Form W-9),to certify that such United States holder is not subject to backup withholding,or to otherwise comply with the applicable requirements of the backupwithholding rules. Certain UnitedStates holders (including, among others, corporations) are not subject to thebackup withholding and information reporting requirements. Non-United Statesholders may be required to comply with applicable certification procedures(usually on IRS Form W-8BEN) to establish that they are not UnitedStates holders in order to avoid the application of such information reportingrequirements and backup withholding.

 

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Payments of principal orinterest made to or through a foreign office of a custodian, nominee or otheragent acting on behalf of a beneficial owner of a US note generally will not besubject to backup withholding. However, if such custodian, nominee or otheragent is (i) a United States person (as defined in section 7701(a)(30)of the Code), (ii) a controlled foreign corporation (as defined in section 957(a) ofthe Code), (iii) a foreign person 50 per cent. or more of whose grossincome is effectively connected with a US trade or business for a specifiedthree-year period, or (iv) a foreign partnership if (A) at any timeduring its tax year, one or more of its partners are United States persons (asdefined in applicable Treasury regulations) who in the aggregate hold more than50 per cent. of the income or capital interest in the partnership or (B) atany time during its taxable year, it is engaged in a US trade or business (eachof (i) through (iv), a “US Connected Holder”), such custodian, nominee orother agent may be subject to certain information reporting requirements withrespect to such payment unless it has in its records documentary evidence thatthe beneficial owner is not a United States holder and certain conditions aremet or the beneficial owner otherwise establishes an exemption. Principal andinterest paid by the US office of a custodian, nominee or agent will be subjectto both backup withholding and information reporting unless the beneficialowner certifies its non-US status under penalties of perjury or otherwise establishesan exemption. Payments of proceeds on the sale of a US note made to or througha foreign office of a broker will not be subject to backup withholding.However, if such broker is a US Connected Holder, information reporting will berequired unless the broker has in its records documentary evidence that thebeneficial owner is not a United States holder and certain conditions are metor 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 withholding is notan 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 mortgages trustee isresident in Jersey for taxation purposes and will be liable to income tax inJersey at a rate of 20 per cent. in respect of the profits it makes from actingas trustee of the mortgages trust. The mortgages trustee will not be liable forany income tax in Jersey in respect of any income it receives in its capacityas mortgages trustee on behalf of the beneficiaries of the mortgages trust.

 

F.             *Dividends and PayingAgents*

 

Not applicable to annualreports filed on Form 20-F.

 

G.            *Statement by Experts*

 

Not applicable to annualreports filed on Form 20-F.

 

H.            *Documents on Display*

 

The issuer, Funding 1 andthe mortgages trustee are subject to the information requirements of the U.S.Securities Exchange Act of 1934, as amended, and are therefore required to filereports, including annual reports on Form 20-F, and otherinformation with the SEC. These materials, including this annual report and theexhibits thereto, may be inspected and copied at the SEC’s public referencerooms in Washington, DC, New York, NY and Chicago, IL. Please call the SEC at +1-800-732-0330for further information on the public reference rooms. Any filings made by theissuer,

 

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Funding 1 or the mortgages trustee will be made available to the publicover the Internet at the SEC’s web site at http://www.sec.gov.

 

I.              *Subsidiary Information*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 11.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Funding 1 has enteredinto the Funding 1 swap agreement with Halifax plc as the Funding 1 swapprovider and the security trustee. The issuer has entered into issuer swapswith the issuer swap providers and the security trustee. In general, the swapsare 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;

 

•                  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 (i) aLIBOR based rate for three-month dollar deposits, applicable to the series 2issuer notes and the series 3 issuer notes, and to address the difference inperiodicity between the interest payment dates in respect of the intercompanyloans, which occur quarterly;

 

•                  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, the series 4 class C issuer notes, theseries 5 class B issuer notes and the series 5 class C issuer notes; and

 

•                  issuerinterest rate swap: to protect the issuer against the possible variance betweena LIBOR based rate for three-month sterling deposits and the fixed rate ofinterest applicable to the series 5 class A issuer notes up to and includingthe interest payment date falling in December 2010 payable, during thisperiod (i) annually on the interest payment date falling in December ofeach year until the occurrence of a trigger event or the enforcement of theissuer security and (ii) quarterly on and following the interest paymentdate occurring immediately thereafter.

 

**TheFunding 1 swap**

 

Some ofthe loans in the portfolio pay a variable rate of interest for a period of timewhich may either be linked to the mortgages trustee variable base rate orlinked to a variable interest rate other than the mortgages trustee variablebase rate, such as a rate set by the Bank of England. Other loans pay a fixedrate of interest for a period of time. However, the interest rate payable byFunding 1 with respect to the issuer term advances is calculated as a marginover LIBOR for three-month sterling deposits. To provide a hedge against thepossible 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)           a LIBOR based rate for three-monthsterling deposits,

 

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Funding 1, the Funding 1swap provider and the security trustee have entered into the Funding 1 swap asamended and restated on June 22, 2005. The Funding 1 swap:

 

•                  hasa notional amount that is sized to hedge against any potential interest ratemismatches in relation to the current issues; 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 Funding 1 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 theintercompany loans) plus a spread for the relevant calculation period to thenotional amount of the Funding 1 swap as described later in this section (knownas the “calculation period swap provider amount”); and

 

•                  theamount produced by applying a rate equal to the weighted average of:

 

(i)                                     theaverage of the standard variable mortgage rates or their equivalent charged toexisting borrowers on residential mortgage loans as published from time totime, after excluding the highest and the lowest rate, of Abbey National plc,HSBC Bank plc, Cheltenham & Gloucester plc, National Westminster BankPlc, Nationwide Building Society, Northern Rock plc and Woolwich plc (and wherethose banks have more than one standard variable rate, the highest of thoserates);

 

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

 

(iii)          the rates of interest payable on thefixed rate loans,

 

for the relevant calculationperiod to the notional amount of the Funding 1 swap (known as the “calculationperiod Funding 1 amount”). “Calculation date” is defined as the first day (orif not a London Business Day, the next succeeding London Business Day) of eachmonth and any other day on which Funding 1 acquires a further interest in thetrust property from and including the calculation date immediately precedingthe effective date. “London Business Day” is defined as a day (other than aSaturday or Sunday) on which banks are generally open for business in London.

 

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

 

•                  thesum of each of the calculation period swap provider amounts calculated duringthe preceding interest period; and

 

•                  thesum of each of the calculation period Funding 1 amounts calculated during thepreceding interest period.

 

After these two amountsare calculated in relation to a Funding 1 interest payment date, the followingpayments will be made on that Funding 1 interest payment date:

 

•                  ifthe first amount is greater than the second amount, then the Funding 1 swapprovider will pay the difference to Funding 1;

 

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•                  ifthe second amount is greater than the first amount, then Funding 1 will pay thedifference to the Funding 1 swap provider; and

 

•                  ifthe two amounts are equal, neither party will make a payment to the other.

 

If a payment is to bemade by the Funding 1 swap provider, that payment will be included in the Funding1 available revenue receipts and will be applied on the relevant Funding 1interest payment date according to the relevant order of priority of paymentsof Funding 1. If a payment is to be made by Funding 1, it will be madeaccording to the relevant order of priority of payments of Funding 1.

 

The notional amount ofthe Funding 1 swap in respect of a calculation period will be an amount insterling equal to:

 

•                  theaggregate principal amount outstanding of all intercompany loans on the firstday of the relevant calculation period, less

 

•                  thebalance of the principal deficiency ledger attributable to all intercompanyloans on the first day of the relevant calculation period, less

 

•                  theamount of the principal receipts in the Funding 1 GIC account attributable toall intercompany loans on the first day of the relevant calculation period.

 

In the event that theFunding 1 swap is terminated prior to the service of any issuer intercompanyloan acceleration notice or final repayment of any intercompany loan, Funding 1shall enter into a replacement Funding 1 swap on terms acceptable to the ratingagencies, with the security trustee and with a swap provider whom the ratingagencies have previously confirmed in writing to Funding 1, the issuer and thesecurity trustee will not cause the then current ratings of the issuer notes tobe downgraded, withdrawn or qualified. If Funding 1 is unable to enter into anew Funding 1 swap on terms acceptable to the rating agencies, this may affectamounts available to pay interest on the intercompany loans.

 

**Theissuer currency swaps**

 

The issuer intercompanyloan is denominated in sterling, and interest payable by Funding 1 to theissuer under the issuer term advances is calculated as a margin over LIBOR forthree-month sterling deposits. However, some of the issuer notes aredenominated in US dollars and accrue interest at either a LIBOR based rate forone-month US dollar deposits or a LIBOR based rate for three-month US dollardeposits. In addition, the series 4 class A1 issuer notes, series 4 class Bissuer notes, series 4 class C issuer notes, series 5 class B issuer notes andseries 5 class C issuer notes are denominated in euro and accrue interest at aEURIBOR based rate for three-month euro deposits. To deal with the potentialinterest rate and/or 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 all euro denominated issuer notes and all US dollar denominatedissuer notes into sterling on terms that match the issuer’s obligations underthe US dollar denominated issuer notes or the euro denominated issuer notes, asapplicable.

 

The currency amount ofeach issuer currency swap is the principal amount outstanding under the issuernotes to which the relevant issuer currency swap relates. Subject, in the caseof the class B and C issuer swaps, to certain deferral of interest provisionsthat will apply when payment of interest under the corresponding offered issuernotes is deferred in accordance with the terms and conditions of such offeredissuer notes, the issuer swap providers will pay to the issuer amounts in USdollars or euro, as applicable that are equal to the amounts of interest to bepaid on each of the classes of the

 

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offered issuer notes and the issuer will pay to the issuer swapproviders the sterling interest amounts received on the issuer term advancescorresponding to the classes 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 class of issuer notes, each issuer currency swapagreement provides that as and when the issuer notes amortize, a correspondingportion of the relevant issuer currency swap so terminated will be swapped fromsterling into US dollars at the relevant dollar currency exchange rate or intoeuro at the euro currency exchange rate, as applicable.

 

The payment obligationsof the series 3 issuer swap provider and the series 5 issuer swap providerunder the relevant issuer currency swaps are guaranteed by the AIG issuer swapguarantor pursuant to a guarantee (the “AIG issuer swap guarantee”).

 

In the event that anyissuer currency swap is terminated prior to the service of an issuer noteacceleration 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 an issuer currencyswap agreement is terminated and the issuer is unable to enter into areplacement swap as described above, then any payments received by the issuerfrom Funding 1 on each Funding 1 interest payment date shall be deposited inthe issuer bank account (or such other account opened for this purpose) andapplied by the issuer to repay the issuer notes on each interest payment dateafter exchanging at the “spot” rate, the relevant proceeds from sterling intoUS dollars or euros as required.

 

**Theissuer interest rate swap**

 

The issuer term advances accrue interest at a LIBOR based ratefor three-month sterling deposits. The series 5 class A issuer notes, until theinterest payment date falling in December 2010 accrues interest at a fixedrate. To deal with the potential interest rate mismatch between (i) itsreceipts in respect of interest payable on the issuer intercompany loan and (ii) itsreceipts and liabilities in respect of interest payable on the series 5 class Aissuer notes, the issuer has, pursuant to the terms of the issuer interest rateswap, swapped its receipts in respect of the interest it receives on the issuerseries 5 term AAA advance on terms that match the issuer’s obligation to payinterest under the series 5 class A issuer notes.

 

Inthe event that the issuer interest rate swap is terminated prior to the serviceof an issuer note acceleration notice or the interest payment date falling in December 2010,the issuer shall enter into a replacement issuer interest rate swap in respectof the series 5 class A issuer notes. Any replacement issuer interest rate swapmust be entered into on terms acceptable to the rating agencies, the issuer andthe security trustee and with a replacement issuer interest rate swap providerwhom the rating agencies have previously confirmed in writing to the issuer andthe security trustee will not cause the then current ratings of the issuernotes to be downgraded, withdrawn or qualified. If the issuer is unable toenter into a replacement issuer interest rate swap on terms acceptable to therating agencies, this may affect amounts available to pay amounts due under theissuer notes.

 

Ifan issuer interest rate swap agreement is terminated and the issuer is unableto enter into a replacement swap as described above, then any interest paymentsreceived by the issuer in respect of the issuer series 5 term AAA advance fromFunding 1 on each Funding 1 interest payment date shall be deposited in theissuer bank account (or such account opened for this purpose) applied by theissuer

 

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topay interest to the holders of the series 5 class A issuer notes on eachinterest payment date.

 

**Ratingsdowngrade of swap providers**

 

Under each of the swapagreements, in the event that the relevant rating(s) of a swap provider, or itsrespective guarantor, as applicable, is or are, as applicable, downgraded by arating agency below the rating(s) specified in the relevant swap agreement (inaccordance with the requirements of the rating agencies) for such swapprovider, and, as a result of the downgrade, the then current ratings of thecurrent notes, in respect of the Funding 1 swap, or the issuer notescorresponding to the relevant issuer swap in respect of the relevant issuerswap, would or may, as applicable, be adversely affected, the relevant swapprovider will, in accordance with the Funding 1 swap or the relevant issuerswap, as applicable, be required to take certain remedial measures, which mayinclude providing collateral for its obligations under the relevant swap,arranging for its obligations under the relevant swap to be transferred to anentity with rating(s) required by the relevant rating agency as specified inthe relevant swap agreement (in accordance with the requirements of the ratingagency), obtaining a guarantee from a satisfactory third party or procuringanother entity with rating(s) required by the relevant rating agency asspecified in the relevant swap agreement (in accordance with the requirementsof the rating agency), to become co-obligor in respect of its obligations underthe relevant swap, or taking such other action as it may agree with therelevant rating agency.

 

In light of the creditrating of Credit Suisse First Boston International (“CSFBi”) as at the closingdate and at the date of this filing, CSFBi, as series 2 issuer swap provider,has provided collateral for its obligations under the series 2 issuer swapsfrom the effective date of such issuer swaps. In the event that CSFBi’s creditrating is restored to the level required under the relevant issuer swapagreements, the obligation to post collateral will cease.

 

**Terminationof the swaps**

 

The Funding 1 swapwill terminate on the date on which the aggregate principal amount outstandingunder all intercompany loans is reduced to zero.

 

Each issuer swapother than the series 2 class A issuer swap, the series 3 class A issuer swap,the series 4 class A1 issuer swap and the series 5 class A issuer swap willterminate on the earlier of the interest payment date falling in June 2042and the date on which all of the relevant class and series of issuer notes areredeemed in full. The series 2 class A issuer swap will terminate on theearlier of the interest payment date falling in September 2010 and thedate on which the series 2 class A issuer notes are redeemed in full. Theseries 3 class A issuer swap will terminate on the earlier of the interestpayment date falling in September 2033 and the date on which the series 3class A issuer notes are redeemed in full. The series 4 class A1 issuer swapwill terminate on the earlier of the interest payment date falling in December 2033and the date on which the series 4 class A issuer notes are redeemed in full.The series 5 class A issuer swap will terminate on the earlier of the interestpayment date falling in December 2010 and the date on which the series 5class A issuer notes are redeemed in full.

 

Any swap may also beterminated in any of the following circumstances, each referred to as a “swapearly termination event”:

 

•                  ifthere is a failure by a party to pay any amounts due under that swap and anyapplicable grace period has expired;

 

•                  inrespect of the issuer swaps, if an event of default under the relevant class ofissuer notes occurs and the security trustee serves an issuer note accelerationnotice;

 

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•                  inrespect of the Funding 1 swap, if an event of default under any intercompanyloan occurs and the security trustee serves an intercompany loan accelerationnotice;

 

•                  inrespect of the issuer swaps, at the option of the issuer, and in respect of theFunding 1 swap, at the option of Funding 1, if certain tax representations bythe relevant issuer swap provider prove to have been untrue or misleading inany material respect;

 

•                  inrespect of the issuer swaps, at the option of the relevant issuer swapprovider, and in respect of the Funding 1 swap, at the option of Funding 1, ifcertain insolvency events occur with respect to the issuer or Funding 1;

 

•                  inrespect of the issuer swaps, at the option of the issuer, and in respect of theFunding 1 swap, at the option of Funding 1, 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 itsobligations under the relevant swap agreement, or if a materialmisrepresentation is made by the swap provider under the relevant swapagreement, or if the relevant swap provider defaults under an over-the-counterderivatives transaction under another agreement between the issuer and suchswap provider; or if a breach of a provision of the relevant swap agreement bythe swap provider is not remedied within the applicable grace period, or, ifapplicable, if the guarantor of the relevant swap provider fails to comply withits obligations under the guarantee;

 

•                  ifa change in law results in the obligations of one of the parties becomingillegal;

 

•                  ifthe relevant swap provider or its guarantor, as applicable, is downgraded andfails to comply with the requirements of the ratings downgrade provisioncontained in the relevant swap agreement; and

 

•                  inthe case of the series 3 and the series 5 issuer swaps, at the option of theseries 3 or the series 5 issuer swap provider (as applicable), but subject toobtaining the consent of the security trustee, if withholding taxes are imposedon payments made by the AIG issuer swap guarantor under the AIG issuer swapguarantee.

 

Upon the occurrence of aswap early termination event, the issuer or the relevant issuer swap providermay be liable to make a termination payment to the other party (in the case ofan issuer swap) and/or Funding 1 or the Funding 1 swap provider may be liableto make a termination payment to the other party (in the case of the Funding 1swap). This termination payment will be calculated and made in sterling. Theamount of any termination payment will be based on the market value of theterminated swap as determined on the basis of quotations sought from leadingdealers as to the cost of entering into a swap with the same terms andconditions that would have the effect of preserving the economic equivalent ofthe respective full payment obligations of the parties (or based upon a goodfaith determination of total losses and costs (or gains) if an insufficientnumber of quotations can be obtained or if basing the valuation on quotationswould not produce a commercially reasonable result). Any such terminationpayment could be substantial.

 

If any issuer swap isterminated early and a termination payment is due by the issuer to an issuerswap provider, then, pursuant to its obligations under the issuer intercompanyloan, Funding 1 shall pay to the issuer an amount equal to the terminationpayment due to the relevant issuer swap provider less any amount received bythe issuer under any replacement issuer swap agreement. These payments will bemade by Funding 1 only after paying interest amounts due on the issuer termadvances and after providing for any debit balance on the principal deficiencyledger. The issuer shall apply amounts received from Funding 1 under the issuerintercompany loan in accordance with the issuer pre-enforcement revenuepriority of payments or, as the case may be, the issuer 

 

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post-enforcement priority of payments. The application by the issuer oftermination payments due to an issuer swap provider may affect the fundsavailable to pay amounts due to noteholders.

 

If the issuer receives atermination payment from an issuer currency swap provider, then the issuershall use those funds towards meeting its costs in effecting currency exchangesat the applicable spot rate of exchange until a replacement issuer currencyswap is entered into and/or to acquire a replacement issuer currency swap.

 

If the issuer receives atermination payment from the issuer interest rate swap provider, then theissuer shall deposit those funds in the issuer bank account (or such otheraccount opened for such purpose) and apply the funds to pay interest on theseries 5 class A issuer notes until a replacement issuer interest rate swap isentered into and/or acquire a replacement issuer interest rate swap.

 

Noteholders will notreceive extra amounts (over and above interest and principal payable on theissuer notes) as a result of the issuer receiving a termination payment.

 

**Transferof the swaps**

 

Each issuer swap providermay, subject to certain conditions specified in the relevant issuer swapagreement, including (without limitation) the satisfaction of certainrequirements of the rating agencies, transfer its obligations under any of theissuer swaps to another entity.

 

**Taxation**

 

Neither Funding 1 nor theissuer is obliged under any of the swaps to gross up payments made by them if withholdingtaxes are imposed on payments made under the Funding 1 swap or the issuerswaps.

 

Each swap provider willbe generally obliged to gross up payments made by it to Funding 1 or the issuerif withholding taxes are imposed on payments made under the Funding 1 swap orthe issuer swaps.

 

The AIG issuer swapguarantor will be obliged to gross up payments made by it to the issuer ifwithholding taxes are imposed on payments under the AIG issuer swapguarantee.  However if the AIG issuerswap guarantor is required to gross up a payment under the AIG issuer swapguarantee in respect of a relevant issuer currency swap, the relevant issuerswap provider may, subject to the consent of the security trustee, terminatethe relevant issuer currency swap.

 

**Item 12.  Description of Securities Other than EquitySecurities**

 

Not applicable to annualreports filed on Form 20-F.

 

**PART II**

 

**Item 13.  Defaults, Dividend Arrearages andDelinquencies**

 

None.

 

**Item 14.  Material Modifications to the Rights ofSecurity Holders and Use of Proceeds**

 

None.

 

**Item 15.  Controls and Procedures**

 

Not applicable.

 

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**Item 16A.  Audit Committee Financial Expert**

 

Not applicable.

 

**Item 16B.  Code of Ethics**

 

Not applicable.

 

**Item 16C.  Principal Accountant Fees and Services**

 

Not applicable.

 

**Item 16D.  Exemptions from the Listing Standards forAudit Committees**

 

Not applicable.

 

**Item 16E.  Purchases of Equity Securities by the Issuerand Affiliated Purchasers**

 

Not applicable.

 

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**PART III**

 

**Item 17.  Financial Statements**

 

Not applicable.

 

**Item 18.  Financial Statements**

 

Not applicable.

 

**Item 19.  Exhibits**

 

The following documentsare filed as part of the Annual Report on Form 20-F:

 

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

 

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

 

Exhibit 12: Section 302certification.

 

Exhibit 15.1:Investor’s Report for the month of January 2004 (incorporated by referencefrom the Form 6-K previously filed on February 13, 2004).

 

Exhibit 15.2:Investor’s Report for the month of February 2004 (incorporated byreference from the Form 6-K previously filed on March 11, 2004and revised March 15, 2004).

 

Exhibit 15.3:Investor’s Report for the month of March 2004 (incorporated by referencefrom the Form 6-K previously filed on April 09, 2004 andrevised July 13, 2004).

 

Exhibit 15.4:Investor’s Report for the month of April 2004 (incorporated by referencefrom the Form 6-K previously filed on May 13, 2004 and revised July 13,2004).

 

Exhibit 15.5:Investor’s Report for the month of May 2004 (incorporated by referencefrom the Form 6-K previously filed on June 14, 2004 and revisedJuly 13, 2004).

 

Exhibit 15.6:Investor’s Report for the month of June 2004 (incorporated by referencefrom the Form 6-K previously filed on July 13, 2004).

 

Exhibit 15.7:Investor’s Report for the month of July 2004 (incorporated by referencefrom the Form 6-K previously filed on August 12, 2004).

 

Exhibit 15.8:Investor’s Report for the month of August 2004 (incorporated by referencefrom the Form 6-K previously filed on September 9, 2004).

 

Exhibit 15.9:Investor’s Report for the month of September 2004 (incorporated byreference from the Form 6-K previously filed on October 13,2004).

 

Exhibit 15.10:Investor’s Report for the month of October 2004 (incorporated by referencefrom the Form 6-K previously filed on November 17, 2004).

 

Exhibit 15.11:Investor’s Report for the month of November 2004 (incorporated byreference from the Form 6-K previously filed on December, 2004).

 

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Exhibit 15.12:Investor’s Report for the month of December 2004 (incorporated byreference from the Form 6-K previously filed on January 14,2005 and revised January 18, 2005).

 

Exhibit 15.13:Servicer compliance statement.

 

Exhibit 15.14:Attestation report of independent accountants.

 

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**SIGNATURES**

 

Each registrant herebycertifies that it meets all of the requirements for filing on Form 20-Fand that it has duly caused and authorized the undersigned to sign this annualreport on its behalf.

 
|                      |   | PERMANENT FINANCING  (NO. 3) 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 30,  2005 |   | Name:                                | David Balai |
|                      |   | Title:                               | Director |

 

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