**As filed with the Securities and ExchangeCommission on June 30, 2004**

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 20-F**

 

**(Mark One)**

 

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

 

**or**

 

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

 

**For the fiscal yearended December 31, 2003**

 

**or**

 

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

 

**For the transition period from                    to                    **

 

**Commission filenumber:   333-109144**

 

**PERMANENTFINANCING (NO. 3) PLC**

(Exact Name of Registrant 1 as specified inits charter)

 

**UnitedKingdom**

(Jurisdiction of Incorporation orOrganization)

 

**BlackwellHouse, Guildhall Yard, London EC2V 5AE, United Kingdom, (011 44 20) 7556 0972**

(Address of Principal ExecutiveOffices)

 

**PERMANENTFUNDING (NO. 1) LIMITED**

(Exact Name of Registrant 2 as specified inits charter)

 

**UnitedKingdom**

(Jurisdiction of Incorporation orOrganization)

 

**BlackwellHouse, Guildhall Yard, London EC2V 5AE, United Kingdom, (011 44 20) 7556 0972**

(Address of Principal ExecutiveOffices)

 

**PERMANENTMORTGAGES TRUSTEE LIMITED**

(Exact Name of Registrant 3 as specified inits charter)

 

**Jersey,Channel Islands**

(Jurisdiction of Incorporation orOrganization)

 

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

(Address of Principal ExecutiveOffices)

 

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

 

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

 

 

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Securities for which there is a reportingobligation pursuant to Section 15(d) of the Act:

 

Title of each class

 

$1,100,000,000 series 1 class A notes dueDecember 2004

 

$38,000,000 series 1 class B notes dueJune 2042

 

$38,000,000 series 1 class C notes dueJune 2042

 

$1,700,000,000 series 2 class A notes dueSeptember 2010

 

$59,000,000 series 2 class B notes dueJune 2042

 

$59,000,000 series 2 class C notes dueJune 2042

 

$1,500,000,000 series 3 class A notes dueSeptember 2033

 

$52,000,000 series 3 class B notes dueJune 2042

 

$52,000,000 series 3 class C notes dueJune 2042

 

Series 1 term AAA advance(1)

 

Series 1 term AA advance(1)

 

Series 1 term BBB advance(1)

 

Series 2 term AAA advance(1)

 

Series 2 term AA advance(1)

 

Series 2 term BBB advance(1)

 

Series 3 term AAA advance(1)

 

Series 3 term AA advance(1)

 

Series 3 term BBB advance(1)

 

Funding 1 interest in the mortgages trust(1)

 

Indicate the number of outstanding shares of each of the issuer’sclasses of capital or common stock as of the close of the period covered by theannual report.

 

Not applicable.

 

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

 

Yes ý No o

 

Indicate by check mark which financial statement item the registranthas elected to follow.

 

Not applicable.

 

 

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(1) These items have not been offered directly to investors. PermanentMortgages Trustee Limited is the registrant for the Funding 1 interest in themortgages trust and is holding the Funding interest in the mortgages trust onbehalf of Permanent Funding (No. 1) Limited. The Funding 1 interest in themortgages trust will be the primary source of payments on the term advanceslisted. Permanent Funding (No. 1) Limited is the registrant for the termadvances and has issued the term advances to Permanent Financing (No. 3) PLC.The term advances are the primary source of payments on the series 1 notes, theseries 2 notes and the series 3 notes. Permanent Financing (No. 3) PLC is theregistrant for the series 1 notes, the series 2 notes and the series 3 notes.

 

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**PRESENTATIONOF INFORMATION**

 

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

 

•                  $1,100,000,000series 1 class A notes due December 2004

•                  $38,000,000series 1 class B notes due June 2042

•                  $38,000,000series 1 class C notes due June 2042

•                  $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 following advancesmade 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 securitytrustee (the “security trustee”) and Citibank, N.A., as agent bank:

 

•                  £658,500,000series 1 term AAA advance

•                  £22,900,000series 1 term AA advance

•                  £22,900,000series 1 term BBB advance

•                  £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 further relates to Funding 1’s interestin the mortgages trust, comprising, among other things, the portfolio of loansand their related security assigned to Permanent Mortgages Trustee Limited (the“mortgages trustee”) by Halifax plc (the “seller”) on June 14, 2002, and onseveral subsequent dates any new loans and their new related security assignedto the mortgages trustee by the seller after November 25, 2003 (the“closing date”), any increase in the outstanding principal balance of a loandue to the borrower taking payment holidays or making underpayments under aloan or a borrower making a drawing under any flexible loan, any interest,principal and other amounts (excluding third party amounts) paid by borrowerson their loans and their related security, the rights under the insurance policiesthat are assigned to the mortgages trustee or of which the mortgages trusteehas the benefit, and amounts on deposit and interest earned on the mortgagestrustee guaranteed investment contract. The mortgages trustee guaranteed investment contract, or GIC, account isthe bank account in which the mortgages trustee holds any cash that is part ofthe trust property until it is distributed to the beneficiaries.  Any actual losses in relation to the loans,any actual reductions occurring in respect of the loans and distributions ofprincipal made from time to time to the beneficiaries or the mortgages trustwill be deducted from the trust property. The composition of the trust propertywill fluctuate as drawings under flexible loans and new loans are added and asthe loans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

Certain terms used herein and not defined have the same meaningascribed to such terms in the Registration Statement filed on Form S-11 (the“Registration Statement”) relating to the securities (file number 333-109144).

 

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Certain items in Form 20-F are not applicable to annual reports filedon Form 20-F.  Therefore, as used inthis filing, “Not applicable to annual reports filed on Form 20-F” means thatthe response to the referenced item is omitted in reliance on the instructionsto Form 20-F published by the United States Securities and Exchange Commission(the “SEC”) as of the date of this annual report that specifically state thatthe item is inapplicable to annual reports filed on Form 20-F.

 

Certain items in Form 20-F are not applicable to the issuer, Funding 1or the mortgages trustee.  Therefore, asused in this filing, “Not Applicable” means the response to the reference itemis omitted in reliance on the procedures outlined in numerous no-action lettersissued by the staff of the SEC with respect to issuers of substantially similarasset-backed securities that file annual reports on Form 10-K, or that thereferenced item is otherwise not applicable.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This annual report includes forward-looking statements including, butnot limited to, statements made under the “Risk Factors” section.  These forward-looking statements can beidentified by the use of forward-looking terminology, such as the words“believes”, “expects”, “may”, “intends”, “should” or “anticipates”, or thenegative or other variations of those terms. These statements involve known and unknown risks, uncertainties andother important factors that could cause the actual results and performance ofthe issuer notes, the seller or the UK residential mortgage industry to differmaterially from any future results or performance expressed or implied in theforward-looking statements.  Theserisks, uncertainties and other factors include, among others: general economicand business conditions in the UK; currency exchange and interest fluctuations;government, statutory, regulatory or administrative initiatives affecting theseller, changes in business strategy, lending practices or customerrelationships and other factors that may be referred to in this annual report.

 

Some of the most significant of these risks, uncertainties and otherfactors are discussed in the section of this annual report entitled “RiskFactors”. Investors are encouraged to carefully consider those factors prior tomaking an investment decision regarding the issuer notes.

 

**INCORPORATIONOF CERTAIN DOCUMENTS BY REFERENCE**

 

Each of the issuer, Funding 1 and the mortgages trustee incorporates byreference its periodic filings on Form 6-K, which contain all financialinformation relating to the securities relevant to the holders of the issuernotes.

 

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**PARTI**

 

**Item 1.  Identity of Directors, Senior Management andAdvisers**

 

Not applicable to annual reports filed on Form 20-F.

 

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

 

Not applicable to annual reports filed on Form 20-F.

 

**Item 3.  Key Information**

 

A.*                                   SelectedFinancial Data*

 

Each of the issuer, Funding 1 and the mortgages trustee incorporates byreference and attaches hereto as exhibits the following reports, filed on Form6-K, which include all financial information relating to the securities that isrelevant to holders of the issuer notes:

 

•                  Investor’sReport for the month of November 2003

•                  Investor’sReport for the month of December 2003

 

B.*                                     Capitalizationand Indebtedness*

 

Not applicable to annual reports filed on Form 20-F.

 

C.*                                     Reasonsfor the Offer and Use of Proceeds*

 

Not applicable to annual reports filed on Form 20-F.

 

D*.            RiskFactors*

 

*This section describes the principal risk factors associated withan investment in the issuer notes. Investors considering purchasing the issuernotes should carefully read and think about all the information contained inthis document, including the risk factors set out here, prior to making anyinvestment decision.*

 

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

 

The issuer notes do not represent an obligation and are not theresponsibility of any of Halifax plc or any of its affiliates, underwriters,managers, the mortgages trustee, the note trustee or any other party to thetransaction other than the issuer.

 

**Theissuer has a limited set of resources available to it to make payments on theissuer notes**

 

The issuer’s ability to make payments of principal and interest on theissuer notes and to pay its operating and administrative expenses will dependprimarily on the funds being received under the issuer intercompany loan.  In addition, the issuer will rely on theissuer dollar currency swaps and the issuer euro currency swaps to providepayments on the issuer notes denominated in US dollars and euro, respectivelyand on the issuer interest rate swap to provide payments of interest on theseries 5 class A notes until the interest payment date falling inDecember 2010.  Noteholders shouldnote that there is no liquidity facility directly available to the issuer,although Funding 1 has the benefit of a liquidity facility to pay interest onthe issuer term advances corresponding to the issuer notes and to pay principalon issuer term advances corresponding to the series 1 class A issuer notes, theseries 2

 

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class A issuer notes, the series 3 class A issuer notes and the series4 class A issuer notes.  The ability ofFunding 1 to draw on the Funding 1 liquidity facility is subject to satisfyingcertain conditions precedent.  TheFunding 1 liquidity facility will be available to repay principal due on theissuer term advance corresponding to the series 3 class A issuer notes and theseries 4 class A issuer notes on their final maturity date only.

 

In addition to the issuer, all relevant issuers (including the previousissuer and, as they are established, each new issuer) have or will have anindirect interest in the Funding 1 liquidity facility (the Funding 1 liquidityfacility will be available to meet interest and principal obligations ofFunding 1 to the previous issuer and new issuers, subject to certain conditionsprecedent).  If a drawing is made underthe Funding 1 liquidity facility to enable Funding 1 to meet its obligations tothe previous 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 other significant sources of fundsavailable to meet its obligations under the issuer notes and / or any otherpayments ranking in priority to the issuer notes.

 

**Funding1 is not obliged to make payments on the issuer term advances if it does nothave enough money to do so, which could adversely affect payments on the issuernotes**

 

Funding 1’s ability to pay amounts due on the issuer term advances willdepend 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 reserve fund;

 

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

 

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

 

According to the terms of the mortgages trust deed, the mortgagestrustee is obliged to pay to Funding 1 the Funding 1 share percentage ofrevenue receipts on the loans by crediting those amounts to the Funding 1 GICaccount on each distribution date.  Themortgages trustee is obliged to pay Funding 1 principal receipts on the loansby crediting those amounts to the Funding 1 GIC account as and when requiredpursuant to the terms of the mortgages trust deed.

 

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

 

Funding 1 will be obliged to pay principal receipts due to the issuerunder the issuer intercompany loan only to the extent that it has principalreceipts available for that purpose after repaying amounts ranking in priorityto the issuer (including repaying any higher ranking new term advances).

 

If there is a shortfall between the amounts payable by Funding 1 to theissuer under the issuer intercompany loan agreement and the amounts payable bythe issuer on the issuer notes, the noteholders may, depending on what othersources of funds are available to the issuer and to Funding 1, not receive thefull amount of interest and / or principal which would otherwise be due andpayable on the issuer notes.

 

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

 

If Funding 1 does not make payments due and payable on the issuer intercompanyloan, then the issuer may not have enough money to make payments on the issuernotes, and in addition the issuer will have only limited recourse to the assetsof Funding 1.  If Funding 1 does not payamounts 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.

 

**Onthe final repayment date of the issuer intercompany loan any outstandingamounts in respect of the issuer term AA advances and the issuer term BBBadvances will be extinguished, which would cause a loss on any class B issuernotes and any class C issuer notes still outstanding**

 

The transaction has been structured in the expectation that on thefinal repayment date of the issuer intercompany loan in June 2042, theinterest and principal due and payable on the issuer term AA advances and theissuer term BBB advances will be in an amount equal to the sum available to payall outstanding interest and / or principal (including interest and / orprincipal deferred and unpaid) on the issuer term AA advances and the issuerterm BBB advances (after paying amounts of a higher order of priority asrequired by the Funding 1 priority of payments).

 

If there is a shortfall between the amount available to pay theinterest and / or principal and the amount required to pay all outstandinginterest and / or principal on the issuer term AA advances and the issuer termBBB advances, then the shortfall will be deemed to be not due and payable underthe issuer intercompany loan agreement and the issuer will not have any claimagainst Funding 1 for the shortfall.

 

If there is a shortfall in interest and / or principal payments underthe issuer intercompany loan agreement, the noteholders may not receive thefull amount of interest and / or principal which would otherwise be due andpayable on the class B issuer notes or the class C issuer notes outstanding.

 

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

 

The only remedy for recovering amounts on the issuer notes is throughthe enforcement of the issuer security. The issuer has no recourse to the assets of Funding 1 unless Funding 1has also defaulted on its obligations under the issuer intercompany loan andthe Funding 1 security has been enforced.

 

If the security created as required by the issuer deed of charge isenforced, the proceeds of enforcement may be insufficient to pay all principaland interest due on the issuer notes.

 

**Thetransaction has been structured in the expectation that the series 1 issuernotes will be redeemed before the series 2 issuer notes and so on**

 

The transaction has been structured in the expectation that:

 

•                  theseries 1 issuer notes will be redeemed in full prior to the redemption of theseries 2 issuer notes, the series 3 issuer notes, the series 4 issuer notes andthe series 5 issuer notes;

 

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•                  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 the series 1 class B issuer notesand the series 1 class C issuer notes are expected to be redeemed before theseries 2 class A issuer notes, the series 3 class A issuer notes, the series 4class A issuer notes and the series 5 class A issuer notes, even though theseries 2 class A issuer notes, the series 3 class A issuer notes, the series 4class A issuer notes and the series 5 class A issuer notes have a higher ratingthat the series 1 class B issuer notes and the series 1 class C issuernotes.  Similarly, the series 2 class Bissuer notes and the series 2 class C issuer notes are expected to be redeemedbefore the series 3 class A issuer notes, the series 4 class A issuer notes andthe series 5 class A issuer notes, and so on for each series of issuer notes.

 

However, there is no assurance that the series 1 issuer notes will beredeemed in full before the series 2 issuer notes, the series 3 issuer notes,the series 4 issuer notes and the series 5 issuer notes or that the series 2issuer notes will be redeemed in full before the series 3 issuer notes, theseries 4 issuer notes and the series 5 issuer notes or that the series 3 issuernotes will be redeemed in full before the series 4 issuer notes and the series5 issuer notes or that the series 4 issuer notes will be redeemed in fullbefore the series 5 issuer notes.  Ineach case, redemption of the issuer notes is ultimately dependent on, amongother things, repayment and redemptions on the loans and on the term advancerating of the issuer term advances.

 

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

 

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

 

The issuer deed of charge requires the security trustee to consider theinterests of each of the issuer secured creditors in the exercise of all of itspowers, trusts, authorities, duties and discretions, but requires the securitytrustee, in the event of a conflict between the noteholders’ interests and theinterests of any of the other issuer secured creditors, to consider only thenoteholders’ interests.  In certaincircumstances, the security trustee can make amendments to the documentswithout the noteholders’ prior consent.

 

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

 

Pursuant to the terms of the Funding 1 deed of charge and the issuerdeed of charge, the security trustee may, without the consent or sanction ofFunding 1’s secured creditors or the issuer’s secured creditors, concur withany person in making or sanctioning any modifications to the transactiondocuments:

 

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•                  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 oris of a formal, minor or technical nature.

 

The security trustee will be entitled to assume that the exercise ofits discretion will not be materially prejudicial to the noteholders’ interestsif each of the rating agencies has confirmed that the then current rating by itof the notes would not be adversely affected by such exercise.

 

In addition, the security trustee will give its consent to anymodifications to the mortgage sale agreement, the servicing agreement, the cashmanagement agreement, the Funding 1 deed of charge, the Funding 1 liquidityfacility agreement, the Funding 1 swap agreement, the intercompany loan termsand conditions, the bank account agreement and the master definitions andconstruction schedule, that are requested by Funding 1 or the cash manager,provided that Funding 1 or the cash manager certifies to the security trusteein writing that the modifications are required in order to accommodate:

 

(i) the addition of new issuers and / or other relevant creditors tothe transaction and / or the issue of new types of notes by new issuers;

 

(ii) the inclusion of Permanent Funding (No. 2) PLC (“Funding 2”) as abeneficiary of the mortgages trust and / or the issue of new notes by Funding2;

 

(iii) the assignment of new types of loans to the mortgages trustee;

 

(iv) changes to be made to the reserve fund required amount and / orthe manner in which the reserve fund is funded;

 

(v) changes to be made to the definitions of asset trigger event andnon-asset trigger event; and

 

(vi) the addition of an additional Funding 1 liquidity facility;

 

and provided further that:

 

•                  inrespect of the matters listed in paragraphs (i), (ii) and (iii), the relevantconditions precedent to, as applicable, the addition of new issuers, theinclusion of Funding 2 as a beneficiary of the mortgages trust or theassignment of new loans to the mortgages trustee, have been satisfied; and

 

•                  inrespect of the matters listed in paragraphs (i) to (vi), 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 to the matters listed inparagraphs (i) to (vi) above may include, *inter alia*, amendments to the provisionsof the Funding 1 deed of charge relating to the application of monies.Accordingly, there can be no assurance that the effect of the modifications tothe transaction documents will not ultimately adversely affect the noteholders’interests. As applicable, any modifications to the documents described abovewill require the actual consent of the Funding 1 liquidity facility provider,the Funding 1 swap provider and each of the issuer swap providers, such consentnot to be unreasonably withheld and to be deemed given if no response

 

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(affirmative or negative) is given within ten business days after therequest for consent is sent to each party.

 

**Theremay be a conflict between the interests of the holders of class A issuer notes,the holders of class B issuer notes and the holders of class C issuer notes,and the interests of one class of noteholders may prevail over the interests ofother classes of noteholders**

 

The issuer trust deed and the terms of the issuer notes provide thatthe note trustee is to have regard to the interests of the holders of all theclasses of issuer notes. There may be circumstances, however, where theinterests of one class of noteholders conflict with the interests of anotherclass or classes of noteholders. The issuer trust deed and the terms of theissuer notes provide that where, in the opinion of the note trustee, there is aconflict, 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.

 

**Theremay be a conflict between the interests of the holders of each series of theclass A issuer notes, the holders of each series of the class B issuer notesand the holders of each series of the class C issuer notes, and the interestsof one series of noteholders may prevail over the interests of other series ofnoteholders**

 

There may also be circumstances where the interests of the class Anoteholders of one series of the issuer notes conflict with the interests ofthe class A noteholders of another series of the issuer notes.  Similarly, there may be circumstances wherethe interests of the class B noteholders of one series of the issuer notesconflict with the interests of the class B noteholders of another series of theissuer notes or the interests of the class C noteholders of one series of theissuer notes conflict with the interests of the class C noteholders of anotherseries of the issuer notes.

 

The issuer trust deed and the terms of the issuer notes will providethat where, in the sole opinion of the note trustee, there is a conflict, thena resolution directing the note trustee to take any action must be passed atseparate meetings of the holders of each series of the class A issuer notes,or, as applicable, each series of the class B issuer notes or each series ofthe class C issuer notes.  A resolutionmay only be passed at a single meeting of noteholders of each series of therelevant class if the note trustee is, in its absolute discretion, satisfiedthat there is no conflict between them.

 

Similar provisions will apply in relation to requests in writing fromholders of a specified percentage of the principal amount outstanding of theissuer notes of each class within each series (the principal amount outstandingbeing converted into sterling for the purposes of making the calculation).  Noteholders should note that as a result ofrepayments of principal first to the series 1 issuer notes, then to the series2 issuer notes, then to the series 3 issuer notes, then to the series 4 issuernotes and then to the series 5 issuer notes, the principal amount outstandingof each series of the issuer notes will change after the closing date.

 

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

 

Holdings has established a new entity, Funding 2, which may issue newnotes from time to time and use the proceeds to pay for a direct interest inthe trust property rather than lending the proceeds to Funding 1.  Simultaneously with the acquisition byFunding 2 of an interest in the trust property, the seller and Funding 1, asexisting beneficiaries of the mortgages trust, would be required

 

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to agree to a decrease in their beneficial interests in the trustproperty (which would require a partial release of security by Funding 1 overits share in the trust property).

 

The seller, Funding 1 and Funding 2 would each have a joint andundivided interest in the trust property but their entitlement to the proceedsfrom the trust property would be in proportion to their respective shares ofthe trust property.  On eachdistribution date the mortgages trustee would distribute interest and principalreceipts to one, two or all three beneficiaries, depending on the terms of themortgages trust.

 

It is anticipated that Funding 2 will issue notes directly to investorsfrom time to time backed by its share of the trust property.  Noteholders would not have a direct orindirect interest in Funding 2’s share of the trust property.

 

Amendments would be made to a number of the issuer transactiondocuments as a result of the inclusion of Funding 2 as a beneficiary of themortgages trust.  In particular (butwithout 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 vice versa) and (iii) to regulate thedistribution of interest and principal receipts in the trust property toFunding 2 and the other beneficiaries; and

 

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

 

There may be conflicts of interest between Funding 1 and Funding 2, inwhich case it is expected that the mortgages trustee will follow the directionsgiven by the relevant beneficiary (excluding the seller) that has the largestshare of the trust property at that time. The interests of Funding 1 may not prevail, which may adversely affectthe noteholders’ interests.

 

Noteholders’ prior consent to the inclusion of Funding 2 as abeneficiary of the mortgages trust and the subsequent amendments to thedocuments and / or release of security by Funding 1 will not be obtained.Before becoming a beneficiary of the mortgages trust, however, Funding 2 willbe 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 willoccur as a result of Funding 2 becoming a beneficiary of the mortgages trust;and

 

•                  providingwritten certification to the security trustee that no principal deficiency is recordedon the principal deficiency ledger in relation to Funding 1’s term advancesthat are outstanding at that time.

 

There can be no assurance that the inclusion of Funding 2 as abeneficiary of the mortgages trust would not affect cashflows available to payamounts due on the noteholders’ issuer notes and therefore adversely affect thenoteholders’ interests.

 

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

 

Since the closing date, Holdings has established new issuers to issuenew notes to investors, and it is likely that Holdings will establishadditional new issuers in the future. The proceeds of each new issue will be used by the new issuer to make anew intercompany loan to Funding 1. Funding 1 will use the proceeds of the new intercompany loan either to:

 

•                  paythe seller for new loans and their related security to be assigned to themortgages trustee;

 

•                  paythe seller for a portion of the existing seller share of the trust property tobe assigned to Funding 1;

 

•                  refinancean intercompany loan or intercompany loans outstanding at that time (and if theissuer’s intercompany loan to Funding 1 is refinanced, noteholders could berepaid early); and / or

 

•                  depositsome of those proceeds in the reserve fund.

 

The current payment and security priorities of the issuer notesrelative to each other as set out in the issuer deed of charge and the issuercash management agreement will not be affected as a result of an issue of newnotes by a new issuer, because that new issue will be separatelydocumented.  However, Funding 1 may berequired to repay to a new issuer amounts owing under a new term advance aheadof or in the same order of priority as amounts owing to the issuer on theissuer term advances, depending on the term advance rating, the scheduledrepayment date of that new term advance and certain other rules regarding therepayment of principal by Funding 1.  Ifthis is the case, then the relevant new noteholders will be paid before thenoteholders.

 

If Holdings establishes new issuers to make new intercompany loans toFunding 1, the noteholders will not have any right of prior review or consentwith respect to those new intercompany loans or the corresponding issuance bynew issuers of new notes.  Similarly,the terms of the Funding 1 transaction documents (including the mortgage sale agreement,the mortgages trust deed, the Funding 1 deed of charge, the definitions of thetrigger events, the criteria for the assignment of new loans to the mortgagestrustee and the amount available to be drawn under the Funding 1 liquidityfacility) may be amended to reflect the new issue.  Noteholders’ consent to these changes will not be required. Therecan be no assurance that these changes will not affect the cashflows availableto pay amounts due on the issuer notes.

 

Before issuing new notes, however, a new issuer will be required tosatisfy 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

 

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•                  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.

 

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

 

The other issuers issuednotes to investors, the equivalent net issue proceeds of which were used by theother issuers to make intercompany loans to Funding 1.  Funding 1 used most of the proceeds of theseintercompany loans to pay the seller for the initial loans (together with theirrelated security) that it assigned to the mortgages trustee on the initialclosing date, which comprised Funding 1’s original share of the trust property.

 

The current payment and security prioritiesof the issuer notes relative to each other as set out in the issuer deed ofcharge and the issuer cash management agreement are not affected as a result ofthe issue of notes by the other issuers, because the other issues wereseparately documented.  However, Funding1 may be required to pay to the other issuers amounts that are owing under oneor more term advances ahead of or in the same order of priority as amountsowing to the issuer on the issuer term advances, depending on the term advancerating, the scheduled repayment date of that term advance and other rulesregarding the payment of interest and the repayment of principal by Funding 1.  If this is the case then the other noteholders will be paid before you.

 

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

 

If Funding 1 enters into a new intercompany loan agreement, then ifrequired it will also enter into a new start-up loan agreement with newstart-up loan providers and the security trustee.  If required by the rating agencies, Funding 1 will use part ofthe proceeds of the new start-up loan to fund further the existing reservefunds.

 

Similarly, if necessary, Funding 1 will also enter into a new Funding 1swap with either the Funding 1 swap provider or a new Funding 1 swap providerand the security trustee.

 

The new issuer, any new start-up loan provider and any new Funding 1swap provider will become party to the Funding 1 deed of charge and will beentitled to share in the security granted by Funding 1 for its benefit (and thebenefit of the other Funding 1 secured creditors) under the Funding 1 deed ofcharge.  In addition, the liabilitiesowed to the Funding 1 liquidity facility provider and the Funding 1 swapprovider which are secured by the Funding 1 deed of charge may increase eachtime that Funding 1 enters into a new intercompany loan agreement.  Those factors could ultimately cause areduction in the payments noteholders receive on the issuer notes.  Noteholders’ consent to the requisitechanges to the transition documents will not be obtained.

 

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

 

The security trustee will exercise its rights under the Funding 1 deedof charge only in accordance with directions given by the issuers (which couldbe the issuer and, if Funding 1 enters into new intercompany loans, any newissuer) that have the highest-ranking outstanding term advances, provided thatthe security trustee is indemnified and / or secured to its satisfaction.

 

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If the security trustee receives conflicting directions, it will followthe directions given by the relevant issuers representing the largest principalamount outstanding of relevant term advances. If the issuer is not in the group representing that largest principalamount, then its interests may not prevail. This could ultimately cause a reduction in the payments the noteholdersreceive on the issuer notes.

 

**Asnew loans are assigned to the mortgages trustee, the characteristics of thetrust property may change from those existing at the closing date, and thosechanges may adversely affect payments on the issuer notes**

 

There is no guarantee that any new loans assigned to the mortgagestrustee will have the same characteristics as the loans in the initialportfolio as of the closing date.  Inparticular, new loans may have different payment characteristics than the loansin the initial portfolio as of the closing date.  The ultimate effect of this could be to delay or reduce thepayments the noteholders receive on the issuer notes.

 

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

 

The yield to maturity of the issuer notes of each class will depend mostlyon (a) the amount and timing of payment of principal on the loans and (b) theprice paid by noteholders of each class of issuer notes.  The yield to maturity of the issuer notes ofeach class may be adversely affected by a higher or lower than anticipated rateof prepayments on the loans.

 

No assurance can be given that Funding 1 will accumulate sufficientfunds during the cash accumulation period relating to the issuer series 1 termAAA advance, the issuer series 2 term AAA advance, each scheduled amortizationinstallment under the issuer series 3 term AAA advance and / or each scheduledamortization installment under the issuer series 4 term AAA advance to enableit to repay these issuer term advances to the issuer so that the correspondingclasses of issuer notes will be redeemed in their entirety on their scheduledredemption dates.

 

During the cash accumulation period for the issuer term advances andscheduled amortization installments, repayments of principal will only be madeon the issuer series 5 term AAA advance, the issuer term AA advances or theissuer term BBB advances that are due and payable if the quarterly CPR of theloans in the trust property is greater than 15 per cent. and certain otherconditions are met.  This means thatthere may be no corresponding repayments of principal on the series 5 class Aissuer notes, the class B issuer notes or the class C issuer notes.

 

The extent to which sufficient funds are saved by Funding 1 during acash accumulation period or received by it from its share in the mortgagestrust on a scheduled repayment date will depend on whether the actual principalprepayment rate of the loans is the same as the assumed principal prepaymentrate.  If Funding 1 is not able to saveenough money during a cash accumulation period or does not receive enough moneyfrom its share in the mortgages trust on a scheduled repayment date to repaythe relevant issuer term AAA advance (and if it is unable to make a drawing onthe Funding 1 liquidity facility or the reserve fund to make good theshortfall) so that the issuer can redeem the class A issuer notes of thecorresponding series on their respective scheduled redemption date(s), thenFunding 1 will be required to pay to the issuer on those scheduled redemptiondates only the amount that it has actually saved or received.  Any shortfall will be deferred and paid onsubsequent Funding 1 interest payment dates when Funding 1 has money availableto make the payment.  In thesecircumstances, unless Funding 1 is able to make a drawing on the Funding 1liquidity facility, there will be a variation in the yield to maturity of therelevant class of issuer notes.

 

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**Theissuer’s ability to redeem the series 1 class A issuer notes, series 2 class Aissuer notes and / or 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 influenced by a wide variety ofeconomic, social and other factors, including prevailing mortgage marketinterest rates, the availability of alternative financing programs, local andregional economic conditions and homeowner mobility.  For instance, prepayments on the loans may be due to borrowersrefinancing their loans and sales of properties by borrowers (eithervoluntarily or as a result of enforcement action taken).  In addition, ifthe seller 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 aprepayment of all of the loans under the mortgage account.  Because these factors are not within itscontrol or the control of Funding 1 or the mortgages trustee, the issuer cannotgive any assurances as to the level of prepayments that the portfolio mayexperience.

 

Variation in the rate of prepayments of principal on the loans mayaffect each class of the issuer notes differently depending upon amountsalready repaid by Funding 1 to the issuer under the issuer intercompany loanand whether a trigger event has occurred, or a loan is subject to a product switchor a further advance or the security granted by the issuer under the issuerdeed of charge has been enforced.  Ifprepayments on the loans occur less frequently than anticipated, then there maynot be sufficient funds available to redeem the series 1 class A issuer notes,series 2 class A issuer notes and / or the series 3 class A issuer notes and /or the series 4 class A issuer notes in full on their respective scheduledredemption dates.

 

**Theseller may change the lending criteria relating to loans that are subsequentlyassigned to the mortgages trustee, which could affect the characteristics ofthe trust property and which may adversely affect payments on the issuer notes**

 

Each of the loans was originated in accordance with the seller’slending criteria at the time of origination. These lending criteria consider a variety of factors such as a potentialborrower’s credit history, employment history and status and repayment ability,as well as the value of the property to be mortgaged.  In the event of the assignment of any new loans and new relatedsecurity to the mortgages trustee, the seller will warrant that those new loansand new related security were originated in accordance with the seller’slending criteria at the time of their origination.  However, the seller retains the right to revise its lendingcriteria as determined from time to time, and so the lending criteriaapplicable to any loan at the time of its origination may not be or have beenthe same as those when other loans were originated.  If new loans that have been originated under revised lendingcriteria are assigned to the mortgages trustee, the characteristics of thetrust property could change.  This couldlead to a delay or a reduction in the payments received on the issuer notes.

 

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

 

The seller does not require a solicitor or licensed conveyancer toconduct a full investigation of the title to a property in all cases.  Where the borrower is remortgaging therewill be a limited investigation to carry out some but not all of the searchesand investigations which would normally be carried out in England and Wales bya solicitor conducting a full investigation of the title to a property.  Properties which have undergone such alimited investigation may be subject to matters which would have been revealedby a full investigation of title and which may have been remedied or, ifincapable of remedy, may have resulted in the properties not being accepted assecurity for a loan had the matters been revealed, though to mitigate againstthis risk search indemnity insurance is obtained in respect of theproperties.  The introduction of loanssecured by the properties into the trust property could result in a change ofthe characteristics of the trust property. This could lead to a delay or a reduction in the payments received onthe issuer notes.

 

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

 

The loans are affected by credit, liquidity and interest raterisks.  Various factors influencemortgage delinquency rates, prepayment rates, repossession frequency and theultimate payment of interest and principal, such as changes in the national orinternational economic climate, regional economic or housing conditions,changes in tax laws, interest rates, inflation, the availability of financing,yields on alternative investments, political developments and governmentpolicies.  Other factors in borrowers’individual, personal or financial circumstances may affect the ability ofborrowers to repay loans.  Loss ofearnings, illness, divorce and other similar factors may lead to an increase indelinquencies by and bankruptcies of borrowers, and could ultimately have anadverse impact on the ability of borrowers to repay loans.

 

In addition, the ability of a borrower to sell a property given assecurity for a loan at a price sufficient to repay the amounts outstandingunder the loan will depend upon a number of factors, including the availabilityof buyers for that property, the value of that property and property values ingeneral at the time.

 

In addition, the mortgage loan industry in the United Kingdom is highlycompetitive.  This competitiveenvironment may affect the rate at which the seller originates new loans andmay also affect the level of attrition of the seller’s existing borrowers.

 

The principal source of income for repayment of the issuer notes by theissuer is the issuer intercompany loan. The principal 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 is adversely affected by any ofthe risks described in this section, the payments on the issuer notes could bereduced or delayed.

 

**Theoccurrence of trigger events and enforcement of the issuer security mayadversely affect the scheduled redemption dates of the series 1 class A issuernotes, series 2 class A issuer notes, series 3 class A issuer notes and / orseries 4 class A issuer notes**

 

If no trigger event has occurred and the issuer security has not beenenforced in accordance with the terms of the issuer deed of charge, thenpayments of principal will not occur on the series 1 class A issuer notes,series 2 class A issuer notes and / or series 3 class A issuer notes and / orseries 4 class A issuer notes before their respective scheduled redemptiondates.

 

If a trigger event occurs or the issuer security is enforced inaccordance with the issuer deed of charge prior to the scheduled redemptiondates for the series 1 class A issuer notes, series 2 class A issuer notes and/ or series 3 class A issuer notes and / or series 4 class A issuer notes, thenthe relevant classes of issuer notes outstanding will not be repaid on theirscheduled redemption dates but will be repaid on each interest payment datefrom monies received from Funding 1 on the issuer term AAA advances of thecorresponding series as described in the following three risk factors.

 

**Ifan asset trigger event occurs, any series 1 class A issuer notes, series 2class 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, the mortgages trustee willdistribute principal receipts on the loans to Funding 1 and the sellerproportionally and equally based on their percentage shares of the trustproperty (that is, the Funding 1 share percentage and the seller sharepercentage).  When an asset triggerevent has occurred, Funding 1 will repay (after making requisite payments tothe Funding 1 liquidity facility provider and to replenish the reserve fund):

 

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*first*, the issuer term AAA advances of eachseries proportionally and equally, until all of those term AAA term advancesare fully repaid;

 

*second*, the issuer term AA advances of eachseries proportionally and equally, until all of those term AA term advances arefully repaid; and

 

*third*, the issuer term BBB advances of eachseries proportionally and equally, until all of those term BBB term advancesare fully repaid, until all of those term BBB term advances are fully repaid.

 

This order of priority of payments may change if Funding 1 enters intonew intercompany loan agreements and if an issuer’s security is enforced.  If an asset trigger event occurs, any series1 class A issuer notes, series 2 class A issuer notes and / or series 3 class Aissuer notes and / or series 4 class A issuer notes then outstanding will notbe repaid on their scheduled redemption dates, and there is also a risk thatthey will not be repaid by their final maturity dates.

 

**Ifa non-asset trigger event occurs, any series 1 class A issuer notes, series 2class 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**

 

If a non-asset trigger event has 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 has occurred, Funding 1 will repay (aftermaking requisite payments to the Funding 1 liquidity facility provider and toreplenish the reserve fund):

 

*first*, the term AAA advance with the earliestfinal repayment date, then to repay the term AAA advance with the next earliestfinal repayment date, and so on until the term AAA advances in respect of theissuer intercompany loan , the previous issuer intercompany loan and any newissuer intercompany loans are fully repaid;

 

*then*, the term AA advances in respect of theissuer intercompany loan, the previous issuer intercompany loan and any newissuer intercompany loans,  until eachof those term AA advances is fully repaid; and

 

*finally*, the term BBB advances respect of theissuer intercompany loan, the previous issuer intercompany loan and any newissuer intercompany loans,  until eachof those term BBB advances is fully repaid.

 

If a non-asset trigger event occurs, any series 1 class A issuer notes,series 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 scheduled redemptiondates.

 

**Ifthe issuer security is enforced, any series 1 class A issuer notes, series 2class 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**

 

If the issuer security is enforced, then the mortgages trustee willdistribute funds as required under the terms of the transactionagreements.  In these circumstances, anyseries 1 class A issuer notes, series 2 class A issuer notes, series 3 class Aissuer notes and / or series 4 class A issuer notes then outstanding will notbe repaid on their scheduled redemption dates and there is also a risk thatthose class A issuer notes may not be repaid by their final maturity dates.

 

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

 

If the servicer at its discretion decides to grant a borrower a furtheradvance under a loan which has been assigned to the mortgages trustee, then theseller will be required to repurchase that loan under the relevant mortgageaccount and its related security from the mortgages trustee save for any loanin arrears at a price equal to the outstanding principal balance of those loanstogether with any accrued and unpaid interest and expenses to the date ofpurchase.  The yield to maturity of theissuer notes may be affected by the repurchase of loans subject to furtheradvances.

 

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

 

Loans subject to product switches will not be repurchased unless on anydistribution date, the seller is in breach of the conditions precedent to thesale of new loans to the mortgages trustee. From and including that date to but excluding the date when thoseconditions precedent have been satisfied, the seller will be required torepurchase any loans and their related security that are subject to productswitches.  The seller will be requiredto repurchase the relevant loan or loans under the relevant mortgage accountand their related security from the mortgages trustee at a price equal to theoutstanding principal balance of those loans together with any accrued andunpaid interest and expenses to the date of purchase.

 

A loan will be subject to a product switch if the borrower and theseller agree on or the servicer offers a variation in the financial terms andconditions applicable to the relevant borrower’s loan, other than:

 

•                  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 may be affected by therepurchase of loans subject to product switches.

 

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

 

The ratings assigned to each class of the issuer notes address thelikelihood of full and timely payment to the noteholders of all payments ofinterest on each interest payment date under those classes of the issuernotes. The ratings also address the likelihood of “ultimate”payment of principal on the final maturity date of each class ofthe issuer notes.  Any rating agency maylower its rating or withdraw its rating if, in the sole judgment of the ratingagency, the credit quality of the issuer notes has declined or is in question.  If any rating assigned to the issuer notesis lowered or withdrawn, the

 

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market value of the issuer notes may be reduced and, in the case of theseries 1 class A issuer notes, the issuer notes may no longer be eligible forinvestment by money market funds.

 

A change to the ratings assigned to each class of the issuer notes willnot affect the term advance ratings assigned to each issuer term advance in theintercompany loans.

 

**Subordinationof the other note classes may not protect noteholders from all risk of loss**

 

The class B issuer notes and class C issuer notes are subordinated inright of payment of interest to the class A issuer notes.  The class C issuer notes are subordinated inright of payment of interest to the class B issuer notes.  However, the transaction has been structuredin the expectation that the series 1 issuer notes will be repaid in full priorto the redemption of the series 2 class A issuer notes, the series 3 class Aissuer notes, the series 4 class A issuer notes and the series 5 class A issuernotes.

 

Accordingly, there is no assurance that these subordination rules willprotect the holders of class A issuer notes or the holders of class B issuernotes from all risk of loss.

 

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

 

Principal repayments on the issuer term AA advances and / or the issuerterm BBB advances will be deferred in the following circumstances:

 

If on a Funding 1 interest payment date;

 

•                  thereis a debit balance on the BBB principal deficiency sub-ledger or the AAprincipal deficiency sub-ledger after application of the Funding 1 availablerevenue receipts on that Funding 1 interest payment date; or any term BBBadvances; or

 

•                  theadjusted 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 term AA advance remains outstanding (whetheror not such term AA advance is then due and payable) after the allocation ofprincipal on that Funding 1 interest payment date to those term advances, theissuer term BBB advances will not be entitled to principal repayments until therelevant circumstance as described above has been remedied or otherwise ceasesto exist.  This means that payments ofprincipal on the class C issuer notes of all series and, as applicable, theclass B issuer notes of all series will be deferred until the earlier of thetime when the relevant circumstance described in this risk factor has beenremedied (if ever) and the final maturity date of the relevant notes.

 

Furthermore, if, on a Funding 1 interest payment date prior to theissuer step-up date:

 

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

 

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•                  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.

 

**Series2 issuer notes, series 3 issuer notes, series 4 issuer notes and series 5issuer notes may be subject to risk if the trust property deteriorates afterrepayment of previous series of the issuer notes**

 

If the loans comprising the trust property do not perform as expectedat any time after the repayment in full of the series 1 issuer notes and / orthe series 2 issuer notes, then the series 2 issuer notes and / or the series 3issuer notes and / or the series 4 issuer notes and / or the series 5 issuernotes may not be repaid in full.  Thisrisk will not affect the series 1 noteholders.

 

**Noteholdersmay be subject to exchange rate risks on the series 1 issuer notes, the series2 issuer notes, the series 3 issuer notes, 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**

 

Repayments of principal and payments of interest on the series 1 issuernotes, the series 2 issuer notes and the series 3 issuer notes will be made inUS dollars and on the series 4 class A1 issuer notes, series 4 class B issuernotes, series 4 class C issuer notes, series 5 class B issuer notes and theseries 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 interestrate exposure connected with that currency exposure, the issuer has enteredinto the issuer dollar currency swaps for the series 1 issuer notes, the series2 issuer 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 payments of amounts due under anissuer swap, then the issuer will have defaulted under that issuer swap.  Each issuer swap provider is obliged only tomake payments under an issuer swap as long as the issuer make payments underthe same.  If an issuer swap provider isnot obliged to make payments, or if it defaults in its obligations to makepayments of amounts in US dollars or euro, as applicable, equal to the fullamount to be paid by it on the payment dates under the relevant issuer swap(which are the same dates as the interest payment dates in respect of theissuer notes), the issuer will be exposed to changes in US dollar / sterling oreuro / sterling currency exchange rates and in the associated interest rates onthese 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.

 

The series 3 issuer swap guarantor and series 5 issuer swap guarantor(the AIG issuer swap guarantor) will be obliged to gross up payments made by itto the issuer if withholding taxes are imposed on payments under the AIG issuerswap guarantee.  However, the AIG issuerswap guarantee provides that, if the AIG issuer swap guarantor is required togross up a payment under the AIG issuer swap guarantee in respect of a relevantissuer currency swap, it may terminate the relevant issuer currency swap.  If it does terminate the relevant issuercurrency swap, the issuer will be exposed to changes in US dollar / sterling oreuro / sterling currency exchange rates and in the associated interest

 

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rates on these currencies. Unless a replacement issuer currency swap is entered into, the issuermay have insufficient funds to make payments due on the issuer notes of anyclass and any series that are then outstanding.

 

# **Noteholders may be subject to interest rate risk onthe series 5 class A issuer notes**

# ** **

The issuer will pay investors a fixed rate of interest on the series 5class A notes until the interest payment date falling in December 2010 butFunding 1 will pay the issuer a LIBOR based rate of interest for three-monthsterling deposits on the advances the issuer made under the issuer intercompanyloan.  To hedge the issuer interest rateexposure against possible adverse floating rate interest movements, the issuerhas entered 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 payments of amounts due under theissuer interest rate swap, then the issuer will have defaulted under the issuerinterest rate swap.  The issuer interestrate swap provider is obliged only to make payments under the issuer interestrate swap if and for so long as the issuer makes payments under the same.  If the issuer interest rate swap provider isnot obliged to make payments, or if it defaults in its obligations to makepayments of amounts equal to the full amount to be paid by it on the paymentdates under the issuer interest rate swap (which are the same dates as theinterest payment dates in respect of the series 5 class A issuer notes), theissuer will be exposed to any difference between the amount payable to them byFunding 1 on the issuer series 5 term AAA advance and the amount of interestpayable by the issuer to investors on the series 5 class A issuer notes.  Unless a replacement issuer interest rateswap is entered into, the issuer may have insufficient funds to make paymentsof interest due on the issuer notes of any class or series that are thenoutstanding.

 

**Theremay be a delay in payment of interest on series 1 class A issuer notes on theoccurrence of a trigger event or enforcement of the issuer security**

 

After the occurrence of a trigger event or enforcementof the issuer security, the interest payments on the series 1 class A issuernotes will no longer be payable monthly, but will be payable quarterly.  In these circumstances a noteholder will notreceive interest under the series 1 class A issuer notes on the expectedpayment dates.

 

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

 

The mortgages trustee GIC provider and the Funding 1 GIC provider arerequired to satisfy certain criteria (including certain criteria and / orpermissions set or required by the FSA from time to time) in order to continueto receive deposits in the mortgages trustee GIC account and the Funding 1 GICaccount respectively.  If either themortgages trustee GIC provider or the Funding 1 GIC provider ceases to satisfythose criteria the relevant account would need to be transferred to anotherentity that does satisfy those criteria. In these circumstances the new GIC provider may not offer a GIC on termsas favorable as those provided by the mortgages trustee GIC provider or theFunding 1 GIC provider.

 

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

 

If any of the issuer swaps terminates, the issuer may as a result beobliged to pay a termination payment to the relevant issuer swap provider.  The amount of the termination payment willbe based on the cost of entering into a replacement issuer swap.  Under the issuer intercompany loanagreement, Funding 1 will be required to pay the issuer an amount equal to anytermination payment due by the issuer to the relevant issuer swapprovider.  Funding 1 will also beobliged to pay the issuer any extra amounts that the issuer may be required topay to enter into a replacement swap.

 

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The issuer cannot give noteholders any assurance that Funding 1 willhave the funds available to make that payment or that the issuer will havesufficient funds available to make any termination payment underany of its issuer swaps or to make subsequent payments to noteholdersin respect of the relevant series and class of the issuer notes.  Nor can the issuer give noteholders anyassurance that it will be able to 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 the relevantissuer swap to terminate by its own default, any termination payment due by theissuer will rank equally not only with payments due to the holders of theseries and class of the issuer notes to which the relevant swap relates butalso with payments due to the holders of any other series and class of theissuer notes to which the relevant 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 swap relates.  Furthermore,any termination payment or additional payment or additional amounts required tobe paid by the issuer following termination of an issuer swap will rank aheadof payments due to the holders of any series and class of the issuer noteswhich ranks below the series and class of the issuer notes to which the relevantissuer swap relates.  Therefore, if theissuer is obliged to make a 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.

 

**Risksassociated with the Funding 1 swap**

 

To provide a hedge against (a) the mortgages trustee variable base ratepayable on the variable rate loans, the rates of interest payable on thetracker rate loans and the fixed rates of interest payable on the fixed rateloans; and (b) the rate of interest payable by Funding 1 on the intercompanyloans, Funding 1 has entered into the Funding 1 swap agreement.  If Funding 1 fails to make timely paymentsunder the Funding 1 swap, it will have defaulted under the Funding 1 swap.  The Funding 1 swap provider is obliged onlyto make payments under the Funding 1 swap as long as Funding 1 makes paymentsunder the same.  If the Funding 1 swapprovider is not obliged to make payments, or defaults in its obligation to makepayments under the Funding 1 swap, Funding 1 will be exposed to the variancebetween the rates of interest payable on the loans and the rate of interestpayable by it under the intercompany loans unless a replacement Funding 1 swapis entered into.  If the Funding 1 swapterminates, Funding 1 may as a result be obliged to pay a termination paymentto the Funding 1 swap provider.  Anyvariance between the rates of interest payable on the loans and the rate ofinterest payable by Funding 1 under the intercompany loans and any terminationpayment payable by it to the Funding 1 swap provider may adversely affect theability of Funding 1 to meet its obligations under the issuer intercompany loanagreement.

 

Funding 1 will receive interest on the variable rate loans, which isbased on HVR 1 or HVR 2.  Thepayment obligations of Funding 1 under the Funding 1 swap will, among otherthings, be based on the average of the standard variable mortgage rates ortheir equivalent 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, Lloyds TSB 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).  While it is anticipated thatthe average rate will broadly track both HVR 1 and HVR 2, the variance betweenthe average rate and

 

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HVR 1 and HVR 2 respectively may affect the ability of Funding 1 tomeet its payment obligations under the Funding 1 swap agreement.

 

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

 

The issuer is a party to contracts with a number of other third partiesthat have agreed to perform services in relation to the issuer notes.  For example, the issuer swap providers haveagreed to provide their swaps, the corporate services provider has agreed toprovide corporate services and the paying agents and the agent bank have agreedto provide payment and calculation services in connection with the issuernotes.  In the event that any of theseparties were to fail to perform their obligations under the respectiveagreements to which they are a party, the noteholders may be adverselyaffected.

 

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

 

If, on any Funding 1 interest payment date, revenue receipts availableto Funding 1 (including the reserve fund) are insufficient to enable Funding 1to pay interest on the issuer term advances and any new term advances and otherexpenses of Funding 1 ranking higher in seniority to interest due on these termadvances, then Funding 1 may use principal receipts on the loans received by itin the mortgages trust to make up the shortfall.

 

Funding 1 will use principal receipts that would have been applied torepay the term advances with the lowest term advance rating to pay interest onthose other term advances and senior expenses described in the precedingparagraph where there is a shortfall of monies to pay those amounts.  At the closing date, the relevant termadvances with the lowest term advance rating include the issuer term BBB advances.  If Funding 1 uses principal to repayinterest and senior expenses in this manner, there will be less principalavailable to repay the issuer term BBB advances.

 

Funding 1 will be obliged to keep a ledger that records any principalapplied to pay interest and senior expenses. When the amount recorded on the ledger is equal to the principal amountoutstanding of the term BBB advances, then Funding 1 will use principalreceipts that would have been applied to repay the term advance with the nextlowest ranking term advance rating to pay interest on the term advances andsenior expenses where there is a shortfall of money to pay those amounts.  At the closing date, the term advances withthe next lowest term advance rating include the issuer term AA advances.  When the amount recorded on the principaldeficiency ledger exceeds the principal amount outstanding on the term AAadvances, Funding 1 will use principal receipts that would have been applied torepay the term AAA advances to pay those amounts.

 

During the term of the transaction, however, it is expected that anyprincipal deficiencies will be recouped from subsequent excess revenue receiptsand amounts standing to the credit of the reserve fund.  The revenue receipts and the reserve fundmonies will be applied first to cover any principal deficiency in respect ofthe term advances with the highest term advance rating (at the closing date,these include the issuer term AAA advances), and then the term advances withthe next highest ranking term advance rating (at the closing date, these includethe issuer term AA advances), and so on down to the term advances with thelowest term advance rating.

 

If there are insufficient funds available because of income orprincipal deficiencies, then one or more of the following consequences mayoccur:

 

•                  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;

 

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•                  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 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.

 

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

 

Any losses from loans included in the trust property will be allocatedto Funding 1 and the seller proportionally on each distribution date inaccordance with the Funding 1 share percentage and the seller share percentageof the trust property.  The seller’sshare of the trust property therefore does not provide credit enhancement forthe Funding 1 share of the trust property or the issuer notes.  Losses on the loans in the trust propertyare allocated proportionately between the seller and Funding 1 depending ontheir respective shares in the trust property.

 

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

 

After an issuer intercompany loan acceleration notice under the issuerintercompany loan is given, the security trustee may, but shall not be obligedto, sell the Funding 1 share of the trust property.  There is no assurance that a buyer would be found or that a salewould realize enough money to repay amounts due and payable under the issuerintercompany loan agreement.

 

The issuer, Funding 1 and the mortgages trustee willnot have any recourse to the seller of the loans, other than in respect of abreach of warranty under the mortgage sale agreement.

 

The issuer, Funding 1, the mortgages trustee and the security trusteewill not undertake any investigations, searches or other actions on any loan orits related security and each of them will rely instead on the warranties givenin the mortgage sale agreement by the seller.

 

If any of the warranties made by the seller (a) in the case of eachloan in the portfolio, was materially untrue on the date the loan was assignedto the mortgages trustee or (b) in the case of each new loan, is materiallyuntrue on the date the new loan is assigned to the mortgages trustee, then theseller will be required to remedy the breach within 20 London business days ofthe seller becoming aware of the same or of receipt by it of a notice from themortgages trustee.

 

If the seller fails to remedy the breach within 20 London businessdays, then the seller will be required to repurchase the loan or loans underthe relevant mortgage account and their related security at their outstandingprincipal balance as of the date of repurchase together with any arrears ofinterest and accrued and unpaid interest and expenses.  There can be no assurance that the sellerwill have the financial resources to repurchase the loan or loans under therelevant mortgage account and their related security.  However, if the seller does not repurchase those loans and theirrelated security when required, then the seller’s share of the trust propertywill be deemed to be reduced by an amount

 

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equal to the principal amount outstanding of those loans together withany arrears of interest and accrued and unpaid interest and expenses.

 

Other than as described here, neither the noteholders nor the issuerwill have any recourse to the assets of the seller.

 

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

 

Each loan in the portfolio is repayable either on a principal repaymentbasis or an interest-only basis.  Of theloans in the portfolio as at January 8, 2004, approximately 36.3 percent. were interest-only loans.  Forinterest-only loans, because the principal is repaid in a lump sum at thematurity of the loan, the borrower is recommended to have some repaymentmechanism such as an investment plan in place to ensure that funds will beavailable to repay the principal at the end of the term.  However, the seller does not ensure that arepayment mechanism is in place in all cases and does not take security overthese repayment mechanisms.  Theborrower is also recommended to take out a life insurance policy in relation tothe loan but, as with repayment mechanisms, the seller does not take securityover these life insurance policies.

 

The ability of a borrower to repay the principal on an interest-onlyloan at maturity depends on the borrower’s responsibility to ensure thatsufficient funds are available from an investment plan or another source, suchas ISAs, pension policies, personal equity plans or endowment policies, as wellas the financial condition of the borrower, tax laws and general economicconditions at the time.  There can be noassurance that the borrower will have the funds required to repay the principalat the end of the term.  If a borrowercannot repay the loan and a loss occurs on the loan, then this may affectrepayments of principal on the issuer notes if that loss cannot be cured byamounts standing to the credit of the reserve fund or the application of excessFunding 1 available revenue receipts.

 

**Theremay be risks associated with the fact that the mortgages trustee has no legaltitle to the mortgages, which may adversely affect payments on the issuer notes**

 

The sale by the seller to the mortgages trustee of the mortgages willtake effect in equity only.  This meansthat legal title to the loans in the trust property remains with theseller, but the mortgages trustee has all the other rights and benefits relatingto ownership of each loan and its related security (which rights and benefitsare subject to the trust in favor of the beneficiaries).  The mortgages trustee has the right todemand that the seller give it legal title to the loans and the relatedsecurity in certain circumstances and until then the mortgages trustee will notapply to H.M. Land Registry or the Central Land Charges Registry to register orrecord its equitable interest in the mortgages.

 

Because the mortgages trustee has not obtained legal title to the loansor their related security, there are risks, as follows:

 

•                  first,if the seller wrongly sold a loan to another person which has already beenassigned to the mortgages trustee, 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 then the mortgages trusteewould not have good title to the affected loan and its related security and itwould not be entitled to payments by a borrower in respect of that loan.  This may affect the ability of the issuer torepay the issuer 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.

 

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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-off rights, then an amountequal to the amount set off will reduce the total amount of the seller share ofthe trust property only, and 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 isexhausted, then the amount of any set-offs would be applied to reduce theFunding 1 share of the trust property.

 

Once notice has been given to borrowers of the transfer of the loansand their related security to the mortgages trustee, independent set-off rightswhich a borrower has against the seller will crystallize and further rights ofindependent set-off would cease to accrue from that date and no new rights ofindependent set-off could be asserted following that notice.  Set-off rights arising under transactionset-off (which are set-off claims arising out of a transaction connected withthe loan) will not be affected by that notice.

 

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

 

The seller has made, and in the future may make, an equitableassignment of the mortgages to the mortgages trustee, with legal title beingretained by the seller.  Therefore, therights of the mortgages trustee may be subject to the direct rights of theborrowers against the seller, including rights of set-off existing prior tonotification to the borrowers of the assignment of the mortgages.  Although the seller does not currently offerflexible loans or delayed cashbacks, it may offer products in the future withthose features, and those loans may be added to the mortgages trust.  Set-off rights may occur if the seller failsto advance to a borrower a drawing under a flexible loan when the borrower isentitled to draw additional amounts under a flexible loan or if the sellerfails to pay to a borrower any delayed cashback which the seller had agreed topay to that borrower after completion of the relevant loan.

 

If the seller fails to advance the drawing or pay the delayed cashback,then the relevant borrower may set off any damages claim arising from theseller’s breach of contract against the seller’s (and, as assignee of themortgages, the mortgages trustee’s) claim for payment of principal and / orinterest under the loan as and when it becomes 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 a drawing will, in many cases, bethe cost to the borrower of finding an alternative source of finance: 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 an alternative loan, he or she mayhave a claim in respect of other losses arising from the seller’s breach ofcontract where there are special circumstances communicated by the borrower tothe seller at the time the mortgage was taken out.

 

In respect of a delayed cashback, the claim is likely to be in anamount equal to the amount due under the delayed cashback together withinterest and expenses and consequential losses (if any).

 

A borrower may also attempt to set off against his or her mortgagepayments an amount greater than the amount of his or her damages claim.  In that case, the servicer will be entitledto take enforcement proceedings against the borrower although the period ofnon-payment by the borrower is likely to continue until a judgment is obtained.

 

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The exercise of set-off rights by borrowers would reduce the incomingcashflow to the mortgages trustee during the exercise.  However, the amounts set off will be appliedto reduce the seller share of the trust property only.  Further there may be circumstances in which:

 

•                  aborrower may seek to argue that certain drawings under flexible loans areunenforceable by virtue of non-compliance with the Consumer Credit Act 1974(“CCA”); or

 

•                  certaindrawings may rank behind liens created by a borrower after the date upon whichthe borrowed entered into its mortgage with the seller.

 

The minimum seller share has been sized in an amount expected to coverthis risk, although there is no assurance that it will.  If the minimum seller share is not sufficientin this respect then there is a risk that noteholders may not receive allamounts due on the issuer notes.

 

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

 

The seller has been appointed by the mortgages trustee and thebeneficiaries as servicer to service the loans.  If the servicer breaches the terms of the servicing agreement,then the mortgages trustee, Funding 1 and / or the security trustee will beentitled to terminate the appointment of the servicer and appoint a newservicer in its place.

 

There can be no assurance that a substitute servicer with sufficientexperience of administering mortgages of residential properties would be foundwho would be willing and able to service the loans on the terms of theservicing agreement.  The ability of asubstitute servicer fully to perform the required services would depend, amongother things, on the information, software and records available at the time ofthe appointment.  Any delay or inabilityto appoint a substitute servicer may affect payments on the loans and hence theissuer’s ability to make payments when due on the issuer notes.

 

The noteholders should note that the servicer has no obligation itselfto advance payments that borrowers fail to make in a timely fashion.

 

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

 

No assurance can be given that Funding 1 will always receive thebenefit of any claims made under any applicable insurance contracts.  This could reduce the principal receiptsreceived by Funding 1 according to the Funding 1 share percentage and couldadversely affect its ability to redeem the issuer notes.  The noteholders should note that buildingsinsurance is renewed annually.

 

**Possibleregulatory changes by the Office of Fair Trading, the Financial ServicesAuthority and any other regulatory authorities may have an impact on theseller, the issuer, the servicer and / or the loans and may adversely affectthe issuer’s ability to make payments when due on the issuer notes**

 

In the United Kingdom, the Office of Fair Trading (the “OFT”) isresponsible for the issue of licenses under, and the superintendence of theworking and the enforcement of, the CCA, related consumer credit regulationsand other consumer protection legislation. The OFT may review businesses and operations, provide guidelines tofollow and take actions when necessary with regard to the mortgage market inthe United Kingdom.

 

Currently, a credit agreement is regulated by the CCA where: (a) theborrower is or includes an individual; (b) the amount of “credit” as defined inthe CCA does not exceed the financial limit,

 

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which is £25,000 for credit agreements made on or after May 1, 1998, orlower amounts for credit agreements made before that date; and (c) the creditagreement is not an exempt agreement under the CCA.

 

In July 2001, the UK Department of Trade and Industry (“DTI”)published a consultation paper on modernizing the CCA that invited views onwhich aspects of the CCA are to be reviewed. The DTI has since published consultation papers on specific aspects ofthe CCA to be reviewed including, March 2002, on the financial limit andexempt agreements under the CCA.

 

In November 2002, the DTI announced its intention that a creditagreement will be regulated by the CCA where, for credit agreements made afterthis change is implemented: (a) the borrower is or includes an individual, savefor partnerships of four or more partners; (b) irrespective of the amount ofcredit although in July 2003, the DTI announced its intention that thefinancial limit will remain for certain business-to-business lending); and (c)the credit agreement is not an exempt agreement.  If this change is implemented, then any loan or further advanceoriginated or varied bilaterally after this time, other than a regulatedmortgage contract under the FSMA or an exempt agreement under the CCA, will beregulated by the CCA.  Such loan orfurther advance will have to comply with requirements as to form and content ofthe credit agreement and, if it does not comply, will be unenforceable againstthe borrower.

 

In December 2003, the DTI published a White Paper on its review ofthe CCA, accompanied by a consultation on (among other things) draftregulations on form and content of credit agreements regulated by the CCA thatmay come into force as early as October 31, 2004.

 

The UK’s Financial Services and Markets Act 2000 (“FSMA”) regulates awide range of financial activities under a single statutory-based regime.  FSMA is not yet in full effect, and will bebrought into effect in stages.  Thefirst stage (known as “N2”) came into effect December 1, 2001.  Mortgage regulation will come into effect ata later stage (known as (“N(M)”) currently expected to be October 2004.

 

FSMA applies to any “regulated activity”.  After N(M) the following four activities: (i) entering into; (ii)in certain circumstances administering; (iii) arranging; and (iv) advising on,a “regulated mortgage contract”, will be regulated activities.  Agreeing to carry on any of the activitieswill also be a regulated activity.

 

The main effect of the introduction of mortgage regulation is that eachentity carrying on a regulated activity with respect to regulated mortgagecontracts will ordinarily be required to hold authorization and permission fromthe FSA to carry on that activity. Generally, each financial promotion will have to be issued or approvedby a person holding authorization and permission from the FSA unless anexemption applies.  If requirements asto authorization of the originator and brokers or as to advertising are notcomplied with, the regulated mortgage contract will be unenforceable againstthe borrower except with approval of a court.

 

The seller will be required to hold authorization and permission toenter into and to administer and, where applicable, to advise on regulatedmortgage contracts.  Brokers (in certaincircumstances) will be required to hold authorization and permission to arrangeand, where applicable, to advise on regulated mortgage contracts.

 

Under the terms of the regulatory regime under FSMA, the issuer andmortgages trustee will not carry on any regulated activity in relation to theregulated mortgage contracts that are administered pursuant to anadministration agreement by an entity having the required authorization andpermission.  If such administrationagreement terminates, however, the issuer and mortgages trustee will have aperiod of not more than one month in which to arrange for mortgage administrationto be carried out by a replacement administrator having the requiredauthorization and permission.

 

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In October 2003, the FSA published a Policy Statement containingits final conduct of business rules. These rules are set out in the Mortgages: Conduct of Business SourceBook (“MCOB”) cover conduct of business requirements for authorizedpersons.  The rules provide for, *inter alia*, certain pre-originationmatters, such as financial promotions and draft pre-application illustrations,start of contract disclosures, post-sale disclosures (annual statements), ruleson contract charges and arrears and repossessions.  The MCOB comes into force on N(M).  Further, in March 2003, the FSA published a consultationpaper covering the changes the FSA is proposing to make to the FSA Handbookrelating to the prudential and authorization-related requirements placed on authorizedpersons in respect of regulated mortgage activities.  The FSA’s Policy Statement and near-final rules on the prudentialand other requirements were published in September 2003, and the FSA madethose rules on January 15, 2004.

 

The FSA has stated in Consultation Paper 146 (Chapter 4, paragraph4.24) that to avoid dual regulation once the new regulatory regime applies, allmortgages regulated by the FSA will not be covered by the CCA.  This carve-out only affects mortgagesentered into after the new regulatory regime is effective (i.e. N(M)).  Before that date, the CCA will continue tobe the relevant legislation.  A courtorder under section 126 of the CCA is necessary to enforce a mortgagesecuring a loan to the extent that it is regulated by the CCA or to be treatedas such, and will also be necessary to enforce a mortgage securing a regulatedmortgage contract.

 

No assurance can be given that additional regulations from the OFT, theFSA or any other regulatory authority will not arise with regard to themortgage market in the United Kingdom generally, the seller’s particular sectorin that market or specifically in relation to the seller.  Any such action or developments orcompliance cost may have a material adverse effect on the seller, the issuerand / or the servicer and their respective businesses and operations.  This may adversely affect the issuer’sability to make payments in full on the issuer notes when due.

 

Meanwhile, in the United Kingdom, self-regulation of the mortgagebusiness exists under the Mortgage Code (the “CML Code”) issued by the Councilof Mortgage Lenders (the “CML”). Halifax currently subscribes to the CML Code.  Membership of the CML and compliance with the CML code arevoluntary.  The CML Code sets outminimum standards 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 accept mortgage business fromintermediaries who are not registered with (before November 1, 2000) theMortgage Code Register of Intermediaries or (on and after November 1,2000) the Mortgage Code Compliance Board.

 

In March 2001, the European Commission published a Recommendationto member states urging their members to subscribe to the code issue by theEuropean Mortgage Federation (the “EMF Code”). On July 26, 2001 the CML decided to subscribe to the codecollectively on behalf of its members. Lenders had until September 30, 2002 to implement the EMF Code, animportant element of which is provision to consumers of a “EuropeanStandardized Information Sheet” (an “ESIS”) similar to the pre-applicationillustration proposed by the FSA. However, UK lenders generally are not in a position to begin to providean ESIS to consumers until N(M).  TheCML has discussed this with the European Commission and the European MortgageFederation.  While compliance with theEMF Code is voluntary, if the EMF Code is not effective, the EuropeanCommission is likely to see further pressure from consumer bodies to issue adirective on mortgage credit or to extend its proposal for a directive onconsumer credit to all mortgage credit.

 

In September 2002, the European Commission published a proposalfor a directive of the European Parliament and of the Council on theharmonization of the laws, regulations and administrative provisions of themember states concerning credit for consumers and surety agreements enteredinto by consumers.  In its current form,the proposal does not include a threshold amount for regulated agreements(unlike the existing Directive 87/102/EEC, as amended, which provides that(subject to certain exceptions) loans not exceeding €20,000 are regulated bysuch Directive) and requires specified requirements to be met in respect ofcertain mortgage loan products

 

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(including new credit agreements for further drawings under certainflexible mortgages and for further advances and amortization tables forrepayment mortgages).  If the proposalcomes into force in its current form, mortgage loans that do not comply withthese requirements may be unenforceable. Significantly, the proposal provides that it does not applyretrospectively (subject to certain exemptions including in respect of newdrawings or further advances made in respect of existing agreements) and doesnot apply to residential mortgage loans except those that include an equityrelease component.  The proposal isunlikely to come into force until 2006 as the co-decision procedure of theEuropean Parliament and of the Commission, from the publication of the proposalto the coming into force of the new consumer credit directive, is likely totake at least two years and member states will then have a further two years inwhich to bring national implementing legislation into force.  The DTI is currently in consultation withconsumer and industry organizations in relation to this proposal.

 

There has been significant opposition from the European Parliament tothe current form of the proposed directive, and it may be substantially amendedbefore it is ultimately brought into effect. Until the final text of the directive is decided and the details of theUnited Kingdom implementing legislation are published, it is not certain whateffect the adoption and implementation of the directive would have on theseller, the issuer and / or the servicer and their respective businesses andoperations.  This may adversely affectthe issuer’s ability to make 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 ContractsRegulations 1999 as amended (the “UTCCR”), which together with the Unfair Termsin Consumer Contracts Regulations 1994 apply to agreements made on or afterJuly 1, 1995 and affect all or almost all of the loans, provide that:

 

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

 

•                  theDirector General of Fair Trading (as head of the OFT), and any “qualifyingbody” within the UTCCR (such as the Financial Services Authority) may seek toinjunct a business against relying on unfair terms.

 

The UTCCR will not generally affect “core terms” which define the mainsubject-matter of the contract, such as the borrower’s obligation to repay theprincipal, but may affect terms that are not considered to be core terms, suchas the lender’s power to vary the interest rate.

 

For example, if a term permitting a lender to vary the interest rate(as the servicer is permitted to do) is found to be unfair, the borrower willnot be liable to pay the increased rate or, to the extent that she or he haspaid it, will be able, as against the lender or any assignee such as the issueror the mortgages trustee, to claim repayment of the extra interest amounts paidor to set-off the amount of the claim against the amount owing by the borrowerunder the loan.  Any non-recovery, claimor set-off ultimately may adversely affect the issuer’s ability to makepayments on the issuer notes.

 

In February 2000, the OFT issued a guidance note on what the OFTconsiders to be fair terms and unfair terms for interest variation in mortgagecontracts.  Where the interest variationterm does not provide for precise and immediate tracking of an external rateoutside the lender’s control, and if the borrower is locked-in by an earlyrepayment charge that is considered to be a penalty, the term is likely to beregarded as unfair under the UTCCR unless the lender (i) notifies the borrowerin writing at least 30 days before the rate change and (ii) permits theborrower to repay the whole loan during the next three months after the rate change,without paying the early repayment charge. The seller has

 

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reviewed the guidance note and has concluded that its compliance withit will have no material adverse effect on the loans or its business.  The guidance note is under review by the OFTand FSA, but there is no indication as to when this review is likely to beconcluded or what changes, if any, may arise from it.

 

In August 2002, the Law Commission for England and Wales and theScottish Law Commission issued a join consultation LCCP No. 166 / SLCDP 119 onproposals to rationalize the UK’s Unfair Contracts Act 1977 and the UTCCR intoa single piece of legislation, and a final report is expected by the end of2003.  The Law Commissions have a dutyunder section 3 of the UK’s Law Commissions Act 1965 to keep the law underreview for a number of purposes, including its simplification.  The proposals are primarily to simplify thelegislation on unfair terms.  It is notproposed that there should be any significant increase in the extent ofcontrols over terms in consumer contracts. Some changes are proposed, however, such as that the legislation shouldnot affect core terms in so far as they are not substantially different fromwhat the borrower should reasonably expect and are transparent.  It is too early to tell how the proposals,if enacted, would affect the loans.

 

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

 

Under FSMA, the Financial Ombudsman Service is required to makedecisions on, among other things, complaints relating to the terms inagreements on the basis of what, in the Ombudsman’s opinion, would be fair andreasonable in all circumstances of the case, taking into account, among otherthings, law and guidance.  Complaintsbrought before the Financial Ombudsman Service for consideration must bedecided on a case by case basis, with reference to the particular facts of anyindividual case.  Each case would firstbe adjudicated by an adjudicator. Either party to the case may appeal against the adjudication.  In the event of an appeal, the case proceedsto a final decision by the Ombudsman.

 

In January 2002, the Ombudsman made a determination on the seller’sappeal to an earlier decision by an adjudicator at the Financial OmbudsmanService concerning a case involving HVR 1 and HVR 2.  In March 2001, two joint borrowers with a capped rate loanoriginated when the seller offered only a single standard variable base ratecontacted the seller and requested that their loan be linked to HVR 2.  The seller informed the borrowers that,because they were still in their product period, they could either transfer toHVR 2 when their product period expired or transfer to HVR 2 immediately andpay the applicable early repayment fee. The borrowers complained to the Financial Ombudsman Service and, onJanuary 29, 2002, on appeal by the seller, the Ombudsman determined in theborrowers’ favor and recommended that the seller recalculate the borrowers’mortgage by reference to HVR 2 from the date when the seller should havegranted their request in March 2001, refund any overpayments and pay £150for any inconvenience caused.  HVR 2 waswithdrawn and ceased to be available to new borrowers with effect fromFebruary 1, 2002.

 

The Ombudsman’s decision only applies to the two borrowers and theirparticular circumstances, though other borrowers may also complain to theOmbudsman.  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.  For each of those loans, the borrowers wouldalso receive £150 for any inconvenience caused.  The borrowers under loans who requested to be transferred after HVR2 was withdrawn and before the announcement in March 2002 were not offereda switch or a refund, though the seller has given or will give each of thesecustomers an *ex gratia* payment of £100.

 

Since then, further decisions by the Ombudsman in similar cases haveconfirmed that affected borrowers were only entitled to a refund of overpaymentsof interest from the date when they asked to be transferred to HVR 2 and notfrom the date where HVR 2 first became available, and also that affectedborrowers were not entitled to apply to be transferred to HVR 2 after it waswithdrawn.

 

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The seller does not believe that any Ombudsman’s decision to date orany other decision by any competent authority in the future (in respect of theseller’s two variable base rates, HVR 1 and HVR 2) would affect the yield onthe loans in such a way as to have a material adverse effect on the ability ofthe issuer to meet its obligations on the issuer notes.

 

As regards other borrowers, in the event that a decision (in respect ofthe seller’s variable base rate) by the Ombudsman or any other competentauthority finds that a borrower’s loan should be linked to HVR 2, then thatborrower may set-off the overpaid sum against the amount owing under his or herloan if the seller does not reimburse that borrower.  Any non-recovery, claim or set-off ultimately may adverselyaffect the issuer’s ability to make payments on the issuer notes, as describedabove.

 

As the Financial Ombudsman Service is required to make decisions on thebasis of, among other things, the principles of fairness, it is not possible topredict how any future decision of the Financial Ombudsman Service would affectthe ability of the 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 issuer will generally be subject to UKcorporation tax, currently at a rate of 30 per cent., on the profit reflectedin their respective profit and loss accounts as increased by the amount of anynon-deductible expenses or losses. If the tax payable by Funding 1 or the issuer is greater than expectedbecause, for example, non-deductible expenses or losses are greater thanexpected, the funds available to make payments on the noteholders’ issuer noteswill be reduced and this may adversely affect the issuer’s ability to makepayments on the issuer notes.

 

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

 

In the event that amounts due under the issuer notes are subject towithholding tax, we will not be obliged to pay additional amounts in relationthereto.  The issuer may, in certaincircumstances, redeem the issuer notes.

 

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

 

If the United Kingdom joins the European Monetary Union prior to thematurity of the issuer notes, investors cannot be assured that this would notadversely affect payments on their issuer notes.

 

It is possible that prior to the maturity of the issuer notes theUnited Kingdom may become a participating member state in the European economicand monetary union and that the euro may become the lawful currency of theUnited 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 or requireus to re-denominate the requisite issuer notes into euro and take additionalmeasures in respect of such issuer notes; and (c) the introduction of the euroas the lawful currency of the United Kingdom may result in the disappearance ofpublished or displayed rates for deposits in sterling used to determine therates of interest on the issuer notes or changes in the way those rates are calculated,quoted and published or displayed.  Theintroduction of the euro could also be accompanied by a volatile interest rateenvironment, which could adversely affect a borrower’s ability to repay itsloan as well as adversely affect investors. It cannot be said with certainty what effect, if any, adoption of theeuro by the United Kingdom would have on investors in the issuer notes.

 

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

 

The structure of the issue of the issuer notes and the ratings whichare assigned to them are based on English law in effect as at the date of theprospectus relating to the issuer notes. No assurance can be given as to the impact of any possible change toEnglish law or administrative practice in the United Kingdom or to the law oradministrative practice of any other relevant jurisdiction after the date ofthis Form 20-F.

 

*Insolvency Act 2000.*Significant changes tothe English insolvency regime have recently been enacted, including theInsolvency Act 2000.  The Insolvency Act2000 allows certain “small” companies to seek protection from their creditorsfor a period of 28 days, for the purpose of putting together a companyvoluntary arrangement, with the option for creditors to extend the moratoriumfor a further two months.  A “small”company is one that satisfies, in any financial year, two or more of thefollowing criteria: (i) its turnover is not more than £5.6 million; (ii) itsbalance sheet total is not more than £2.8 million; (iii) the number ofemployees is not more than 50.  Whetheror not a company is a “small” company may change from period to period andconsequently no assurance can be given that the issuer, the mortgages trusteeor Funding 1 will not, at any given time, be determined to be a “small”company.  The Secretary of State forTrade and Industry may by regulation modify the eligibility requirements for“small” companies and can make different provisions for different cases.  No assurance can be given that any suchmodification or different provisions will not be detrimental to the interestsof the noteholders.

 

Secondary legislation has now been enacted whichexclude certain special purpose companies in relation to capital markettransactions from the operational moratorium provisions.  Such exceptions include (amongst othermatters): (i) a company that is party to an agreement that is or forms part ofa capital market arrangement (as defined in the secondary legislation) underwhich (a) a party has incurred or when the agreement was entered into wasexpected to incur a debt of at least £10 million under the arrangement and (b)the arrangement involves the issue of a capital markets investment (alsodefined, but generally, a rated, listed or traded bond); and (ii) a companywhich has incurred a liability (including a present, future or contingentliability) of at least £10 million. While the issuer, the mortgages trustee and Funding 1 should fall withinthe exceptions, there is no guidance as to how the legislation will beinterpreted and the Secretary of State for Trade and Industry may be regulationmodify the exception.  No assurance maybe given that any modification of the eligibility requirements for “small”companies and / or the exceptions will not be detrimental to the interests ofthe noteholders.

 

If the issuer and / or the mortgages trustee and / or Funding 1 isdetermined to be a “small” company and determined not to fall within one of theexceptions (by reason of modification of the exceptions or otherwise), then theenforcement of the issuer security by the security trustee may, for a period,be prohibited by the imposition of a moratorium.

 

*Enterprise Act 2002.*On September 15,2003, the corporate insolvency provisions of the Enterprise Act 2002 came intoforce, amending certain provisions of the Insolvency Act 1986 (as amended, the“Insolvency Act”).  These provisionsintroduced significant reforms to corporate insolvency law.  In particular the reforms restrict the rightof the holder of a floating charge created after September 15, 2003 toappoint an administrative receiver (unless an exception applies) and insteadgives primacy to collective insolvency procedures (in particular,administration).

 

The holder of a floating charge created before September 15, 2003over the whole or substantially the whole of the assets of a company (such asthe security trustee under the Funding 1 deed of charge) retains the ability toblock the appointment of administrator by appointing an administrativereceiver, who will primarily act in the interests of the floating chargeholder.

 

The Insolvency Act contains provisions that continue to allow for theappointment of an administrative receiver in relation to certain transactionsin the capital markets.  The relevantexemption provides that the right to appoint an administrative receiver isretained for certain types of security (such as the issuer security) that formpart of a capital markets arrangement (as defined in the

 

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Insolvency Act) that involved iindebtedness of at least £50 million(or, when the relevant security document was entered into (being in respect ofthe transactions described in the prospectus relating to the issuer notes andthe issued deed of charge), a party to the relevant transaction (such as theissuer) was expected to incur a debt of at least £50 million) and the issue ofa capital markets investment (also defined, but generally, a rated, listed ortraded bond).  The Secretary of Statefor Trade and Industry may, by secondary legislation, modify the capital marketexception and / or provide that the exception 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 the provisions of the Enterprise Act have neverbeen considered judicially, no assurance can be given as to whether theEnterprise Act could have a detrimental effect on the transaction described inthe prospectus relating to the issuer notes or in the interests of thenoteholders.

 

The Insolvency Act also contains a new out-of-court route intoadministration for a qualifying floating charge holder, the directors or thecompany 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.  Ifthe qualifying floating charge holder does not respond to the directors’ noticeof intention to appoint, the directors, or as the case may be, the company’sappointee will automatically take office after the notice period haselapsed.  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 provisions of the Insolvency Act give primary emphasis to therescue of the company as a going concern. The purpose of realizing property to make a distribution to one or morecreditors is subordinated to the primary purposes of rescuing the company as agoing concern or achieving a better result for the creditors as a whole thanwould be likely than if the company were wound up.  No assurances can be given that the primary purposes of the newprovisions will not conflict with the interests of the noteholders were theissuer ever subject to administration.

 

In addition to the introduction of a prohibition on the appointment ofan administrative receiver as set out above, section 176A of theInsolvency Act provides that in relation to floating charges created afterSeptember 15, 2003 any receiver (including an administrative receiver),liquidator or administrator of a company is required to make a “prescribedpart” of the company’s “net property” available for the satisfaction ofunsecured debts in priority to the claims of the floating charge holder.  The company’s “net property” is defined asthe amount of the chargor’s property that would be available for satisfactionof debts 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 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 per cent. of the first £10,000 of floatingcharge realizations plus 20 per cent. of the floating charge realizationsthereafter, provided that such amount may not exceed £600,000.

 

This obligation does not apply if the net property is less than aprescribed minimum and the relevant officeholder is of the view that the costof making a distribution to unsecured creditors would be disproportionate tothe 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 charge realizations upon the enforcement of the issuer securityand the security created by the second supplemental Funding 1 deed of chargemay be reduced by the 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 issuer notes are exchanged for definitive issuernotes, which will only occur under a limited set of circumstances, thenoteholders’ beneficial ownership of the issuer notes will only be recorded inbook-entry form with DTC, Euroclear or Clearstream, Luxembourg.  The lack of the issuer notes in physicalform could, among other things:

 

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

 

•                  makeit difficult for the noteholders to pledge the issuer notes if the issuer notesin physical 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 the issuer notes that are not in physical form.

 

**Ifthe noteholders 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 to submit to the non-exclusive jurisdiction ofthe courts of England, and it may be necessary for noteholders to bring a suitin England to enforce their rights against the issuer.

 

**Proposedchanges to the Basel Capital Accord and the risk-weighted asset framework mayresult in changes to the risk-weighting of the issuer notes or permit the issuerto redeem or purchase the issuer notes**

 

The Basel Committee on Banking Supervision has issued proposals forreform of the 1988 Capital Accord and has proposed a framework that placesenhanced emphasis on market discipline and sensitivity to risk.  The third consultative paper on the NewBasel Capital Accord was issues on April 29, 2003 with the consultationperiod ending on July 31, 2003. The Committee intends to finalize the New Basel Capital Accord by nolater than the middle of 2004, allowing for implementation of the new frameworkin each country at year end 2006.  Ifimplemented in accordance with their current form, the proposals could affectthe risk-weighting of the issuer notes in respect of certain investors if thoseinvestors are subject to the new framework following the implementation of theNew Basel Capital Accord.  Consequently,investors should consult their own advisers as to the consequences to andeffect on investors of the proposed implementation of the New Basel CapitalAccord.  The issuer cannot predict theprecise effects of potential changes that might result if the proposals wereadopted in their current form.

 

The issuer may, under certain circumstances relating to implementationof the New Basle Capital Accord in the United Kingdom, require investors tosell their issuer notes or redeem their issuer notes.

 

**Item 4.  Information on the Company**

 

A.*                                   Historyand Development of the Company*

 

Not applicable.

 

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B.*            BusinessOverview*

 

Not applicable.

 

C.*            OrganizationalStructure*

 

Not applicable.

 

D.*            Property,Plants and Equipment*

 

The issuer

 

The property of the issuer consists primarily of its right to receivepayments of interest and principal from Funding 1 on the various term advancesmade under the issuer intercompany loan agreement.

 

Funding 1

 

The property of Funding 1 consists primarily of its interest in thetrust property held by the mortgages trustee (which entitles Funding 1 toreceive certain payments of principal and interest from the trust propertyaccording to the terms of the mortgages trust deed) and amounts available undera reserve fund.

 

The mortgages trustee

 

The trust property includes the portfolio of loans and their relatedsecurity assigned to the mortgages trustee by the seller on June 14, 2002,and on several subsequent dates, any new loans and their new related securityassigned to the mortgages trustee by the seller after the closing date, anyincrease in the outstanding principal balance of a loan due to the borrowertaking payment holidays or making underpayments under a loan or a borrowermaking a drawing under any flexible loan, any interest, principal and otheramounts (excluding third party amounts) paid by borrowers on their loans andtheir related security, the rights under the insurance policies that areassigned to the mortgages trustee or of which the mortgages trustee has thebenefit, and amounts on deposit and interest earned on the mortgages trusteeguaranteed investment contract.  Anyactual losses in relation to the loans, any actual reductions occurring inrespect of the loans and distributions of principal made from time to time tothe beneficiaries or the mortgages trust will be deducted from the trustproperty.  The composition of the trustproperty will fluctuate as drawings under flexible loans and new loans areadded, as borrowers take payment holidays or make underpayments under a loanand as the loans 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.*                                   OperatingResults*

 

Not applicable.

 

B.*            Liquidityand Capital Resources*

 

Not applicable.

 

C.*            Researchand Development, Patents and Licenses, etc.*

 

Not applicable.

 

D*.**                                    TrendInformation*

 

Not applicable.

 

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E.*             Off-balanceSheet Arrangements*

 

Not applicable.

 

F.*             TabularDisclosure of Contractual Obligations*

 

Not applicable.

 

G*.**                                     SafeHarbor*

 

Not applicable.

 

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

 

A.*            Directorsand Senior Management*

 

The following sets out the names, business addresses and businessoccupations of the directors of the issuer, Funding 1 and the mortgagestrustee.  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         |   | Blackwell House  Guildhall Yard  London EC2V 5AE                 |   | Provision of directors to special purpose companies |   |
|                          |   |                                                             |   |                                                |   |
| SFM Directors (No. 2) Limited |   | Blackwell House  Guildhall Yard  London EC2V 5AE                 |   | 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         |   | Blackwell House  Guildhall Yard  London EC2V 5AE                 |   | Provision of directors to special purpose companies |   |
|                          |   |                                                             |   |                                                |   |
| SFM Directors (No. 2) Limited |   | Blackwell House  Guildhall Yard  London EC2V 5AE                 |   | 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 mortgages trustee

 
| **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 an employee of a company in the same group of companiesas the seller.

 

B.*                                     Compensation*

 

The issuer

 

In accordance with the issuer corporate services agreement entered intobetween the issuer, the seller, the security trustee, the note trustee,Holdings and Structured Finance Management Limited (“SFM”), the seller and SFMwill each provide directors and other corporate services for the issuer inconsideration for a payment of a separate fee payable by the issuer toSFM.  No other remuneration is paid toany director or officer in connection with such director’s or officer’sactivities on behalf of the issuer.

 

Funding 1

 

In accordance with the Funding 1 corporate services agreement enteredinto between Funding 1, the seller, the security trustee, the note trustee,Holdings, Permanent PECOH Limited, SFM, and SFM Corporate Services Limited(“SFM Corporate”), the seller and SFM will each provide directors and SFM willprovide other corporate services for Funding 1 in consideration for a paymentof a separate fee payable by Funding 1 to SFM. No other remuneration is paid to any director or officer in connectionwith such director’s or officer’s activities on behalf of Funding 1.

 

The mortgages trustee

 

In accordance with the mortgages trustee corporate services agreemententered into between the mortgages trustee, the security trustee, the notetrustee and SFM Offshore Limited (“SFM Offshore”), the seller and SFM Offshorewill each provide directors and SFM Offshore will provide other corporateservices for the mortgages trustee in consideration for a payment of a separatefee payable by the mortgages trustee to SFM Offshore.  No other remuneration is paid to any director or officer inconnection with such director’s or officer’s activities on behalf of themortgages trustee.

 

C.            *BoardPractices*

 

Not applicable.

 

D.            *Employees*

 

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

 

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E.             *ShareOwnership*

 

Not applicable.

 

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

 

A.            *MajorShareholders*

 

The issuer and Funding 1 are wholly owned by Permanent HoldingsLimited, a company incorporated under the laws of England and Wales.  SFM Corporate holds all of the beneficialinterest in the issued shares of Holdings on a discretionary trust for thebenefit of The National Society for the Prevention of Cruelty to Children inthe United Kingdom and for other charitable purposes.

 

SFM Offshore holds all of the issued shares of the mortgages trustee intrust for charitable purposes.

 

Neither SFM Corporate nor SFM Offshore is affiliated with Halifax plc.

 

B.            *RelatedParty Transactions*

 

None, other than with respect to the making of payments in respect tothe securities as described in the Registration Statement and “Item 3.D — RiskFactors.”

 

C.            *Interests ofExperts and Counsel*

 

Not applicable to annual reports filed on Form 20-F.

 

**Item 8.  Financial Information**

 

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

 

The issuer, Funding 1 and the mortgages trustee know of no materiallegal or arbitration proceedings involving their respective companies that mayhave significant effects on the registrants’ financial position orprofitability, including governmental proceedings pending or known to becontemplated and any material proceeding in which any director or affiliate iseither a party adverse to a registrant or has a material interest adverse to aregistrant.

 

**Item 9.  The Offer and Listing**

 

A.*                                   Offerand Listing Details*

 

Not applicable.

 

B.*            Planof Distribution*

 

Not applicable to annual reports filed on Form 20-F.

 

C.*            Markets*

 

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

 

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D.*            SellingShareholders*

 

Not applicable to annual reports filed on Form 20-F.

 

E.*             Dilution*

 

Not applicable to annual reports filed on Form 20-F.

 

F.*             Expensesof the Issue*

 

Not applicable to annual reports filed on Form 20-F.

 

**Item 10.  Additional Information**

 

A.*            ShareCapital*

 

Not applicable to annual reports filed on Form 20-F.

 

B.*            Memorandumand Articles of Association*

 

The memorandum and articles of association for each of the issuer,Funding 1 and the mortgages trustee are incorporated by reference from theRegistration Statement.  Please also seethe description of the issuer, Funding 1 and the mortgages trustee set forth inthe Registration Statement.

 

C.                                     *MaterialContracts*

 

Not applicable other than with respect to contracts relating to theissuer notes, which were described in the Registration Statement.

 

D.*            ExchangeControls*

 

None.

 

E.*             Taxation*

 

**UnitedKingdom Taxation**

 

The following section summarizes the material UK tax consequencesof the purchase, ownership and disposition of the issuer notes based on currentlaw and practice in the UK. The summary assumes that the profit in Funding 1’sprofit and loss account will not exceed 0.01 per cent. of the Funding 1available revenue receipts and that the profit in the issuer’s profit and lossaccount will not exceed 0.01 per cent. of the interest on the issuer termadvances under the issuer intercompany loan. It further assumes that all payments made pursuant to the finaldocumentation are calculated on arm’s length terms.  The summary does not purport to be a complete analysis of all taxconsiderations of the purchase, ownership and disposition of the issuernotes.  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 besubject to tax in a jurisdiction other than the UK or who may be unsure as totheir tax position should seek their own professional advice.

 

**Taxationof US residents**

 

As discussed in more detail below, no UK withholding tax will berequired in relation to interest payments on the issuer notes provided that theissuer notes are listed on a recognised stock exchange, which includes theLondon Stock Exchange.  If the issuernotes cease to be listed on a “recognised stock exchange”, an amount must bewithheld on account of UK income tax at the lower rate (currently 20 percent.), subject to any direction to the contrary from the Inland Revenue in

 

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respect of such relief as may beavailable pursuant to the provisions of an applicable double taxation treaty.

 

Residents of the US are generally not subject to tax in the UK onpayments on the issuer notes under the terms of the double taxation treatybetween the US and the UK (the “Treaty”), subject to completion ofadministrative formalities, except where the issuer notes are effectivelyconnected with a permanent establishment or a fixed base of the noteholdersituated in the UK or where the amounts paid on the issuer notes not exceed thereturn on comparable debt instruments, in which event the UK may tax the excessin accordance with UK domestic law.

 

Subject to the opinions set out in the preceding paragraphs, asdiscussed in more detail under “**Direct assessment of non-UK resident holders of theissuer notes to UK tax on interest**” below, a noteholder who is resident in the US for US tax purposes andwho is not resident in the UK for UK tax purposes will not be subject to UK taxin respect of any payments on the issuer notes unless they are held by or for atrade, profession or vocation carried on by him through a branch or agency (or,in the case of a noteholder that is a company, through a permanentestablishment) in the UK.

 

US resident noteholders will not be liable toUK tax in respect of a disposal of the issuer notes provided they are notwithin the charge to UK corporation tax and (i) are not resident or ordinarilyresident in the UK, and (ii) do not carry on a trade, profession or vocationcarried on by him through a branch or agency in connection with which interestis received or to which the issuer notes are attributable.

 

**Withholdingtax**

 

There will be no UK withholding tax in relation to interest payments onthe issuer notes provided that, so far as concerns deduction by the issuer orits paying agents, the issuer notes are listed on a “recognized stockexchange”, as defined in Section 841 of the Income and Corporation TaxesAct 1988 (“ICTA”).  The London StockExchange is current a recognized stock exchange for this purpose.  If the issuer notes cease to be listed on a“recognized stock exchange”, an amount must be withheld on account of UK incometax at the lower rate (currently 20 per cent.) from interest paid on them,subject to any direction to the contrary by the Inland Revenue in respect ofsuch relief as may be available pursuant to the provisions of an applicabledouble taxation treaty or to the interest being paid to persons (includingcompanies within the charge to UK corporation tax) and in circumstancesspecified in Section 349A to 349D if the ICTA.

 

Noteholders who are individuals may wish to note that the InlandRevenue has power to obtain information (including the name and address of thebeneficial owner of the interest) from any person in the UK who either paysinterest to, or receives interest for the benefit of, an individual.Information so obtained may, in certain circumstances, be exchanged by theInland Revenue with the tax authorities of other jurisdictions.

 

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

 

Interest on the issuer notes has a UK source. Accordingly, payments ofinterest on the issuer notes will in principle be within the charge to UK taxeven if paid without withholding or deduction. However, other than where theprovisions of the Treaty apply to allow certain interest paid to residents ofthe US to be taxed in the UK, such payments will not be chargeable to UK tax inthe hands of a noteholder who is not resident for tax purposes in the UK unlesssuch noteholder carries on a trade, profession or vocation through a branch oragency (or, in the case of a noteholder which is a company which carries on atrade through a permanent establishment) in the UK in connection with which thepayments are received or to which the issuer notes are attributable, in which case(subject to exemptions for interest received by certain categories of agentsuch as some brokers and investment managers) tax may be levied on the UKbranch or agency or permanent establishment.

 

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

 

In general, noteholders who are within the charge to UK corporation tax(other than authorized unit trusts) will normally be subject to tax on allprofits and gains, including interest and profit and gains attributable tocurrency regulations, arising on or in connection with the issuer notes underthe loan relationship rules.  Any suchprofits and gains will generally fall to be calculated in accordance with thestatutory accounting treatment of the issuer notes in the hands of the relevantnoteholder, and will generally be charged to tax as income in respect of eachaccounting period to which they are allocated, in accordance with thataccounting treatment.  Relief may beavailable in respect of losses or for related expenses on a similar basis.

 

**Taxationof returns: other noteholders**

 

Noteholders who are not within the charge to UK corporation tax and whoare resident or ordinarily resident in the UK for tax purposes or who carry ona trade, profession or vocation in the UK through a branch or agency inconnection with which interest on the issuer notes is received or to which theissuer notes are attributable will generally be liable to UK tax on the amountof any interest received in respect of the issuer notes.  As the series 1 issuer notes, series 2issuer notes and series 3 issuer notes are denominated in US dollars and theseries 4 class A1 issuer notes, series 4 class B issuer notes, series 4 class Cissuer notes, series 5 class B issuer notes and series 5 class C issuer notesare denominated in euro, they will not be regarded by the Inland Revenue asconstituting “qualifying corporate bonds” within the meaning ofSection 117 of the Taxation of Chargeable Gains Act 1992.  Accordingly, a disposal of any of theseissuer notes may give rise to a chargeable gain or an allowable loss for thepurpose of the UK taxation of chargeable gains.

 

It is expected that the series 5 class A issuer notes and the series 4class A2 issuer notes will be regarded by the Inland Revenue as constituting“qualifying corporate bonds” within the meaning of Section 117 of theTaxation of Chargeable Gains Act 1992. Accordingly, a disposal of any of these issuer notes is not expected togive rise to a chargeable gain or an allowable loss for the purpose of the UKtaxation of chargeable gains.

 

A disposal of the issuer notes by such noteholders as described abovemay also give rise to a charge to tax on income in respect of an amountrepresenting interest accrued on the issuer notes since the preceding paymentdate.  For the issuer notes whichconstitute variable rate securities, taxation in respect of such a disposalwill be computed on the basis that such amount as the Inland Revenue considersto be just and reasonable will be treated as accrued income.  However, the transferee of a variable ratesecurity will not be entitled to any relief on such amount.  All of the issuer notes will constitutevariable rate issuer notes for this purpose.

 

**Stampduty and stamp duty reserve tax**

 

No UK stamp duty or stamp duty reserve tax is payable on the issue ortransfer of the offered global issuer notes or on the issue or transfer of anote in definitive form.

 

**UKtaxation of Funding 1 and the issuer**

 

Funding 1 and the issuer will generally be subject to UK corporationtax, currently at a rate of 30 per cent., on the profit reflected in theirrespective profit and loss accounts as increased by the amounts of anynon-deductible expenses or losses. Examples of non-deductible expenses and losses include generalprovisions for bad debts.  In respect ofFunding 1, the profit in the profit and loss account will not exceed0.01 per cent. of the Funding 1 available revenue receipts. In respect ofthe issuer, the profit in the profit and loss account will not exceed0.01 per cent. of the interest on the issuer term advances under theissuer intercompany loan.

 

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**UKtaxation of the mortgages trustee**

 

The mortgages trustee will have no liability to UK tax in respect ofany income, profit or gain arising 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**

 

OnJune 3, 2003, the European Council of Economics and Finance Ministersadopted a Directive on the taxation of savings income (the “EU Savings TaxDirective”) under which Member States will be required from a date not earlier thanJanuary 1, 2005 to provide to the tax authorities of other Member Statesdetails of payments of interest and other similar income paid by a person to anindividual in another Member State, except that Austria, Belgium and Luxembourgwill instead be required (unless during that period they elect otherwise) tooperate a withholding system 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).

 

Jerseyis not a member of the European Union and therefore is not required toimplement the EU Savings Tax Directive. However, the Policy & ResourcesCommittee of the States of Jersey has announced that, in keeping with Jersey’spolicy of constructive international engagement, Jersey, in line with stepsproposed by other relevant third countries proposes to introduce a withholdingtax system in respect of payments of interest, or other similar income, made toan individual beneficial owner resident in an EU Member State by a paying agentsituated in Jersey (the terms “beneficial owner” and “paying agent” for thispurpose are as defined in the EU Savings Tax Directive). The withholding taxsystem would apply for a transitional period prior to the implementation of asystem of automatic communication to EU Member States of information regardingsuch payments. During this transitional period, such an individual beneficialowner resident in an EU Member State will be entitled to request a paying agentnot to withhold tax from such payments but instead to apply a system by whichthe details of such payments are communicated to the tax authorities of the EUMember State in which the beneficial owner is resident.

 

The States of Jersey have not yet adopted measures toimplement these proposals but are expected to adopt such measures on the sametimetable as EU Member States and other relevant third countries.

 

**UnitedStates Federal Income Taxation**

 

The following section summarizes the material US federal incometax consequences of the purchase, ownership and disposition of the series 1issuer notes, series 2 issuer notes and series 3 issuer notes (the “USnotes”).  In general, the summaryassumes that a holder acquires the US notes at original issuance and holdsthe 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 notdiscuss special tax considerations that may apply to certain types oftaxpayers, including, without limitation, the following: (i) financialinstitutions; (ii) insurance companies; (iii) dealers or traders in stocks,securities, notional principal contracts or currencies; (iv) tax-exemptentities; (v) regulated investment companies; (vi) persons that will hold theUS notes as part of a “hedging” or “conversion” transaction or as a position ina “straddle” for US federal income tax purposes; (vii) persons that own (or aredeemed to own) 10 per cent. or more of the voting shares of the issuer; (viii)persons who hold US notes through partnerships or other pass-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.

 

This summary is based on the US Internal Revenue Code of 1986, asamended (the “Code”), US Treasury regulations and judicial and administrativeinterpretations thereof, in each case as in effect or available on the date offiling of this Form 20-F.  All of theforegoing are subject to change, and any change may apply retroactively andcould affect the tax consequences described below.

 

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**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 used in this section, the term “United Statesholder” means a beneficial owner of US notes that is for US federal income taxpurposes: (i) a citizen or resident of the United States; (ii) acorporation (or other entity treated as a corporation) or partnership, createdor organized in or under the laws of the United States or any state thereof(including the District of Columbia); (iii) any estate the income of which issubject to US federal income tax regardless of the source of its income; or(iv) any trust if a court within the United States is able to exercise primarysupervision over the administration of the trust and one or more United Statespersons have the authority to control all substantial decisions of thetrust.  If a partnership holds US notes,the tax treatment of a partner will generally depend upon the status of thepartner and upon the activities of the partnership. Partners of partnershipsholding US notes should consult their own tax advisers.  A “Non-United States holder” is a beneficialowner of US notes that is not a United States holder.

 

**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 itscapacity as trustee of the mortgages trust covenants not to engage in anyactivities in the United States (directly or through agents), not to derive anyincome from sources within the United States as determined under US federalincome tax principles, and not to hold any property if doing so would cause itto be engaged or deemed to be engaged in a trade or business within the UnitedStates as determined under US federal income tax principles.  Assuming compliance with these covenants,none of the issuer, Funding 1 or the mortgages trustee acting in its capacityas trustee of the mortgages trust will be subject to US federal incometax.  No elections will be made to treatthe issuer, Funding 1 or the mortgages trustee or any of their assets as aREMIC or a FASIT (two types of securitisation vehicles having a special taxstatus under the Code).

 

**Characterizationof the US notes**

 

Although there is no authority regarding the treatment of instrumentsthat are substantially similar to the US notes, and while it is not free fromdoubt, the issuer believes that the US notes will be treated as debt for USfederal income tax purposes.  The issuerintends to treat the US notes as indebtedness of the issuer for all purposes,including US tax purposes.  Thediscussion in the next section assumes this result.

 

The US notes will not be qualifying real property loans in the hands ofdomestic savings and loan associations, real estate investment trusts, orREMICs under sections 7701(a)(19)(C), 856(c)(5)(C) or 860G(a)(3) of the Code,respectively.

 

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

 

*Qualified Stated Interest and Original Issue Discount.*Theissuer intends to treat interest on the US notes as “qualified stated interest”under US Treasury regulations relating to original issue discount (hereafterthe “OID regulations”).  As aconsequence, discount on the US notes arising from an issuance at less than parwill only be required to be accrued under the OID regulations if such discountexceeds a statutorily defined *de minimis* amount.  Qualified stated interest, which generallymust be unconditionally payable at least annually, is taxed under a holder’snormal method of accounting as ordinary interest income.  *Deminimis* OID is included in income on a *pro rata* basis as principalpayments are made on the US notes.

 

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It is possible that interest on the class B and class C US notes couldbe treated as original issue discount (“OID”) because such interest is subjectto deferral in certain limited circumstances. A United States holder of a US note issued with OID must include OID inincome over the term of such US note under a constant yield method that takesinto account the compounding of interest. Under the Code, OID is calculated and accrued using prepaymentassumptions where payments on a debt instrument may be accelerated by reason ofprepayments of other obligations securing 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 themortgage loans is not expected to alter the scheduled principal payments on theclass B and class C US notes and, accordingly, the issuer intends to assumethat the class B and class C US notes will have their principal repaidaccording to the schedule for purposes of accruing any OID.  No representation is made that the mortgageloans will pay on the basis of such prepayment assumption or in accordance withany other prepayment scenario.

 

In general, United States holders who report income for US federalincome tax purposes under the accrual method are required to accrue OID onshort-term obligations, such as the series 1 class A issuer notes, on astraight-line basis unless an election is made to accrue the OID under aconstant yield method (based on daily compounding).  A United States holder who is an individual or other cash methodholder is not required to accrue such OID unless such holder elects to doso.  If such an election is not made,any gain recognized by such holder on the sale, exchange or maturity of theseries 1 class A issuer notes will be ordinary income to the extent of theholder’s ratable share of OID accrued on a straight-line basis, or uponelection under the constant yield method (based on daily compounding), throughthe date of the sale, exchange or maturity.

 

As an alternative to the above treatments, United States holders mayelect to include in gross income all interest with respect to the class B andclass C US notes, including stated interest, acquisition discount, OID, *de minimis*OID, market discount, *de minimis* market discount, and unstatedinterest, as adjusted by any amortizable bond premium or acquisition premium,using the constant yield method described above.

 

Interest income on the US notes will be treated as foreign sourceincome for US federal income tax purposes, which may be relevant in calculatinga United States holder’s foreign tax credit limitation for US federal incometax purposes.  The limitation on foreigntaxes eligible for the US foreign tax credit is calculated separately withrespect to specific classes of income. For this purpose, the interest on the US notes should generallyconstitute “passive income” or, in the case of certain United States holders,“financial services income”.

 

*Sales and Retirement.* In general, a UnitedStates holder of a US note will have a basis in such US note equal to the costof the US note to such holder, and reduced by any payments thereon other thanpayments of stated interest.  Upon asale or exchange of the US note, a United States holder will generallyrecognize gain or loss equal to the difference between the amount realized(less any accrued interest, which would be taxable as such) and the holder’stax basis in the US note.  Such gain orloss will be long-term capital gain or loss if the United States holder hasheld the US note for more than one year at the time of disposition. **Investorsshould consult their own tax advisors with respect to the treatment of capitalgains (which may be taxed at lower rates than ordinary income for taxpayers whoare individuals, trusts or estates that hold the US notes for more than oneyear) and capital losses (the deductibility of which is subject tolimitations).**

 

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

 

Subject to the backup withholding rules discussed below, a Non-UnitedStates holder generally should not be subject to US federal income orwithholding tax on any payments on a US note and gain from the sale, redemptionor other disposition of a US note unless: (i) that payment and / or gain iseffectively connected with the conduct by that Non-United States holder of atrade or

 

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business in the United States; (ii) in the case of any gain realized onthe sale or exchange of a US note by an individual Non-United States holder,that holder is present in the United States for 183 days or more in the taxableyear of the sale, exchange or retirement and certain other conditions are met;or (iii) the Non-United States holder is subject to tax pursuant to provisionsof the Code applicable to certain expatriates. **Non-UnitedStates holders should consult their own tax advisors regarding the US federalincome and other tax consequences of owning US notes.**

 

**Alternativecharacterization of the US notes**

 

The proper characterization of the arrangement involving the issuer andthe holders of the US notes is not clear because there is no authority ontransactions comparable to that contemplated herein.  The issuer intends to treat the US notes as debt for all USfederal income tax purposes. Investors should consult their own tax advisorswith respect to the potential impact of an alternative characterization of theUS notes for US tax purposes.

 

One possible alternative characterization is that the US InternalRevenue Service (“IRS”) could assert that the class C or any other class of USnotes should be treated as equity in the issuer for US federal income taxpurposes.  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 Statesholder and certain other factors, might also constitute an interest in a controlledforeign corporation for such United States holder.  This would have certain timing and character consequences forUnited States holders and could require certain elections and disclosures thatwould need to be made shortly after acquisition to avoid potentially adverse UStax consequences.

 

If a United States holder were treated as owning an equity interest ina PFIC, unless a United States holder makes a “QEF election” or “mark to marketelection”, a United States holder will be subject to a special tax regime (i)in respect of gains realized on the sale or other disposition of the relevantnotes, and (ii) in respect of distributions on the relevant notes held for morethan one taxable year to the extent those distributions constitute “excess distributions”.  Although not free from doubt, the PFIC rulesshould not apply to gain realized in respect of any notes disposed of duringthe same taxable year in which 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 theUS notes pay interest at a floating rate, it is possible that a US holder willreceive “excess distributions” as a result of fluctuations in the rate ofUSD-LIBOR over the term of the US notes. In general, under PFIC rules, a United States holder will be required toallocate such excess distributions and any gain realized on a sale of its notesto each day during the United States 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”).  Thedeferred tax (other than the tax on amounts allocable to the year ofdisposition or receipt of the distribution) will then be increased by aninterest charge computed by reference to the rate generally applicable tounderpayments of tax (which interest charge generally will be non-deductibleinterest expense for individual taxpayers).

 

**Backupwithholding and information reporting**

 

Backup withholding and information reportingrequirements may apply to certain payments on the US notes and proceeds of thesale or redemption of the US notes to United States holders.  The issuer, its agent, a broker,or any paying agent, as the case may be, may be required to withhold tax fromany payment that is subject to backup withholding if the United States holderfails to furnish the United States holder’s taxpayer identification number(usually on IRS Form W-9), to certify that such United States holder is notsubject to backup withholding, or to otherwise comply with the applicablerequirements of the backup withholding rules.  Certain United Statesholders (including, among

 

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others, corporations) are not subject to the backup withholding andinformation reporting requirements. Non-United States holders may be required to comply with applicablecertification procedures (usually on IRS Form W-8BEN) to establish that theyare not United States holders in order to avoid the application of suchinformation reporting requirements and backup withholding.

 

Payments of principal or interest made to or through a foreign officeof a custodian, nominee or other agent acting on behalf of a beneficial ownerof a US note generally will not be subject to backup withholding. However, ifsuch custodian, nominee or other agent is (i) a United States person (asdefined in section 7701(a)(30) of the Code), (ii) a controlled foreigncorporation (as defined in section 957(a) of the Code), (iii) a foreignperson 50 per cent. or more of whose gross income is effectively connected witha US trade or business for a specified three-year period, or (iv) a foreignpartnership if (A) at any time during its tax year, one or more of its partnersare United States persons (as defined in applicable Treasury regulations) whoin the aggregate hold more than 50 per cent. of the income or capital interestin the partnership or (B) at any time during its taxable year, it is engaged ina US trade or business (each of (i) through (iv), a “US Connected Holder”),such custodian, nominee or other agent may be subject to certain informationreporting requirements with respect to such payment unless it has in itsrecords documentary evidence that the beneficial owner is not a United Statesholder and certain conditions are met or the beneficial owner otherwiseestablishes an exemption. Principal and interest paid by the US office of acustodian, nominee or agent will be subject to both backup withholding andinformation reporting unless the beneficial owner certifies its non-US statusunder penalties of perjury or otherwise establishes an exemption. Payments ofproceeds on the sale of a US note made to or through a foreign office of abroker will not be subject to backup withholding. However, if such broker is aUS Connected Holder, information reporting will be required unless the brokerhas in its records documentary evidence that the beneficial owner is not aUnited States holder and certain conditions are met or the beneficial ownerotherwise establishes an exemption. Payments of proceeds on the sale of a USnote made to or through the US office of a broker will be subject to backupwithholding and information reporting unless the beneficial owner certifies,under penalties of perjury, that it is not a US holder or otherwise establishesan exemption.

 

Backup withholding is not an additional tax.  Any amounts withheld under the backup withholding rules will berefunded or credited against the United States holder’s US federal income taxliability, provided that the required information is furnished to the IRS.  **Holders of US notes should consult their tax advisorsas to their qualification for exemption from backup withholding and theprocedure for obtaining an exemption.**

 

**MaterialJersey (Channel Islands) Tax Considerations**

 

The mortgages trustee is resident in Jersey for taxation purposes andwill be liable to income tax in Jersey at a rate of 20 per cent. in respect ofthe profits it makes from acting as 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.                                      *Dividendsand Paying Agents*

 

Not applicable to annual reports filed on Form 20-F.

 

G.                                     *Statement byExperts*

 

Not applicable to annual reports filed on Form 20-F.

 

H.            *Documents onDisplay*

 

The issuer, Funding 1 and the mortgages trustee are subject to theinformation requirements of the U.S. Securities Exchange Act of 1934, asamended, and are therefore required to file reports,

 

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including annual reports on Form 20-F, and other information with theSEC.  These materials, including thisannual report and the exhibits thereto, may be inspected and copied at theSEC’s public reference rooms in Washington, DC, New York, NY and Chicago, IL.  Please call the SEC at +1-800-732-0330 for furtherinformation on the public reference rooms. As of the date of this annual report, the issuer, Funding 1 and themortgages trustee, as foreign private issuers, are not required to make filingswith the SEC by electronic means, although they are entitled to do so.  Any filings made by the issuer, Funding 1 orthe mortgages trustee will be made available to the public over the Internet atthe SEC’s web site at http://www.sec.gov.

 

I.                                         *SubsidiaryInformation*

 

Not applicable to annual reports filed on Form 20-F.

 

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

 

Funding 1 has entered into the Funding 1 swap agreement with Halifaxplc as the Funding 1 swap provider and the security trustee.  The issuer has entered into issuer swapswith the issuer swap providers and the security trustee.  In general, the swaps are designed to do thefollowing:

 

•                  Funding 1 swap:to hedge against the possible variance between the mortgages trustee variablebase rate payable on the variable rate loans, the rates of interest payable onthe tracker rate loans and the fixed rates of interest payable on the fixedrate loans and a LIBOR based rate for three-month sterling deposits;

 

•                  issuer dollarcurrency swaps: to protect the issuer against changes in the sterling to dollarexchange rate following the closing date and the possible variance between aLIBOR based rate for three-month sterling deposits and either (i) a LIBOR basedrate for one-month dollar deposits applicable to the series 1 class A issuernotes, or (ii) a LIBOR based rate for three-month dollar deposits, applicableto the series 1 class B issuer notes, the series 1 class C issuer notes, theseries 2 issuer notes and the series 3 issuer notes, and to address thedifference in periodicity between the interest payment dates in respect of theintercompany loans, which occur quarterly, and the interest payment dates inrespect of the series 1 class A issuer notes, which occur (i) monthly until theoccurrence of a trigger event or enforcement of the issuer security and (ii)quarterly on and following the interest payment date occurring immediatelythereafter; and

 

•                  issuer eurocurrency swaps: to protect the issuer against changes in the sterling to euroexchange rate following the closing date and the possible variance between aLIBOR based rate for three-month sterling deposits and a EURIBOR based rate forthree-month euro deposits applicable to the series 4 class A1 issuer notes, theseries 4 class B issuer notes, the series 4 class C issuer notes, the series 5class B issuer notes and the series 5 class C issuer notes.

 

•                  issuer interestrate swap: to protect the issuer against the possible variance between a LIBORbased rate for three-month sterling deposits and the fixed rate of interestapplicable to the series 5 class A issuer notes up to and including theinterest payment date falling in December 2010 payable, during this period(i) annually on the interest payment date falling in December of each yearuntil the occurrence of a trigger event or the enforcement of the issuersecurity and (ii) quarterly on and following the interest payment dateoccurring immediately thereafter.

 

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**TheFunding 1 swap**

 

Some of the loans in the portfolio pay a variable rate of interest fora period of time which may either be linked to the mortgages trustee variablebase rate or linked to a variable interest rate other than the mortgagestrustee variable base rate, such as a rate set by the Bank of England.  Other loans pay a fixed rate of interest fora period of time.  However, the interestrate payable by Funding 1 with respect to the issuer term advances iscalculated as a margin over LIBOR for three-month sterling deposits.  To provide a hedge against the possible variancebetween:

 

(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 ratefor three-month sterling deposits,

 

Funding 1, the Funding 1 swap provider and the security trustee haveentered into the Funding 1 swap as amended and restated on November 25,2003.  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 followingamounts 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 thissection (known as 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, Lloyds TSB plc, National Westminster Bank Plc, NationwideBuilding Society, Northern Rock plc and Woolwich plc (and where those bankshave more than one standard variable rate, the highest of those rates);

 

(ii)                                  therates of interest payable on the tracker rate loans; and

 

(iii)                               therates of interest payable on the fixed rate loans,

 

for the relevant calculation period to the notional amount of theFunding 1 swap (known as the “calculation period Funding 1 amount”).  “Calculation date” is defined as the firstday (or if not a London Business Day, the next succeeding London Business Day)of each month and any other day on which Funding 1 acquires a further interestin the trust property from and including the calculation date immediatelypreceding the effective date.  “LondonBusiness Day” is defined as a day (other than a Saturday or Sunday) on whichbanks are generally open for business in London.

 

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

 

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•                  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 amounts are calculated in relation to a Funding 1interest payment date, the following payments will be made on that Funding 1interest payment date:

 

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

 

•                  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 be made by the Funding 1 swap provider, that paymentwill be included in the Funding 1 available revenue receipts and will beapplied on the relevant Funding 1 interest payment date according to therelevant order of priority of payments of 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 of the Funding 1 swap in respect of a calculationperiod will be an amount in sterling 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 the Funding 1 swap is terminated prior to the serviceof any issuer intercompany loan acceleration notice or final repayment of anyintercompany loan, Funding 1 shall enter into a new Funding 1 swap on termsacceptable to the rating agencies, with the security trustee and with a swapprovider whom the rating agencies have previously confirmed in writing toFunding 1, the issuer and the security trustee will not cause the then currentratings of the issuer notes to be downgraded, withdrawn or qualified.  If Funding 1 is unable to enter into a newFunding 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 intercompany loan is denominated in sterling, and interestpayable by Funding 1 to the issuer under the issuer term advances is calculatedas a margin over LIBOR for three-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 USdollar deposits.  In addition, theseries 4 class A1 issuer notes, series 4 class B issuer notes, series 4 class Cissuer notes, series 5 class B issuer notes and series 5 class C issuer notesare denominated in euro and accrue interest at a EURIBOR based rate forthree-month euro deposits.  To deal withthe potential interest rate and / or currency mismatch between (i) its receipts

 

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and liabilities 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 of each issuer currency swap is the principalamount outstanding under the term advance for the issuer notes to which therelevant issuer currency swap relates. In order to allow for the effective currency amount of each issuercurrency swap to amortize at the same rate as the relevant class of issuernotes, each issuer currency swap agreement provides for a number of conditionalmini-swaps intended to ensure that as and when the issuer notes amortize, aportion 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 obligations of the series 3 issuer swap provider and the series 5issuer swap provider under the relevant issuer currency swaps are guaranteed bythe AIG issuer swap guarantor pursuant to a guarantee (the “AIG issuer swapguarantee”).

 

In the event that any issuer currency swap is terminated prior to theservice of an issuer note acceleration notice or the final redemption of therelevant US dollar denominated or euro denominated issuer notes, as applicable,the issuer shall enter into a replacement issuer currency swap in respect ofthat class and series of issuer notes. Any replacement issuer currency swap must be entered into on termsacceptable to the rating agencies, the issuer and the security trustee and witha replacement issuer currency swap provider whom the rating agencies havepreviously confirmed in writing to the issuer and the security trustee will notcause the then current ratings of the issuer notes to be downgraded, withdrawnor qualified.  If the issuer is unableto enter into any replacement issuer currency swaps on terms acceptable to therating agencies, this may affect amounts available to pay amounts due under theissuer notes.

 

If an issuer currency swap agreement is terminated and the issuer isunable to enter into a replacement swap as described above, then any paymentsreceived by the issuer from Funding 1 on each Funding 1 interest payment dateshall be deposited in the issuer bank account (or such other account opened forthis purpose) and applied by the issuer to repay the issuer notes on eachinterest payment date after exchanging at the “spot” rate, the relevantproceeds from sterling into US dollars or euros as required.

 

**Theissuer interest rate swap**

 

The issuer term advancesaccrue interest at a LIBOR based rate for 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 potentialinterest rate mismatch between (i) its receipts in respect of interest payableon the issuer intercompany loan and (ii) its receipts and liabilities inrespect of interest payable on the series 5 class A issuer notes, the issuerhas, pursuant to the terms of the issuer interest rate swap, swapped itsreceipts in respect of the interest it receives on the issuer series 5 term AAAadvance on terms that match the issuer’s obligation to pay interest under theseries 5 class A issuer notes.

 

In theevent that the issuer interest rate swap is terminated prior to the service ofan issuer note acceleration notice or the interest payment date falling inDecember 2010, the issuer shall enter into a replacement issuer interestrate swap in respect of 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 to enter into a replacement issuerinterest rate swap on terms acceptable to the rating

 

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agencies, this may affectamounts available to pay amounts due under the issuer notes.

 

If anissuer interest rate swap agreement is terminated and the issuer is unable toenter into 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 the issuerbank account (or such account opened for this purpose) applied by the issuer 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 swap agreements, in the event that the relevantrating(s) of a swap provider, or its respective guarantor, as applicable, is orare, as applicable, downgraded by a rating agency below the rating(s) specifiedin the relevant swap agreement (in accordance with the requirements of therating agencies) for such swap provider, and, as a result of the downgrade, thethen current ratings of the current notes, in respect of the Funding 1 swap, orthe issuer notes corresponding to the relevant issuer swap in respect of therelevant issuer swap, would or may, as applicable, be adversely affected, therelevant swap provider will, in accordance with the Funding 1 swap or therelevant issuer swap, as applicable, be required to take certain remedialmeasures, which may include providing collateral for its obligations under therelevant swap, arranging for its obligations under the relevant swap to betransferred to an entity with rating(s) required by the relevant rating agencyas specified in the relevant swap agreement (in accordance with therequirements of the rating agency), 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 credit rating of CSFBi as at the closing date and atthe date of this filing, CSFBi, as series 1 issuer swap provider and series 2issuer swap provider, has provided collateral for its obligations under theseries 1 issuer swaps and the series 2 issuer swaps from the effective date ofsuch issuer swaps.  In the event thatCSFBi’s credit rating is restored to the level required under the relevantissuer swap agreements, the obligation to post collateral will cease.

 

**Terminationof the swaps**

 

The Funding 1 swap will terminate on the date on which the aggregateprincipal amount outstanding under all intercompany loans is reduced to zero.

 

Each issuer swap other than the series 1 class A issuer swap, theseries 2 class A issuer swap, the series 3 class A issuer swap, the series 4class A1 issuer swap and the series 5 class A issuer swap will terminate on theearlier of the interest payment date falling in June 2042 and the date onwhich all of the relevant class and series of issuer notes are redeemed infull.  The series 1 class A issuer swapwill terminate on the earlier of the interest payment date falling inDecember 2004 and the date on which the series 1 class A issuer notes areredeemed in full.  The series 2 class Aissuer swap will terminate on the earlier of the interest payment date fallingin September 2010 and the date on which the series 2 class A issuer notesare redeemed in full.  The series 3class A issuer swap will terminate on the earlier of the interest payment datefalling in September 2033 and the date on which the series 3 class Aissuer notes are redeemed in full.  Theseries 4 class A1 issuer swap will terminate on the earlier of the interestpayment date falling in December 2033 and the date on which the series 4class A issuer notes are redeemed in full. The series 5 class A issuer swap will terminate on the earlier of theinterest payment date falling in December 2010 and the date on which theseries 5 class A issuer notes are redeemed in full.

 

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

 

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•                  ifthere is a failure by a party to pay any amounts due under that swap;

 

•                  inrespect of the issuer swaps, if an event of default under the issuer notesoccurs and the security trustee serves an issuer note acceleration notice;

 

•                  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, if certain taxrepresentations by the relevant issuer swap provider prove to have been untrueor misleading in any respect;

 

•                  inrespect of the issuer swaps, at the option of the relevant issuer swapprovider, if certain insolvency events occur with respect to the issuer;

 

•                  uponthe occurrence of an insolvency of the relevant swap provider, or itsguarantor, as applicable, or the merger of the relevant swap provider withoutan assumption of the obligations under the relevant swap agreement, or changesin law resulting in the obligations of one of the parties becoming illegal; and

 

•                  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.

 

Upon the occurrence of a swap early termination event, the issuer orthe relevant issuer swap provider may be liable to make a termination paymentto the other party (in the case of an issuer swap) and / or Funding 1 or theFunding 1 swap provider may be liable to make a termination payment to theother party (in the case of the Funding 1 swap).  This termination payment will be calculated and made in sterling.  The amount of any termination payment willbe based on the market value of the terminated swap as determined on the basisof quotations sought from leading dealers as to the cost of entering into aswap with the same terms and conditions that would have the effect ofpreserving the economic equivalent of the respective full payment obligationsof the parties (or based upon a good faith determination of total losses andcosts (or gains) if an insufficient number of quotations can be obtained or ifbasing the valuation on quotations would not produce a commercially reasonableresult).  Any such termination paymentcould be substantial.

 

If any issuer swap is terminated early and a termination payment is dueby the issuer to an issuer swap provider, then, pursuant to its obligationsunder the issuer intercompany loan, Funding 1 shall pay to the issuer an amountequal to the termination payment due to the relevant issuer swap provider lessany amount received by the issuer under any replacement issuer swapagreement.  These payments will be madeby Funding 1 only after paying interest amounts due on the issuer term advancesand after providing for any debit balance on the principal deficiencyledger.  The issuer shall apply amountsreceived from Funding 1 under the issuer intercompany loan in accordance with theissuer pre-enforcement revenue priority of payments or, as the case may be, theissuer post-enforcement priority of payments. The application by the issuer of termination payments due to an issuerswap provider may affect the funds available to pay amounts due to noteholders.

 

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

 

If the issuer receives a termination payment from the issuer interestrate swap provider, then the issuer shall deposit those funds in the issuerbank account (or such other account opened for such

 

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purpose) and apply the funds to pay interest on the series 5 class Aissuer notes until a replacement issuer interest rate swap is entered into and/ or acquire a replacement issuer interest rate swap.

 

Noteholders will not receive extra amounts (over and above interest andprincipal payable on the issuer notes) as a result of the issuer receiving atermination payment.

 

**Transferof the swaps**

 

Each issuer swap provider may, subject to certain conditions specifiedin the relevant issuer swap agreement, including (without limitation) thesatisfaction of certain requirements of the rating agencies, transfer itsobligations under any of the issuer swaps to another entity.

 

**Taxation**

 

Neither Funding 1 nor the issuer is obliged under any of the swaps togross up payments made by them if withholding taxes are imposed on paymentsmade under the swaps.

 

A swap provider will be obliged to gross up payments made by it toFunding 1 or the issuer if withholding taxes are imposed on payments made underthe swaps.

 

The AIG issuer swap guarantor will be obliged to gross up payments madeby it to the issuer if withholding taxes are imposed on payments under the AIGissuer swap guarantee.  However, the AIGissuer swap guarantor may terminate the relevant issuer currency swap if it isobliged to gross up payments made by it to the issuer.

 

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

 

Not applicable to annual reports filed on Form 20-F.

 

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**PARTII**

 

**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.

 

**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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**PARTIII**

 

**Item 17.  Financial Statements**

 

Not applicable.

 

**Item 18.  Financial Statements**

 

Not applicable.

 

**Item 19.  Exhibits**

 

The following documents are filed as part of the Annual Report on Form20-F:

 

Exhibit 1: a copy of the Memorandum and Articles of Association of eachof the issuer, Funding 1 and the mortgages trustee is incorporated by referencefrom the Registration Statement.

 

Exhibit 2: instruments defining the rights of the security holders asdescribed in the Registration Statement are incorporated by reference from theRegistration Statement.

 

Exhibit 12: Section 302 certification.

 

Exhibit 15.1: Investor’s Report for the month of November 2003(incorporated by reference from the Form 6-K previously filed onDecember 8, 2003).

 

Exhibit 15.2: Investor’s Report for the month of December 2003(incorporated by reference from the Form 6-K previously filed onJanuary 22, 2004).

 

Exhibit 15.3: Servicer compliance statement.

 

Exhibit 15.4: Attestation report of independent accountants.

 

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**SIGNATURES**

 

Each registrant hereby certifies that it meets all of the requirementsfor filing on Form 20-F and that it has duly caused and authorized theundersigned to sign this annual report 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 |   |
|                | Name:                               | David Balai |
| Date: June 30, 2004 | Title:                              | Director |

 

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