** **

**As filed with the Securities andExchange Commission on June 30, 2005**

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

******FORM 20-F**

 
| **(Mark  One)**                                  |
|--------------------------------------------------|
|                                             |
| **o**                                            | **Registration  statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act  of 1934** |
|                                             |
| **or**                                           |
|                                             |
| **ý**                                       | **Annual  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|                                             |
| **For  the fiscal year ended December 31, 2004** |
|                                             |
| **or**                                           |
|                                             |
| **o**                                            | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**For the transition period from                   to                   **

** **

**Commissionfile number:  333-102040**

 

**PERMANENT FINANCING (NO. 2) PLC**

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

** **

**United Kingdom**

(*Jurisdiction ofIncorporation or Organization*)

** **

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

*(Address of Principal Executive Offices*)

 

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

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

** **

**United Kingdom**

(*Jurisdiction of Incorporationor Organization*)

** **

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

*(Address of Principal Executive Offices*)

 

**PERMANENT MORTGAGES TRUSTEE LIMITED**

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

** **

**Jersey, Channel Islands**

(*Jurisdiction ofIncorporation or Organization*)

** **

**47 Esplanade, St. Helier, Jersey JE1 0BD, (011 441534) 510 924**

*(Address of Principal Executive Offices*)

 

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

 

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

 

Securitiesfor which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

Titleof each class

 

$1,750,000,000series 2 class A notes due September 2007

 

$61,000,000series 2 class B notes due June 2042

 

$61,000,000series 2 class C notes due June 2042

 

$1,750,000,000series 4 class A notes due December 2009

 

Series2 term AAA advance(1)

 

Series2 term AA advance(1)

 

Series2 term BBB advance(1)

 

Series4 term AAA advance(1)

 

Funding1 interest in the mortgages trust(1)

 

Indicate the number ofoutstanding shares of each of the issuer’s classes of capital or common stockas of the close of the period covered by the annual report.

 

**Not applicable.**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes ýNo o

 

Indicate by check markwhich financial statement item the registrant has elected to follow.

 

**Notapplicable.**

 

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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 is the primary source of payments on the term advances listed.Permanent Funding (No. 1) Limited is the registrant for the term advances andhas issued the term advances to Permanent Financing (No. 2) PLC. The termadvances are the primary source of payments on the series 2 notes and theseries 4 notes. Permanent Financing (No. 2) PLC is the registrant for theseries 2 notes and the series 4 notes.

 

 

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**PRESENTATIONOF INFORMATION**

 

This annual report onForm 20-F relates to Permanent Financing (No. 2) PLC (the “issuer”) and thefollowing securities (the “issuer notes”), which were issued pursuant to atrust deed dated March 6, 2003, (the “issuer trust deed”), between the issuerand U.S. Bank National Association (since, succeeded by The Bank of New York),as note trustee (the “note trustee”):

 

•                  $1,750,000,000 series 2 class A notesdue September 2007

•                  $61,000,000 series 2 class B notesdue June 2042

•                  $61,000,000 series 2 class C notesdue June 2042

•                  $1,750,000,000 series 4 class A notesdue December 2009

 

This annual report onForm 20-F also relates to the following advances made pursuant to theintercompany loan agreement dated March 6, 2003 (the “issuer intercompany loanagreement”), between the issuer, Permanent Funding (No. 1) Limited (“Funding1”), U.S. Bank National Association (since, succeeded by The Bank of New York),as security trustee (the “security trustee”) and Citibank, N.A., as agent bank:

 

•                  £1,108,016,000 series 2 term AAAadvance

•                  £38,622,000 series 2 term AA advance

•                  £38,622,000 series 2 term BBB advance

•                  £1,107,250,000 series 4 term AAAadvance

 

This annual report onForm 20-F further relates to Funding 1’s interest in the mortgages trust,comprising, among other things, the portfolio of loans and their relatedsecurity assigned to Permanent Mortgages Trustee Limited (the “mortgagestrustee”) by Halifax plc (the “seller”) on June 14, 2002, and on severalsubsequent dates any new loans and their new related security assigned to themortgages trustee by the seller after March 6, 2003 (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. The mortgages trustee guaranteed investmentcontract, or GIC, account is the bank account in which the mortgages trusteeholds any cash that is part of the trust property until it is distributed tothe beneficiaries. Any actual losses in relation to the loans, any actualreductions occurring in respect of the loans and distributions of principalmade from time to time to the beneficiaries or the mortgages trust will bededucted from the trust property. The composition of the trust property willfluctuate as drawings under flexible loans and new loans are added and as theloans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

Certain terms used hereinand not defined have the same meaning ascribed to such terms in theRegistration Statement filed on Form S-11 (the “Registration Statement”)relating to the securities (file number 333-102040).

 

Certain items in Form20-F are not applicable to annual reports filed on Form 20-F. Therefore, asused in this filing, “Not applicable to annual reports filed on Form 20-F”means that the response to the referenced item is omitted in reliance on theinstructions to Form 20-F published by the United States Securities andExchange Commission (the “SEC”) as of the date of this annual report thatspecifically state that the item is inapplicable to annual reports filed onForm 20-F.

 

Certain items in Form20-F are not applicable to the issuer, Funding 1 or the mortgages trustee.Therefore, as used in this filing, “Not applicable” means the response to thereference item is 

 

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omitted in reliance on the procedures outlined in numerous no-actionletters issued by the staff of the SEC with respect to issuers of substantiallysimilar asset-backed securities that file annual reports on Form 10-K, or thatthe referenced item is otherwise not applicable.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This annual reportincludes forward-looking statements including, but not limited to, statementsmade under the “Risk Factors” section. These forward-looking statements can beidentified by the use of forward-looking terminology, such as the words“believes”, “expects”, “may”, “intends”, “should” or “anticipates”, or thenegative or other variations of those terms. These statements involve known andunknown risks, uncertainties and other important factors that could cause theactual results and performance of the issuer notes, the seller or the UKresidential mortgage industry to differ materially from any future results orperformance expressed or implied in the forward-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 mostsignificant of these risks, uncertainties and other factors are discussed inthe section of this annual report entitled “Risk Factors”. Investors areencouraged to carefully consider those factors prior to making an investmentdecision regarding the issuer notes.

 

**INCORPORATIONOF CERTAIN DOCUMENTS BY REFERENCE**

 

Each of the issuer,Funding 1 and the mortgages trustee incorporates by reference its periodicfilings on Form 6-K, which contain all financial information relating to thesecurities relevant to the holders of the issuer notes.

 

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**PART I**

 

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

 

Not applicable to annualreports filed on Form 20-F.

 

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

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 3.  Key Information**

 

A.*            Selected Financial Data*

 

Each of the issuer,Funding 1 and the mortgages trustee incorporates by reference and attacheshereto as exhibits the following reports, filed on Form 6-K, which include allfinancial information relating to the securities that is relevant to holders ofthe issuer notes:

 

•                  Investor’s Report for the month ofJanuary 2004

•                  Investor’s Report for the month ofFebruary 2004

•                  Investor’s Report for the month ofMarch 2004

•                  Investor’s Report for the month ofApril 2004

•                  Investor’s Report for the month ofMay 2004

•                  Investor’s Report for the month ofJune 2004

•                  Investor’s Report for the month ofJuly 2004

•                  Investor’s Report for the month ofAugust 2004

•                  Investor’s Report for the month ofSeptember 2004

•                  Investor’s Report for the month ofOctober 2004

•                  Investor’s Report for the month ofNovember 2004

•                  Investor’s Report for the month ofDecember 2004

 

B.*            Capitalization and Indebtedness*

 

Not applicable to annualreports filed on Form 20-F.

 

C.*            Reasons for the Offer and Use ofProceeds*

 

Not applicable to annualreports filed on Form 20-F.

 

D*.            Risk Factors*

 

*This section describes the principal risk factorsassociated with an investment in the issuer notes. Investors consideringpurchasing the issuer notes should carefully read and think about all theinformation contained in this document, including the risk factors set outhere, prior to making any investment decision.*

 

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

 

The issuer notes do notrepresent an obligation and are not the responsibility of any of Halifax plc orany of its affiliates, underwriters, managers, the mortgages trustee, the notetrustee or any other party to the transaction other than the issuer.

 

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

 

The issuer’s ability tomake payments of principal and interest on the issuer notes and to pay itsoperating and administrative expenses will depend primarily on the funds beingreceived under the issuer intercompany loan. In addition, the issuer will relyon the issuer dollar currency swaps and the issuer euro currency swaps toprovide payments on the issuer notes denominated in US dollars and euro,respectively.

 

Noteholders should notethat there is no liquidity facility directly available to the issuer, althoughFunding 1 has the benefit of a liquidity facility to pay interest on the issuerterm advances corresponding to the issuer notes and to pay principal on theclass A issuer notes other than the series 3 class A issuer notes (save asdescribed below) and the series 5 class A issuer notes. In the event that theseller suffers certain ratings downgrades, Funding 1 will be required to fundthe liquidity reserve fund, though there can be no assurance that Funding 1will have sufficient resources to do so at such time, and Funding 1 may drawmoney from the liquidity reserve fund, to the extent it has been funded, to payamounts due to the issuer. The ability of Funding 1 to draw on the Funding 1liquidity facility is subject to satisfying certain 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 on theirfinal maturity date only.

 

In addition to theissuer, all relevant issuers (including the previous issuer and, as they areestablished, each new issuer) have or will have an indirect interest in theFunding 1 liquidity facility (the Funding 1 liquidity facility will beavailable to meet interest and principal obligations of Funding 1 to theprevious issuer and new issuers, subject to certain conditions precedent). If adrawing is made under the Funding 1 liquidity facility to enable Funding 1 tomeet its obligations to the previous issuer or to new issuers, then that mayaffect the amount of funds available to Funding 1 to meet its obligations tothe issuer.

 

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

 

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

 

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

 

•                  Funding 1 receiving enough funds fromits entitlement to the trust property on or before each Funding 1 interestpayment date;

 

•                  Funding 1 receiving the requiredfunds from the Funding 1 swap provider;

 

•                  the amount of funds credited to thegeneral reserve fund;

 

•                  the amount of funds credited to theliquidity reserve fund;

 

•                  Funding 1 making drawings aspermitted under the Funding 1 liquidity facility; and

 

•                  the allocation of funds between theissuer term advances, the previous term advances and any new term advances.

 

According to the terms ofthe mortgages trust deed, the mortgages trustee is obliged to pay to Funding 1the Funding 1 share percentage of revenue receipts on the loans by creditingthose amounts to the Funding 1 GIC account on each distribution date. Themortgages trustee is obliged to pay 

 

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Funding 1 principal receipts on the loans by crediting those amounts tothe Funding 1 GIC account as and when required pursuant to the terms of themortgages trust deed.

 

Funding 1 will be obligedto pay revenue receipts due to the issuer under the issuer intercompany loanonly to the extent that it has revenue receipts left over after making paymentsranking in priority to the issuer, such as payments of certain fees andexpenses of Funding 1 and payments on certain higher ranking new term advancesunder new intercompany loans.

 

Funding 1 will be obligedto pay principal receipts due to the issuer under the issuer intercompany loanonly to the extent that it has principal receipts available for that purposeafter repaying amounts ranking in priority to the issuer (including repayingany higher ranking new term advances).

 

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

 

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

 

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

 

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

 

The transaction has beenstructured in the expectation that on the final repayment date of the issuerintercompany loan in June 2042, the interest and principal due and payable onthe issuer term AA advances and the issuer term BBB advances will be in anamount equal to the sum available to pay all outstanding interest and/orprincipal (including interest and/or principal deferred and unpaid) on theissuer term AA advances and the issuer term BBB advances (after paying amountsof a higher order of priority as required by the Funding 1 priority ofpayments).

 

If there is a shortfallbetween the amount available to pay the interest and/or principal and theamount required to pay all outstanding interest and/or principal on the issuerterm AA advances and the issuer term BBB advances, then the shortfall will bedeemed to be not due and payable under the issuer intercompany loan agreementand the issuer will not have any claim against Funding 1 for the shortfall.

 

If there is a shortfallin interest and/or principal payments under the issuer intercompany loanagreement, the noteholders may not receive the full amount of interest and/orprincipal which would otherwise be due and payable on the class B issuer notesor 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**

 

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The only remedy forrecovering amounts on the issuer notes is through the enforcement of the issuersecurity. The issuer has no recourse to the assets of Funding 1 unless Funding1 has also defaulted on its obligations under the issuer intercompany loan andthe Funding 1 security has been enforced.

 

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

 

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

 

The transaction has beenstructured in the expectation that:

 

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

 

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

 

•                  the series 4 issuer notes will beredeemed in full prior to the redemption of the series 5 issuer notes.

 

This means, among otherthings, that the series 2 class B issuer notes and the series 2 class C issuernotes are expected to be redeemed before the series 3 class A issuer notes, theseries 4 class A issuer notes and the series 5 class A issuer notes, eventhough the series 3 class A issuer notes, the series 4 class A issuer notes andthe series 5 class A issuer notes have a higher rating that the series 2 classB issuer notes and the series 2 class C issuer notes. Similarly, the series 3class B issuer notes and the series 3 class C issuer notes are expected to beredeemed before the series 4 class A issuer notes and the series 5 class Aissuer notes.

 

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

 

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

 

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

 

The issuer deed of chargerequires the security trustee to consider the interests of each of the issuersecured creditors in the exercise of all of its powers, trusts, authorities,duties and discretions, but requires the security trustee, in the event of aconflict between the noteholders’ interests and the interests of any of theother issuer secured creditors, to consider only the noteholders’ interests. In

 

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certain circumstances, the security trustee can make amendments to thedocuments without 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 chargeand the issuer deed of charge, the security trustee may, without the consent orsanction of Funding 1’s secured creditors or the issuer’s secured creditors,concur with any person in making or sanctioning any modifications to thetransaction documents:

 

•                  which in the opinion of the securitytrustee it may be expedient to make, provided that the security trustee is ofthe opinion that the modification will not be materially prejudicial to theinterests of the secured creditors or, if it is not of that opinion in relationto any secured creditor, the secured creditor has given its written consent tothe modification; or

 

•                  which in the opinion of the securitytrustee is made to correct a manifest error or an error established as such tothe satisfaction of the security trustee or is of a formal, minor or technicalnature.

 

The security trustee willbe entitled to assume that the exercise of its discretion will not bematerially prejudicial to the noteholders’ interests if each of the ratingagencies has confirmed that the then current rating by it of the notes wouldnot be adversely affected by such exercise.

 

In addition, the securitytrustee will give its consent to any modifications to the mortgage saleagreement, the servicing agreement, the cash management agreement, the Funding1 deed of charge, the Funding 1 liquidity facility agreement, the Funding 1swap agreement, the intercompany loan terms and conditions, the bank accountagreement and the master definitions and construction schedule, that arerequested by Funding 1 or the cash manager, provided that Funding 1 or the cashmanager certifies to the security trustee in writing that the modifications arerequired in order to accommodate:

 

**i)****               **the entry by Funding 1 into newintercompany loan agreements and/or the issue of new types of notes by newissuers and/or the addition of other relevant creditors to the transaction;

 

**ii)****           **theinclusion of Permanent Funding (No. 2) PLC (“Funding 2”) as a beneficiary ofthe mortgages trust;

 

**iii)****       **theissue of new notes by Funding 2;

 

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

 

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

 

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

 

**vii)****      **theinclusion of an additional Funding 1 liquidity facility;

 

and provided furtherthat:

 

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•                  in respect of the matters listed inparagraphs (i) to (iv), the relevant conditions precedent have been satisfied;and

 

•                  in respect of the matters listed inparagraphs (i) to (vii), the security trustee has received written confirmationfrom each of the rating agencies that the relevant modifications will notadversely affect the then current ratings of the notes.

 

The modificationsrequired to give effect to the matters listed in paragraphs (i) to (vii) abovemay include, *inter alia*, amendments to theprovisions of the Funding 1 deed of charge relating to the application ofmonies. Accordingly, there can be no assurance that the effect of themodifications to the transaction documents will not ultimately adversely affectnoteholders’ interests. Any modifications to the documents described above willrequire the actual consent of the Funding 1 liquidity facility provider, theFunding 1 swap provider and each of the issuer swap providers (in respect ofeach document to which they are a party), as applicable, such consent not to beunreasonably withheld and to be deemed given if no response (affirmative ornegative) is given within ten business days after the request for consent issent to each such party.

 

**There maybe a conflict between the interests of the holders of class A issuer notes, theholders of class B issuer notes and the holders of class C issuer notes, andthe interests of one class of noteholders may prevail over the interests ofother classes of noteholders**

 

The issuer trust deed andthe terms of the issuer notes provide that the note trustee is to have regardto the interests of the holders of all the classes of issuer notes. There maybe circumstances, however, where the interests of one class of noteholdersconflict with the interests of another class or classes of noteholders. Theissuer trust deed and the terms of the issuer notes provide that where, in theopinion of the note trustee, there is a conflict, then:

 

•                  the note trustee is to have regardonly to the interests of the class A noteholders in the event of a conflictbetween the interests of the class A noteholders on the one hand and the classB noteholders and/or the class C noteholders on the other hand; and

 

•                  the note trustee is to have regardonly to the interests of the class B noteholders in the event of a conflictbetween the interests of the class B noteholders on the one hand and the classC noteholders on the other hand.

 

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

 

There may also becircumstances where the interests of the class A noteholders of one series ofthe issuer notes conflict with the interests of the class A noteholders ofanother series of the issuer notes. Similarly, there may be circumstances wherethe interests of the class B noteholders of one series of the issuer 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 andthe terms of the issuer notes will provide that where, in the sole opinion ofthe note trustee, there is a conflict, then a resolution directing the notetrustee to take any action must be passed at separate meetings of the holdersof each series of the class A issuer notes, or, as applicable, each series ofthe class B issuer notes or each series of the 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.

 

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Similar provisions willapply in relation to requests in writing from holders of a specified percentageof the principal amount outstanding of the issuer notes of each class withineach series (the principal amount outstanding being converted into sterling forthe purposes of making the calculation). Noteholders should note that, as aresult of repayments of principal first to the series 2 issuer notes, then tothe series 3 issuer notes, then to the series 4 issuer notes and then to theseries 5 issuer notes, the principal amount outstanding of each series of theissuer 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 establisheda separate entity, Funding 2, which may issue new notes from time to time anduse the proceeds to pay for a direct interest in the trust property rather thanlending the proceeds to Funding 1. Simultaneously with the acquisition by Funding2 of an interest in the trust property, the seller and Funding 1, as existingbeneficiaries of the mortgages trust, would be required to agree to a decreasein their beneficial interests in the trust property (which would require apartial release of security by Funding 1 over its share in the trust property).

 

The seller, Funding 1 andFunding 2 would each have a joint and undivided interest in the trust propertybut their entitlement to the proceeds from the trust property would be inproportion to their respective shares of the 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 thatFunding 2 will issue notes directly or indirectly to investors from time totime backed by its share of the trust property. Noteholders would not have adirect or indirect interest in Funding 2’s share of the trust property.

 

Amendments would be madeto a number of the issuer transaction documents as a result of the inclusion ofFunding 2 as a beneficiary of the mortgages trust. In particular (but withoutlimitation), amendments would be made to:

 

•                  the mortgage sale agreement to enablethe purchase by Funding 2 of interests in the trust property;

 

•                  the mortgages trust deed (i) toestablish Funding 2 as a beneficiary of the trust, (ii) to enable theacquisition by Funding 2 of an interest in the trust property from time to timeand (iii) to regulate the distribution of interest and principal receipts inthe trust property to Funding 2 and the other beneficiaries;

 

•                  the cash management agreement toregulate the application of monies to Funding 2;

 

•                  the servicing agreement to ensurethat Funding 2 receives the benefit of the servicers duties under thatagreement; and

 

•                  the master definitions andconstruction agreement.

 

In addition, Funding 1,Funding 2 and the seller may enter into new agreements to regulate the makingof decisions between them.

 

There may be conflicts ofinterest between Funding 1 and Funding 2, in which case it is expected that themortgages trustee will follow the directions given by the relevant beneficiary(excluding the seller) that has the largest share of the trust property at thattime. The interests of Funding 1 may not prevail, which may adversely affectthe noteholders’ interests.

 

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

 

•                  obtaining a written confirmation fromeach of the rating agencies that the then current ratings of the notesoutstanding at that time will not be adversely affected as a result of Funding2 becoming a beneficiary of the mortgages trust;

 

•                  providing written certification tothe security trustee that no event of default under any of Funding 1’sintercompany loan agreements outstanding at that time has occurred which hasnot been remedied or waived and no event of default will occur as a result ofFunding 2 becoming a beneficiary of the mortgages trust; and

 

•                  providing written certification tothe security trustee that no principal deficiency is recorded on the principaldeficiency ledger in relation to Funding 1’s term advances that are outstandingat that time.

 

There can be no assurancethat the inclusion of Funding 2 as a beneficiary of the mortgages trust wouldnot affect cashflows available to pay amounts due on the noteholders’ issuernotes and therefore adversely affect the noteholders’ interests.

 

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

 

Since the closing date,Holdings has established new issuers to issue new notes to investors, and it islikely that Holdings will establish additional new issuers in the future. Theproceeds of each new issue will be used by the new issuer to make a newintercompany loan to Funding 1. Funding 1 will use the proceeds of the newintercompany loan either to:

 

•                  pay the seller in relation to theinitial consideration for new loans and their related security to be assignedto the mortgages trustee;

 

•                  pay the seller for a portion of theseller share of the trust property to be assigned to Funding 1, which willresult in an increase in Funding 1’s share of the trust property;

 

•                  refinance in whole or in part anintercompany 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

 

•                  deposit some of those proceeds in thegeneral reserve fund.

 

The payment and securitypriorities of the issuer notes relative to each other as set out in the issuerdeed of charge and the issuer cash management agreement will not be affected asa result of an issue of new notes by a new issuer, because that new issue willbe separately documented. However, Funding 1 may be required to repay to a newissuer amounts owing under a new term advance ahead of or in the same order ofpriority as amounts owing to the issuer on the issuer term advances, dependingon the term advance rating, the scheduled repayment date of that new termadvance and certain other rules regarding the repayment of principal by Funding1. If this is the case, then the relevant new noteholders will be paid beforethe noteholders.

 

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If Holdings establishesnew issuers to make new intercompany loans to Funding 1, the noteholders willnot have any right of prior review or consent with respect to those newintercompany loans or the corresponding issuance by new issuers of new notes.Similarly, the terms of the Funding 1 transaction documents (including themortgage sale agreement, the mortgages trust deed, the Funding 1 deed ofcharge, the definitions of the trigger events, the criteria for the sale of newloans to the mortgages trustee and the amount available to be drawn under theFunding 1 liquidity facility) may be amended to reflect the new issue.Noteholders’ consent to these changes will not be required. There can be noassurance that these changes will not affect the cashflows available to payamounts due on the issuer notes.

 

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

 

•                  obtaining a written confirmation fromeach of the rating agencies that the then current ratings of the notesoutstanding at that time will not be adversely affected because of the newissue;

 

•                  providing written certification tothe security trustee that no event of default under any of the intercompanyloan agreements outstanding at that time has occurred which has not beenremedied or waived and no event of default will occur as a result of the issueof the new notes; and

 

•                  providing written certification tothe security trustee that no principal deficiency is recorded on the principaldeficiency ledger in relation to the term advances outstanding at that time.

 

**Funding 1has 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**

 

Theother issuers issued notes to investors, the equivalent net issue proceeds ofwhich were used by the other issuers to make intercompany loans to Funding 1.Funding 1 used most of the proceeds of these intercompany loans to pay theseller for the initial loans (together with their related security) that itassigned to the mortgages trustee on the initial closing date, which comprisedFunding 1’s original share of the trust property. Funding 1 used most of theproceeds of each other issuers’ intercompany loan to pay the seller for loans(together with their related security) sold to the mortgages trustee or to payconsideration to the seller for an increase in Funding 1’s share in themortgages trust.

 

Thepayment and security priorities of the issuer notes relative to each other asset out in the issuer deed of charge and the issuer cash management agreementare not affected as a result of the issue of notes by the other issuers, becausethe other issues were separately documented. However, Funding 1 may be requiredto pay to the other issuers amounts that are owing under one or more termadvances ahead of or in the same order of priority as amounts owing to theissuer on the issuer term advances, depending on the term advance rating, thescheduled repayment date of that term advance and other rules regarding thepayment of interest and the repayment of principal by Funding 1. If this is thecase then the other noteholders will be paid before the holders of the issuernotes.

 

**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 intoa new intercompany loan agreement, then if required it will also enter into anew start-up loan agreement with new start-up loan providers and the securitytrustee.

 

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If required by the ratingagencies, Funding 1 will use part of the proceeds of the new start-up loan tofund further the general reserve fund. Similarly, if necessary, Funding 1 willalso enter into a new Funding 1 swap with either the Funding 1 swap provider ora new Funding 1 swap provider and the security trustee.

 

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

 

**There maybe conflicts between the issuer and any new issuers, and the issuer’s interestsmay not prevail, which may adversely affect payments on the issuer notes**

 

The security trustee willexercise its rights under the Funding 1 deed of charge only in accordance withdirections given by the issuers (which could be the issuer and, if Funding 1enters into new intercompany loans, any new issuer) that have thehighest-ranking outstanding term advances, provided that the security trusteeis indemnified and/or secured to its satisfaction.

 

If the security trusteereceives conflicting directions, it will follow the directions given by therelevant issuers representing the largest principal amount outstanding ofrelevant term advances. If the issuer is not in the group representing that largestprincipal amount, then its interests may not prevail. This could ultimatelycause a reduction in the payments the noteholders receive on the issuer notes.

 

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

 

There is no guaranteethat any new loans sold to the mortgages trustee will have the samecharacteristics as the loans in the initial portfolio as of the closing date.In particular, new loans may have different payment characteristics than theloans in the initial portfolio as of the closing date. The ultimate effect ofthis could be to delay or reduce the payments the noteholders receive on theissuer notes.

 

**The yieldto maturity of the issuer notes may be adversely affected by prepayments orredemptions on the loans**

 

The yield to maturity ofthe issuer notes of each class will depend mostly on (a) the amount and timingof payment of principal on the loans and (b) the price paid by noteholders ofeach class of issuer notes. The yield to maturity of the issuer notes of eachclass may be adversely affected by a higher or lower than anticipated rate ofprepayments on the loans.

 

No assurance can be giventhat Funding 1 will accumulate sufficient funds during the cash accumulationperiod relating to the issuer series 2 term AAA advance, each scheduledamortization installment under the issuer series 3 term AAA advance or theissuer series 4 term AAA advance to enable it to repay these issuer termadvances to the issuer so that the corresponding classes of issuer notes willbe redeemed in their entirety on their scheduled redemption dates.

 

During the cashaccumulation period for the issuer term advances and scheduled amortizationinstallments, repayments of principal will only be made on the issuer series 5term AAA advance, the issuer term AA advances or the issuer term BBB advancesthat are due and payable if the quarterly 

 

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CPR of the loans in the trust property is greater than 15 per cent. andcertain other conditions are met. This means that there may be no correspondingrepayments of principal on the series 5 class A issuer notes, the class Bissuer notes or the class C issuer notes.

 

The extent to whichsufficient funds are saved by Funding 1 during a cash accumulation period orreceived by it from its share in the mortgages trust on a scheduled repaymentdate will depend on whether the actual principal prepayment rate of the loansis the same as the assumed principal prepayment rate. If Funding 1 is not ableto save enough money during a cash accumulation period or does not receiveenough money from its share in the mortgages trust on a scheduled repaymentdate to repay the relevant issuer term AAA advance (and if it is unable to makea drawing on the Funding 1 liquidity facility or the reserve fund to make goodthe shortfall) so that the issuer can redeem the class A issuer notes of the correspondingseries on their respective scheduled redemption date(s), then Funding 1 will berequired to pay to the issuer on those scheduled redemption dates only theamount that it has actually saved or received. Any shortfall will be deferredand paid on subsequent Funding 1 interest payment dates when Funding 1 hasmoney available to make the payment. In these circumstances there will be avariation in the yield to maturity of the relevant class of issuer notes.

 

**Theissuer’s ability to redeem the series 2 class A issuer notes and/or the series3 class A issuer notes and/or the series 4 class A issuer notes on theirscheduled redemption dates is affected by the rate of prepayment on the loans**

 

The rate of prepayment ofloans is influenced by a wide variety of economic, social and other factors,including prevailing mortgage market interest rates, the availability ofalternative financing programs, local and regional economic conditions andhomeowner mobility. For instance, prepayments on the loans may be due toborrowers refinancing their loans and sales of properties by borrowers(either voluntarily or as a result of enforcement action taken). In addition,if the seller is required to repurchase a loan or loans under amortgage account and their related security because, for example, one ofthe loans does not comply with the loan warranties in the mortgage saleagreement, then the payment received by the mortgages trustee will have thesame effect as a prepayment of all of the loans under the mortgage account.Because these factors are not within its control or the control of Funding 1 orthe mortgages trustee, the issuer cannot give any assurances as to the level ofprepayments that the portfolio may experience.

 

Variation in the rate ofprepayments of principal on the loans may affect each class of the issuer notesdifferently depending upon amounts already repaid by Funding 1 to the issuerunder the issuer intercompany loan and whether a trigger event has occurred, ora loan is subject to a product switch or a further advance or the securitygranted by the issuer under the issuer deed 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 2 class A issuer notesand/or the series 3 class A issuer notes and/or the series 4 class A issuernotes in full on their respective scheduled redemption 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 wasoriginated in accordance with the seller’s lending criteria at the time oforigination. These lending criteria consider a variety of factors such as apotential borrower’s credit history, employment history and status andrepayment ability, as well as the value of the property to be mortgaged. In theevent of the sale of any new loans and new related security to the mortgagestrustee, the seller will warrant that those new loans and new related securitywere originated in accordance with the seller’s lending criteria at the time oftheir origination. However, the seller retains the right to revise its lendingcriteria as determined from time to time, and so the lending criteriaapplicable to any loan at the time of its origination may not be or have beenthe same as those when 

 

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other loans were originated. If new loans that have been originatedunder revised lending criteria are sold to the mortgages trustee, thecharacteristics of the trust property could change. This could lead to a delayor a reduction in the payments received on the issuer notes.

 

**The seller has adopted procedures relating to investigationsand searches for remortgages which could affect the characteristics of thetrust property and which may adversely affect payments on the issuer notes**

 

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

 

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

 

The loans are affected bycredit, liquidity and interest rate risks. Various factors influence mortgagedelinquency rates, prepayment rates, repossession frequency and the ultimatepayment 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 financialcircumstances may affect the ability of borrowers to repay loans. Loss ofearnings, illness, divorce and other similar factors may lead to an increase indelinquencies by and bankruptcies of borrowers, and could ultimately have anadverse impact on the ability of borrowers to repay loans.

 

In addition, the abilityof a borrower to sell a property given as security for a loan at a pricesufficient to repay the amounts outstanding under the loan will depend upon anumber of factors, including the availability of buyers for that property, thevalue of that property and property values in general at the time.

 

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

 

**The occurrenceof trigger events and enforcement of the issuer security may adversely affectthe scheduled redemption dates of the series 2 class A issuer notes, series 3class A issuer notes and/or series 4 class A issuer notes**

 

If no trigger event hasoccurred and the issuer security has not been enforced in accordance with theterms of the issuer deed of charge, then payments of principal will not occuron the series 2

 

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class A issuer notes and/or series 3 class A issuer notes and/or series4 class A issuer notes before their respective scheduled redemption dates.

 

If a trigger event occursor the issuer security is enforced in accordance with the issuer deed of chargeprior to the scheduled redemption dates for the series 2 class A issuer notesand/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.

 

**If anasset trigger event occurs, any series 2 class A issuer notes, series 3 class Aissuer notes, and/or series 4 class A issuer notes then outstanding will not berepaid on their scheduled redemption dates**

 

When an asset triggerevent has occurred, the mortgages trustee will distribute principal receipts onthe loans to Funding 1 and the seller proportionally and equally based on theirpercentage shares of the trust property (that is, the Funding 1 sharepercentage and the seller share percentage). When an asset trigger event hasoccurred, Funding 1 will repay (after making requisite payments to the Funding1 liquidity facility provider and to replenish the reserve fund):

 

*first*,the issuer term AAA advances in respect of the issuer intercompany loan, theprevious intercompany loans and any new intercompany loans, until all of thoseterm AAA term advances are fully repaid;

 

*then*,the issuer term AA advances in respect of the issuer intercompany loan, theprevious intercompany loans and any new intercompany loans, until all of thoseterm AA term advances are fully repaid;

 

*then*,the issuer term A advances in respect of the previous intercompany loans andany new intercompany loans, until all of those term A term advances are fullyrepaid; and

 

*finally*,the issuer term BBB advances in respect of the issuer intercompany loan, theprevious intercompany loans and any new intercompany loans, until all of thoseterm BBB term advances are fully repaid.

 

If an asset trigger eventoccurs, any series 2 class A issuer notes and/or series 3 class A issuer notesand/or series 4 class A issuer notes then outstanding will not be repaid ontheir scheduled redemption dates, and there is also a risk that they will notbe repaid by their final maturity dates.

 

**If anon-asset trigger event occurs, any series 2 class A issuer notes, series 3class A issuer notes and/or series 4 class A issuer notes then outstanding willnot be repaid on their scheduled redemption dates**

 

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

 

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

 

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

 

*then*,the issuer term A advances in respect of the previous intercompany loans andany new intercompany loans, until all of those term A term advances are fullyrepaid; and

 

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

 

If a non-asset triggerevent occurs, any series 2 class A issuer notes, series 3 class A issuer notesand/or series 4 class A issuer notes then outstanding will not be repaid ontheir scheduled redemption dates.

 

**If theissuer security is enforced, any series 2 class A issuer notes, series 3 classA issuer notes and/or series 4 class A issuer notes then outstanding will notbe repaid on their scheduled redemption dates**

 

If the issuer security isenforced, then the mortgages trustee will distribute funds as required underthe terms of the transaction agreements. In these circumstances, any 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 and there is also a risk that those class A issuer notes may not berepaid by their final maturity dates.

 

**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 itsdiscretion decides to grant a borrower a further advance under a loan which hasbeen assigned to the mortgages trustee, then the seller will be required torepurchase that loan under the relevant mortgage account and its related securityfrom the mortgages trustee save for any loan in arrears at a price equal to theoutstanding principal balance of those loans together with any accrued andunpaid interest and expenses to the date of purchase. The yield to maturity ofthe issuer 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 productswitches will not be repurchased unless on any distribution date, the seller isin breach of the conditions precedent to the sale of new loans to the mortgagestrustee. 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 required to repurchase the relevant loan or loansunder the relevant mortgage account and their related security from themortgages trustee at a price equal to the outstanding principal balance ofthose loans together with any accrued and unpaid interest and expenses to thedate of purchase.

 

A loan will be subject toa product switch if the borrower and the seller agree on or the servicer offersa variation in the financial terms and conditions applicable to the relevantborrower’s loan, other than:

 

•                  any variation agreed with a borrowerto control or manage arrears on the loan;

 

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•                  any variation to the interest rate asa result of a borrower being linked to HVR 2;

 

•                  any variation in the maturity date ofthe loan unless, while the issuer intercompany loan is outstanding, it isextended beyond June 2040;

 

•                  any variation imposed by statute;

 

•                  any variation of the rate of interestpayable in respect of the loan where that rate is offered to the borrowers ofmore than 10 per cent. by outstanding principal amount of loans comprised inthe trust property in any interest period; or

 

•                  any variation in the frequency withwhich the interest payable in respect of the loan is charged.

 

The yield to maturity ofthe issuer notes may be affected by the repurchase of loans subject to productswitches.

 

**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 toeach class of the issuer notes address the likelihood of full and timelypayment to the noteholders of all payments of interest on each interest paymentdate under those classes of the issuer notes.The ratings also address the likelihood of “ultimate” payment ofprincipal on the final maturity date of each class of the issuernotes. Any rating agency may lower its rating or withdraw its rating if, in thesole judgment of the rating agency, the credit quality of the issuer notes hasdeclined or is in question. If any rating assigned to the issuer notes islowered or withdrawn, the market value of the issuer notes may be reduced.

 

A change to the ratingsassigned to each class of the issuer notes will not affect the term advanceratings assigned to each issuer term advance in the intercompany loans.

 

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

 

The class B issuer notesand class C issuer notes are subordinated in right of payment of interest tothe class A issuer notes. The class C issuer notes are subordinated in right ofpayment of interest to the class B issuer notes. However, the transaction hasbeen structured in the expectation that the series 2 issuer notes will berepaid in full prior to the redemption of the series 3 class A issuer notes,the series 4 class A issuer notes and the series 5 class A issuer notes.

 

Accordingly, there is noassurance that these subordination rules will protect the holders of class Aissuer notes or the holders of class B issuer notes from all risk of loss.

 

**Principal payments on the original pass-through notes will bedeferred in some circumstances**

 

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

 

If on aFunding 1 interest payment date;

 

•                  there is a debit balance on the BBBprincipal deficiency sub-ledger, the A principal deficiency sub-ledger or theAA principal deficiency sub-ledger after application of the Funding 1 availablerevenue receipts on that Funding 1 interest payment date; or any term BBBadvances; or

 

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•                  the adjusted general reserve fundlevel is less than the reserve fund threshold; or

 

•                  the aggregate outstanding principalbalance of loans in the mortgages trust, in respect to which the aggregateamount in arrears is more than three times the monthly payment then due, ismore than 5 per cent. of the aggregate outstanding principal balance of loansin the mortgages trust;

 

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

 

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

 

•                  one or more bullet term advancesand/or scheduled amortization installments are then in a cash accumulationperiod;

 

•                  the quarterly CPR is less than 15 percent.; and

 

•                  there is a cash accumulationshortfall at that time;

 

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

 

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

 

If the loans comprisingthe trust property do not perform as expected at any time after the repaymentin full of the series 2 issuer notes, then the series 3 issuer notes and/or theseries 4 issuer notes and/or the series 5 issuer notes may not be repaid infull.

 

**Noteholdersmay be subject to exchange rate risks on the series 2 issuer notes, the series3 issuer notes and the series 4 issuer notes**

 

Repayments of principaland payments of interest on the series 2 issuer notes and the series 4 class Aissuer notes will be made in US dollars and on the series 3 issuer notes,series 4 class B issuer notes and series 4 class C issuer notes will be made ineuro, but the issuer term advances made by the issuer to Funding 1 andrepayments of principal and payments of interest by Funding 1 to the issuer underthe issuer intercompany loan will be in sterling.

 

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To hedge its currencyexchange rate exposure, including the interest rate exposure connected withthat currency exposure, the issuer has entered into the issuer dollar currencyswaps for the series 2 issuer notes and the series 4 class A issuer notes withthe issuer dollar currency swap providers and the issuer euro currency swapsfor the series 3 issuer notes and the series 4 class B issuer notes and theseries 4 class C issuer notes with the issuer euro currency swap providers.

 

If the issuer fails tomake timely payments of amounts due under an issuer swap, then the issuer willhave defaulted under that issuer swap. Each issuer swap provider is obligedonly to make payments under an issuer swap as long as the issuer make paymentsunder the same. If an issuer swap provider is not obliged to make payments, orif it exercises any right to terminate that it may have under the relevantissuer swap, or if it defaults in its obligations to make payments of amountsin US dollars or euro, as applicable, equal to the full amount to be paid by iton the payment dates under the relevant issuer swap (which are the same datesas the interest payment dates in respect of the issuer notes), the issuer willbe exposed to changes in US dollar / sterling or euro / sterling currencyexchange rates and in the associated interest rates on these currencies. Unlessa replacement issuer swap is entered into, the issuer may have insufficientfunds to make payments due on the issuer notes of any class and any series thatare then outstanding.

 

Each issuer swap providerwill be obliged to gross up payments made by it to the issuer if withholdingtaxes are imposed on payments under the relevant issuer swap and the AIG issuerswap guarantor will be obliged to gross up payments made by it to the issuer ifwithholding taxes are imposed on payments under the AIG issuer swap guarantee.However, if such a gross up is required, the relevant swap provider may subjectto obtaining the consent of the security trustee, terminate the relevant issuercurrency swap. If it does terminate the relevant issuer currency swap, theissuer will be exposed to changes in currency exchange rates and in the associatedinterest rates on these currencies. Unless a replacement issuer currency swapis entered into, the issuer may have insufficient funds to make payments due onthe issuer notes of any class and any series that are then outstanding.

 

**The mortgages trustee GIC provider or the Funding 1 GICprovider may cease to satisfy certain criteria to provide the mortgages trusteeGIC account or the Funding 1 GIC account**

 

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

 

The criteria referred toabove include a requirement that the short-term, unguaranteed and unsecuredratings of the mortgages trustee GIC provider or the Funding 1 GIC provider, asthe case may be, are at least A-1+ by Standard & Poor’s, F1+ by Fitch andP-1 by Moody’s, unless each rating agency confirms that its then current ratingof the notes would not be adversely affected as a result of such ratingsfalling below these minimum ratings.

 

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

 

If any of the issuerswaps terminate, the issuer may as a result be obliged to make a terminationpayment to the relevant issuer swap provider. The amount of the terminationpayment will be based on the cost of entering into a replacement issuer swap.Under the issuer intercompany loan agreement, Funding 1 will be required to paythe issuer an amount equal to any termination payment

 

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due by the issuer to the relevant issuer swap provider. Funding 1 willalso be obliged to pay the issuer any extra amounts that the issuer may be requiredto pay to enter into a replacement swap.

 

The issuer cannot givenoteholders any assurance that Funding 1 will have the funds available to makethat payment or that the issuer will have sufficient funds available to makeany termination payment under any of its issuer swaps or to makesubsequent payments to noteholders in respect of the relevant series andclass of the issuer notes. Nor can the issuer give noteholders any assurancethat 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 relevantissuer swap provider has caused the relevant issuer swap to terminate by itsown default, any termination payment due by the issuer will rank equally notonly with payments due to the holders of the series and class of the issuernotes which rank equally with the series and class of issuer notes to which therelevant swap relates but also with payments due to the holders of any otherseries and class of issuer notes to which the relevant swap relates. Anyadditional amounts required to be paid by the issuer following termination ofthe relevant issuer swap (including any extra costs incurred (for example, fromentering into “spot” currency or interest rate swaps) if the issuer cannotimmediately enter into a replacement swap) will also rank equally not only withpayments due to the holders of the series and class of the issuer notes towhich the relevant issuer swap relates but also with payments due to the holderof any other series and class of the issuer notes which rank equally with theseries and class of the issuer notes to which the relevant issuer swap relates.Furthermore, any termination payment or additional payment or additionalamounts required to be paid by the issuer following termination of an issuerswap will rank ahead of payments due to the holders of any series and class ofthe issuer notes which ranks below the series and class of the issuer notes towhich the relevant issuer swap relates. Therefore, if the issuer is obliged tomake a termination payment to the relevant issuer swap provider or to pay anyother additional amount as a result of the termination of the relevant issuerswap, this may affect the funds which the issuer has available to make paymentson the issuer notes of any class and any series.

 

**Risksassociated with the Funding 1 swap**

 

To provide a hedgeagainst (a) the mortgages trustee variable base rate payable on the variablerate loans, the rates of interest payable on the tracker rate loans and thefixed rates of interest payable on the fixed rate loans; and (b) the rate ofinterest payable by Funding 1 on the intercompany loans, Funding 1 has enteredinto 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. TheFunding 1 swap provider is obliged only to make payments under the Funding 1swap if and for so long as Funding 1 makes payments under the same. If theFunding 1 swap provider is not obliged to make payments, or if it exercises anyright to terminate that it may have under the Funding 1 swap, or if it defaultsin its obligation to make payments under the Funding 1 swap, Funding 1 will beexposed to the variance between the rates of interest payable on the loans andthe rate of interest payable by it under the intercompany loans unless a replacementFunding 1 swap is entered into. If the Funding 1 swap terminates, Funding 1 mayas a result be obliged to make a termination payment to the Funding 1 swapprovider. Any variance between the rates of interest payable on the loans andthe rate of interest payable by Funding 1 under the intercompany loans and anytermination payment payable by it to the Funding 1 swap provider may adverselyaffect the ability of Funding 1 to meet its obligations under the issuerintercompany loan agreement.

 

Funding 1 will receiveinterest on the variable rate loans, which is based on HVR 1 orHVR 2. The payment obligations of Funding 1 under the Funding 1 swap will,among other things, be based on the average of the standard variable mortgagerates or their equivalent charged to existing borrowers on residential mortgageloans as published from time to time, after excluding the highest and thelowest rate, of Abbey National plc, HSBC Bank plc, Cheltenham & Gloucesterplc, National Westminster Bank Plc, Nationwide Building Society, Northern Rockplc and Woolwich plc (and 

 

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where those banks have more than one standard variable rate, thehighest of those rates). While it is anticipated that the average rate willbroadly track both HVR 1 and HVR 2, the variance between the average rate andHVR 1 and HVR 2, respectively, may affect the ability of Funding 1 to meet itspayment obligations under the Funding 1 swap agreement.

 

**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 tocontracts with a number of other third parties that have agreed to performservices in relation to the issuer notes. For example, the issuer swapproviders have agreed to provide their respective issuer swaps, the corporateservices provider has agreed to provide corporate services and the payingagents and the agent bank have agreed to provide payment and calculationservices in connection with the issuer notes. In the event that any of theseparties were to fail to perform their obligations under the 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 1interest payment date, revenue receipts available to Funding 1 (including thereserve fund) are insufficient to enable Funding 1 to pay interest on theissuer term advances and any new term advances and other expenses of Funding 1ranking higher in seniority to interest due on these term advances, thenFunding 1 may use principal receipts on the loans received by it in the mortgagestrust to make up the shortfall.

 

Funding 1 will useprincipal receipts that would have been applied to repay the term advances withthe lowest term advance rating to pay interest on those other term advances andsenior expenses described in the preceding paragraph where there is a shortfallof monies to pay those amounts. At the closing date, the relevant term advanceswith the lowest term advance rating include the issuer term BBB advances. IfFunding 1 uses principal to repay interest and senior expenses in this manner,there will be less principal available to repay the issuer term BBB advances.

 

Funding 1 will be obligedto keep a ledger that records any principal applied to pay interest and seniorexpenses (as well as any losses on the loans causing a principal deficiency).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. Whenthe amount recorded on the principal deficiency ledger exceeds the principalamount outstanding on the term A advances, Funding 1 will use principal thatwould have been applied to repay the term AA advances to pay those amounts.When the amount recorded on the principal deficiency ledger exceeds theprincipal amount outstanding on the term AA advances, Funding 1 will useprincipal receipts that would have been applied to repay the term AAA advancesto pay those amounts.

 

During the term of thetransaction, however, it is expected that any principal deficiencies will berecouped from subsequent excess revenue receipts and amounts standing to thecredit of the reserve fund. The revenue receipts and the reserve fund monieswill be applied first to cover any principal deficiency in respect of the termadvances with the highest term advance rating and then the term advances withthe next highest ranking term advance rating and so on down to the termadvances with the lowest term advance rating.

 

If there are insufficientfunds available because of income or principal deficiencies, then one or moreof the following consequences may occur:

 

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•                  the interest and other net income ofFunding 1 may not be sufficient, after making the payments to be made inpriority, to pay, in full or at all, interest due on the issuer term BBBadvances and the issuer term AA advances;

 

•                  there may be insufficient funds torepay any of the issuer term BBB advances and the issuer term AA advances priorto their final repayment dates unless the other net income of Funding 1 issufficient, after making other prior ranking payments, to reduce any principaldeficiency in respect of the term BBB advances, term A advances and term AAadvances;

 

•                  if the amount of principaldeficiencies exceeds the principal amount outstanding of any of the term advances(and the principal deficiencies cannot be covered by the other income ofFunding 1), then the issuer may not receive the full principal amount of any orall of the issuer term advances and, accordingly, the noteholders may notreceive the full face value of the class C issuer notes, the class B issuernotes and the class A issuer notes, as the case may be; and/or

 

•                  the issuer may be unable to pay, infull or at all, interest due on the issuer notes.

 

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

 

Any losses from loansincluded in the trust property will be allocated to Funding 1 and the sellerproportionally on each distribution date in accordance with the Funding 1 sharepercentage and the seller share percentage of 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 theloans in the trust property are allocated proportionately between the sellerand Funding 1 depending on their 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 issuerintercompany loan acceleration notice under the issuer intercompany loan isgiven, the security trustee may, but shall not be obliged to, sell the Funding1 share of the trust property. There is no assurance that a buyer would befound or that a sale would realize enough money to repay amounts due andpayable under the issuer intercompany loan agreement.

 

The issuer, Funding 1 andthe mortgages trustee will not have any recourse to the seller of the loans,other than in respect of a breach of warranty under the mortgage saleagreement.

 

The issuer, Funding 1,the mortgages trustee and the security trustee will not undertake anyinvestigations, searches or other actions on any loan or its related securityand each of them will rely instead on the warranties given in the mortgage saleagreement by the seller.

 

If any of the warrantiesmade by the seller (a) in the case of each loan in the portfolio, wasmaterially untrue on the date the loan was assigned to the mortgages trustee or(b) in the case of each new loan, is materially untrue on the date the new loanis assigned to the mortgages trustee, then the seller will be required toremedy the breach within 20 London business days of the seller becoming awareof the same or of receipt by it of a notice from the mortgages trustee.

 

If the seller fails toremedy the breach within 20 London business days, then the seller will berequired to repurchase the loan or loans under the relevant mortgage accountand their related security at their outstanding principal balance as of thedate of repurchase together with any arrears of interest 

 

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and accrued and unpaid interest and expenses. There can be no assurancethat the seller will have the financial resources to repurchase the loan orloans under the relevant mortgage account and their related security. However,if the seller does not repurchase those loans and their related security whenrequired, then the seller’s share of the trust property will be deemed to bereduced by an amount equal to the principal amount outstanding of those loanstogether with any arrears of interest and accrued and unpaid interest andexpenses.

 

Other than as describedhere, neither the noteholders nor the issuer will have any recourse to theassets of the seller.

 

**There canbe no assurance that a borrower will repay principal at the end of the term onan interest-only loan, which may adversely affect repayments on the issuernotes**

 

Each loan in theportfolio is repayable either on a principal repayment basis or aninterest-only basis. Of the loans in the portfolio as at January 1, 2005,approximately 33.27 per cent. were interest-only loans. For interest-only loans,because the principal is repaid in a lump sum at the maturity of the loan, theborrower is recommended to have some repayment mechanism such as an investmentplan in place which is intended to provide sufficient funds to repay theprincipal 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. The borrower is also recommended to take out a lifeinsurance policy in relation to the loan but, as with repayment mechanisms, theseller does not take security over these life insurance policies.

 

The ability of a borrowerto repay the principal on an interest-only loan at maturity depends on theborrower’s responsibility to ensure that sufficient funds are available from aninvestment plan or another source, such as ISAs, pension policies, personalequity plans or endowment policies, as well as the financial condition of theborrower, tax laws and general economic conditions at the time.

 

There can be no assurancethat the borrower will have the funds required to repay the principal at theend of the term. If a borrower cannot repay the loan and a loss occurs on theloan, then this may affect repayments of principal on the issuer notes if thatloss cannot be cured by amounts standing to the credit of the reserve fund orthe application of excess Funding 1 available revenue receipts.

 

**There maybe risks associated with the fact that the mortgages trustee has no legal titleto the loans and their related security, which may adversely affect payments onthe issuer notes**

 

The sale by the seller tothe mortgages trustee of the English mortgages will take effect in equity only.The sale by the seller to the mortgages trustee of the Scottish mortgages hasbeen given effect by a Scottish declaration of trust by the seller (and anysale of Scottish mortgages in the future will be given effect by furtherScottish declarations of trust) by which the beneficial interest in theScottish mortgages has been or will be transferred to the mortgages trustee. Ineach case this means that legal title to the loans in the trust propertyremains with the seller, but the mortgages trustee has all the other rights andbenefits relating to ownership of each loan and its related security(which rights and benefits are subject to the trust in favor of thebeneficiaries). The mortgages trustee has the right to demand that the sellergive it legal title to the loans and the related security in certaincircumstances and until then the mortgages trustee will not give notice of thesale of the English mortgages to any borrower or apply to the Land Registry orthe Central Land Charges Registry to register or record its equitable interestin the English mortgages or take any steps to complete or perfect its title tothe Scottish mortgages.

 

Because the mortgagestrustee has not obtained legal title to the loans or their related security,there are risks, as follows:

 

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•                  first, if the seller wrongly sold aloan which has already been assigned to the mortgages trustee to anotherperson, and that person acted in good faith and did not have notice of theinterests of the mortgages trustee or the beneficiaries in the loan, then sheor he might obtain good title to the loan, free from the interests of themortgages trustee and the beneficiaries. If this occurred then the mortgagestrustee would not have good title to the affected loan and its related securityand it would not be entitled to payments by a borrower in respect of that loan.This may affect the ability of the issuer to repay the issuer notes; and

 

•                  second, the rights of the mortgagestrustee and the beneficiaries may be subject to the rights of the borrowersagainst the seller, such as the rights of set-off which occur in relation totransactions or deposits made between some borrowers and the seller and therights of borrowers to redeem their mortgages by repaying the loan directly tothe seller. If these rights were exercised, the mortgages trustee may receiveless money than anticipated from the loans, which may affect the ability of theissuer to repay the issuer notes.

 

However, if a borrowerexercises any set-off rights, then an amount equal to the amount set off willreduce the total amount of the seller share of the trust property only, and theminimum seller share has been sized in an amount expected to cover this risk,although there is no assurance that it will. 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 beengiven to borrowers of the transfer of the loans and their related security tothe mortgages trustee, independent set-off rights which a borrower has againstthe seller will crystallize (such as, for example, set-off rights associatedwith borrowers holding deposits with the seller) 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 rightsarising under transaction set-off (which are set-off claims arising out of atransaction connected with the loan) will not be affected by that notice.

 

**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, andin the future may make, an equitable assignment of the relevant loans and theirrelated security, or in the case of Scottish loans a transfer of the beneficialinterest in the relevant loans and their related security, with legal titlebeing retained by the seller. Therefore, the rights of the mortgages trusteemay be subject to the direct rights of the borrowers against the seller, includingrights of set-off existing prior to notification to the borrowers of the saleof the mortgages. Although the mortgages trustee does not currently includeflexible loans or delayed cashbacks, those loans may be added to the mortgagestrust in the future. Set-off rights (including analogous rights in Scotland)may occur if the seller fails to advance to a borrower a drawing or permit theborrower to make an underpayment or to take a payment holiday under a flexibleloan or if the seller fails to pay to a borrower any delayed cashback which theseller had agreed to pay to that borrower after completion of the relevantloan.

 

If the seller fails toadvance the drawing or permit the borrower to make an underpayment or take apayment holiday or pay the delayed cashback, then the relevant borrower may setoff any damages claim (or exercise analogous rights in Scotland) arising fromthe seller’s breach of contract against the seller’s (and, as assignee orholder of the beneficial interest in the loans and their related security, themortgages trustee’s) claim for payment of principal and/or interest under theloan as and when it becomes due. These set-off claims will constitutetransaction set-off as described in the immediately preceding risk factor.

 

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The amount of the claimin respect of a drawing will, in many cases, be the cost to theborrower of finding an alternative source of finance although, in the caseof flexible loans or delayed cashbacks which are Scottish, it is possible thatthe borrower’s right of set-off could extend to the full amount of the relevantdrawing: the borrower may obtain a loan elsewhere, in which case the damageswould be equal to any difference in the borrowing costs together with any consequentiallosses, namely the associated costs of obtaining alternative funds (forexample, legal fees and survey fees). If the borrower is unable to obtain analternative loan, he or she may have a claim in respect of other losses arisingfrom the seller’s breach of contract where there are special circumstancescommunicated by the borrower to the seller at the time the mortgage was takenout or which otherwise were reasonably foreseeable. In either case, the damagesclaim will be limited by general legal principles concerning remoteness of lossand mitigation. These include (i) the principle that something, which is a realpossibility but would only occur in a small minority of cases, will not usuallyfall within the contractual measure of damages, and (ii) the borrower’s duty tomitigate his loss.

 

In respect of a delayedcashback, underpayment or payment holiday, 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 alsoattempt to set off against his or her mortgage payments an amount greater thanthe amount of his or her damages claim (or exercise analogous rights inScotland). In that case, the servicer will be entitled to take enforcementproceedings against the borrower although the period of non-payment by theborrower is likely to continue until a judgment is obtained.

 

The exercise of set-offrights by borrowers would reduce the incoming cashflow to the mortgages trusteeduring the exercise. However, the amounts set off will be applied to reduce theseller share of the trust property only.

 

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

 

The minimum seller sharehas been sized in an amount expected to cover this risk, although there is noassurance that it will. If the minimum seller share is not sufficient in thisrespect then there is a risk that noteholders may not receive all amounts dueon the issuer notes or that payments may not be made when due.

 

**If theservicer is removed, there is no guarantee that a substitute servicer would befound, which could delay collection of payments on the loans and ultimatelycould adversely affect payments on the issuer notes**

 

The seller has beenappointed by the mortgages trustee and the beneficiaries as servicer to servicethe loans. If the servicer breaches the terms of the servicing agreement, thenthe mortgages trustee, Funding 1 and/or the security trustee will be entitledto terminate the appointment of the servicer and appoint a new servicer in itsplace.

 

There can be no assurancethat a substitute servicer with sufficient experience of administeringmortgages of residential properties would be found who would be willing andable to service the loans on the terms of the servicing agreement. In addition,as described below, any substitute servicer may be required to be authorizedunder FSMA (as defined below in order to administer loans that constituteregulated mortgage contracts). The ability of a substitute servicer fully toperform the required services would depend, among other things, on theinformation, software and records available at the time of the appointment. Anydelay or inability to appoint a substitute servicer may affect payments on theloans and hence the issuer’s ability to make payments when due on the issuernotes.

 

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The noteholders shouldnote that the servicer has no obligation itself to advance payments thatborrowers 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 giventhat Funding 1 will always receive the benefit of any claims made under anyapplicable insurance contracts. This could reduce the principal receiptsreceived by Funding 1 according to the Funding 1 share percentage and couldadversely affect the issuer’s ability to redeem the issuer notes. Thenoteholders should note that buildings insurance is renewed annually.

 

**Regulatorychanges by the Office of Fair Trading, the Financial Services Authority and anyother regulatory authorities may have an impact on the seller, the issuer, theservicer, the mortgages trustee, Funding 1, Funding 2 and/or the loans and mayadversely affect the issuer’s ability to make payments when due on the issuernotes**

 

In the United Kingdom,the Office of Fair Trading (the “OFT”) is responsible for the issue of licensesunder, and the superintendence of the working and the enforcement of theConsumer Credit Act (the “CCA”), related consumer credit regulations and otherconsumer protection legislation. The OFT may review businesses and operations,provide guidelines to follow and take actions when necessary with regard to themortgage market in the United Kingdom.

 

Currently, a creditagreement is regulated by the CCA where: (a) the borrower is or includes anindividual; (b) the amount of “credit” as defined in the CCA does not exceedthe financial limit, which is £25,000 for credit agreements made on or afterMay 1, 1998, or lower amounts for credit agreements made before that date; and(c) the credit agreement is not an exempt agreement under the CCA, for example,a regulated mortgage contract under the FSMA (as defined below).

 

Any credit agreement thatis wholly or partly regulated by the CCA or to be treated as such has to complywith requirements under the CCA as to licensing of lenders and brokers,documentation and procedures of credit agreements, and (in so far as will beapplicable) pre-contract disclosure. If it does not comply with thoserequirements, then to the extent that the credit agreement is regulated by theCCA or to be treated as such, it is unenforceable against the borrower: (a)without an order of the OFT, if the lender or any broker does not hold therequired license at the relevant time; (b) totally, if the form to be signed bythe borrower is not signed by the borrower personally or omits or mis-states a‘‘prescribed term’’; or (c) without a court order in other cases and, inexercising its discretion whether to make the order, the court would take intoaccount any prejudice suffered by the borrower and any culpability of thelender.

 

Any credit agreement fora loan or further advance might be wholly or partly regulated by the CCA ortreated as such because of technical rules on: (a) determining whether anycredit under the CCA arises, or whether the financial limit of the CCA isexceeded; (b) determining whether the credit agreement is an exempt agreementunder the CCA; and (c) changes to credit agreements.

 

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

 

Under section 75 of theCCA in certain circumstances: (a) the lender is liable to the borrower inrelation to misrepresentation and breach of contract by a supplier in atransaction financed by the lender, where the related credit agreement is or istreated as entered into under pre-existing arrangements, or in contemplation offuture arrangements, between the lender and the supplier; and 

 

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(b) the lender has an indemnity from the supplier against suchliability, subject to any agreement between the lender and the supplier.

 

In November 2002, the UKDepartment of Trade and Industry (the “DTI”) announced its intention that acredit agreement will be regulated by the CCA where, for credit agreements madeafter this change is implemented: (a) the borrower is or includes anindividual, save for partnerships of four or more partners; (b) irrespective ofthe amount of credit (although in July 2003, the DTI announced its intentionthat the financial limit will remain for certain business-to-business lending);and (c) the credit agreement is not an exempt agreement. In December 2003, the DTIpublished a White paper proposing amendments to the CCA and to secondarylegislation made under it.

 

In June 2004, secondarylegislation was made on: (a) amending requirements as to documentation ofcredit agreements, coming into force on May 31, 2005, or August 31, 2005 foragreements given to the borrower for signature but not made before May 31,2005; (b) pre-contract disclosure, coming into force on May 31, 2005; and (c)replacing the formula for calculating the maximum amount payable on early settlementwith a formula more favorable to the borrower, coming into force on May 31,2005 for new agreements or on May 31, 2007 or 31st May, 2010 (depending on theterm of the agreement) for agreements existing before May 31, 2005.

 

In December 2004, the UKParliament published a consumer Credit Bill proposing to amend the CCA by,among other things: (a) changing the definition of a credit agreement regulatedby the CCA to that announced by the DTI as described above; and (b) repealingthe rule that, to the extent that a credit agreement is regulated by the CCA ortreated as such, it may be unenforceable totally. If these changes are enacted,then any credit agreement made or changed such that a new contract is enteredinto after this time, other than a regulated mortgage contract under the FSMAor other exempt agreement under the CCA, will be regulated by the CCA. Suchcredit agreement will have to comply with requirements as described above and,if it does not comply, it will be unenforceable without an order of the OFT orwithout a court order as described above.

 

This consumer Credit Billalso proposes to amend the CCA by: (a) strengthening the licensing regime; (b)reforming the law on extortionate credit, with the retrospective effect onexisting agreements; and (c) extending the jurisdiction of the Ombudsman (asdescribed below) to license holders under the CCA. Further proposals to amendthe CCA and secondary legislation made under it are expected at an unspecifiedtime.

 

The seller hasinterpreted certain technical rules under the CCA in a way common with manyother lenders in the mortgage market. If such an interpretation were held to beincorrect by a court or the Ombudsman, then a credit agreement, to the extentthat it is regulated by the CCA or treated as such, would be unenforceable asdescribed above. If such interpretation were challenged by a significant numberof borrowers, then this could lead to significant disruption and shortfall inincome of the mortgages trustee. Court decisions have been made on technicalrules under the CCA against certain mortgage lenders, but such decisions arevery few and are generally county court decisions not binding on other courts.

 

The seller has given or,as applicable, will give warranties to the mortgages trustee in the mortgagesale agreement that, among other things, each loan and its related security isenforceable (subject to certain exemptions). If a loan or its related securitydoes not comply with these warranties, and if the default cannot be or is not curedwithin 20 London business days, then the seller will be required to repurchasethe loans under the relevant mortgage account and their related security fromthe mortgages trustee.

 

In the United Kingdom,regulation of residential mortgage business by the FSA under the FinancialServices and Markets Act 2000 (the “FSMA”) came into force on October 31, 2004,the date known as “N(M)”.****Enteringinto, arranging, advising on and administering regulated mortgage 

 

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contracts, and agreeing to do any of these things,****are (subject to applicable exemptions)regulated activities under the FSMA.

 

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

 

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

 

Any credit agreementintended to be a regulated mortgage contract under the FSMA might instead bewholly or partly regulated by the CCA or treated as such, or unregulated,because of technical rules on: (a) determining whether the credit agreementfalls within the definition of “regulated mortgage contract”; and (b) changesto credit agreements.

 

The seller is required tohold authorisization and permission to enter into and to administer and, whereapplicable, to advise on regulated mortgage contracts. Subject to anyexemption, brokers will be required to hold authorization and permission toarrange and, where applicable, to advise on regulated mortgage contracts.

 

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

 

The FSA Mortgages:Conduct of Business Sourcebook (“MCOB”), which sets out its rules for regulatedmortgage activities, came into force on October 31, 2004. These rules cover, *inter alia*, certain pre-originationmatters, such as financial promotion and pre-application illustrations,pre-contract and start of contract and post-contract disclosure, contractchanges, charges, arrears and repossessions. FSA rules for prudential andauthorization requirements for mortgage firms and insurance intermediaries, andfor extending the appointed representatives regime came into force on October31, 2004 for mortgages and on January 14, 2005 for general insurance.

 

A borrower who is aprivate person is entitled to claim damages for loss suffered as a result ofany contravention by an authorized person of an FSA rule, and may set-off theamount of the claim 

 

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against the amount owing by the borrower under the loan or any otherloan that the borrower has taken (or exercise analogous rights in Scotland).Any such set-off may adversely affect the issuer’s ability to make payments onthe issuer notes.

 

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

 

No assurance can be giventhat additional regulations from the OFT, the FSA or any other regulatoryauthority will not arise with regard to the mortgage market in the UnitedKingdom generally, the seller’s particular sector in that market orspecifically in relation to the seller. Any such action or developments orcompliance costs may have a material adverse effect on the seller, the issuerand/or the servicer and their respective businesses and operations. This mayadversely affect our ability to make payments in full on the issuer notes whendue.

 

Prior to M(N), in theUnited Kingdom, self-regulation of mortgage business existed under the MortgageCode (the “CML Code”) issued by the Council of Mortgage Lenders (the “CML”).Halifax subscribed to the CML Code and on and from N(M), as an authorizedperson, has been subject to the FSA requirements in MCOB. Membership of the CMLand compliance with the CML Code were voluntary. The CML Code sets out minimumstandards of good mortgage business practice, from marketing to lendingprocedures and dealing with borrowers experiencing financial difficulties.Since April 30, 1998 lender-subscribers to the CML Code may not accept mortgagebusiness introduced by intermediaries who were not registered with (beforeNovember 1, 2000) the Mortgage Code Register of Intermediaries or (on and afterNovember 1, 2000 until October 31, 2004) the Mortgage Code Compliance Board.

 

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

 

There has beensignificant opposition from the European Parliament to the original form of theproposed directive. On February 13, 2004, the Committee of Legal Affairs andthe Internal Market published the European Parliament’s amendments to theproposed draft. These amendments provide that (subject to certain exceptions)loans not exceeding euro 100,000 will be regulated, but that the proposeddirective will not apply to any loan secured by a land mortgage or, inScotland, a standard security, and will not apply to any credit agreement orsurety agreement made before national implementing legislation comes intoforce. In October 2004, the European Commission published an amended form ofthe proposed directive. In this amended form, the proposed directive providesthat (subject to certain exceptions) loans not exceeding euro 100,000 will beregulated, and that it will indeed apply to any loan secured by a land mortgageor, in Scotland a standard security that includes an equity release component,but it is unclear whether it will apply to any credit agreement or surety 

 

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agreement made before national implementing legislation comes intoforce. There are differences in opinion as to the extent to which mortgageloans should be included in the scope of the proposed directive, which may besubstantially further amended before it is ultimately brought into effect.

 

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

 

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

 

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

 

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

 

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

 

•                  the OFT and any “qualifying body”within the UTCCR (such as the FSA) may seek to enjoin (or in Scotlandinterdict) a business from relying on unfair terms.

 

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

 

For example, if a termpermitting the lender to vary the interest rate (as the seller is permitted todo) is found to be unfair, the borrower will not be liable to pay the increasedrate or, to the extent that she or he has paid it, will be able, as against thelender, or any assignee such as the mortgages trustee, to claim repayment ofthe extra interest amounts paid or to set-off the amount of the claim againstthe amount owing by the borrower under the loan or any other loan that theborrower has taken. Any such non-recovery, claim or set-off may adverselyaffect the issuer’s ability to make payments on the issuer notes.

 

In February 2000, the OFTissued a guidance note on what the OFT considers to be fair terms and unfairterms for interest variation in mortgage contracts. Where the interestvariation term does not provide for precise and immediate tracking of anexternal rate outside the lender’s control, and if the borrower is locked in,for example by an early repayment charge that is considered to be a penalty,the term is likely to be regarded as unfair under the UTCCR unless the lender(i) notifies the affected borrower in writing at least 30 days before the ratechange and (ii) permits the affected borrower to repay the whole loan during thenext three months after the rate change, without paying the early repaymentcharge. The seller has reviewed the guidance note and has concluded that itscompliance with it will have no material adverse effect on the loans or itsbusiness. The guidance note has been withdrawn from the OFT website and iscurrently under review by the OFT and FSA. The FSA has 

 

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agreed with the OFT totake responsibility for the enforcement of the UTCCR in mortgage agreements. Itis expected that the FSA will issue guidance on interest variation termsshortly.

 

In August 2002, the LawCommission for England and Wales and the Scottish Law Commission issued a jointconsultation LCCP No. 166/SLCDP 119 on proposals to rationalize the UK’s UnfairContract Terms Act 1977 and the 1999 Regulations into a single piece oflegislation and a final report, together with a bill on unfair terms, waspublished in February 2005. The Law Commissions have a duty under section 3 ofthe UK’s Law Commissions Act 1965 to keep the law under review for a number ofpurposes, including its simplification. The proposals are primarily to simplifythe legislation on unfair terms. It is not proposed that there should be anysignificant increase in the extent of controls over terms in consumercontracts. Some changes are proposed, however, such as that (a) a consumer mayalso challenge a negotiated term in agreement on the basis that it is “unfair”and “unreasonable” within the legislation and therefore not binding on theconsumer; and (b) in any challenge by a consumer (but not by the OFT or aqualifying body) of a standard term or a negotiated term, the burden of prooflies on the business to show that the term is fair and reasonable. It is tooearly to tell how the proposals, if enacted, would affect the loans.

 

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

 

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

 

Under FSMA, the FinancialOmbudsman Service is required to make decisions on, among other things,complaints relating to activities and transactions under its jurisdiction onthe basis of what, in the Ombudsman’s opinion, would be fair and reasonable inall circumstances of the case, taking into account, among other things, law andguidance. Complaints brought before the Financial Ombudsman Service forconsideration must be decided on a case-by-case basis, with reference to theparticular facts of any individual case. Each case would first be adjudicatedby an adjudicator. Either party to the case may appeal against theadjudication. In the event of an appeal, the case proceeds to a final decisionby the Ombudsman.

 

In January 2002, theOmbudsman made a determination on the seller’s appeal to an earlier decision byan adjudicator at the Financial Ombudsman Service concerning a case involvingHVR 1 and HVR 2. In March 2001, two joint borrowers with a capped rate loanoriginated when Halifax offered only a single standard variable base ratecontacted Halifax and requested that their loan be linked to HVR 2. Halifaxinformed the borrowers that, because they were still in their product period,they could either transfer to HVR 2 when their product period expired ortransfer to HVR 2 immediately and pay the applicable early repayment fee. Theborrowers complained to the Financial Ombudsman Service and, on January 29,2002, on appeal by Halifax, the Ombudsman determined in the borrowers’ favorand recommended that Halifax recalculate the borrowers’ mortgage by referenceto HVR 2 from the date when the seller should have granted their request inMarch 2001, refund any overpayments and pay £150 for any inconvenience caused.HVR 2 was withdrawn and ceased to be available to new borrowers with effectfrom February 1, 2002.

 

The Ombudsman’s decisiononly applies to the two borrowers and their particular circumstances, thoughother borrowers may also complain to the Ombudsman. In March 2002, the sellerannounced that borrowers under loans who were in similar circumstances and whohad asked to be transferred to HVR 2 when it was available would be invited tomake a product switch to HVR 2 and to obtain a refund for all overpayments ofinterest since the date they had asked to be transferred. For each of thoseloans, the borrowers would also receive £150 for any inconvenience caused. Theborrowers under loans who requested to be transferred after HVR 2 was withdrawnand before the 

 

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announcement in March 2002 were not offered a switch or a refund,though the seller has given or will give each of these customers an ex gratiapayment of £100.

 

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

 

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

 

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

 

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

 

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

 

Funding 1 and the issuerwill generally be subject to UK corporation tax, currently at a rate of 30 percent., on the profit reflected in their respective profit and loss accounts asincreased by the amount of any non-deductible expenses or losses. If the taxpayable by Funding 1 or the issuer is greater than expected because, forexample, non-deductible expenses or losses are greater than expected, the fundsavailable to make payments on the noteholders’ issuer notes will be reduced andthis may adversely affect the issuer’s ability to make payments on the issuernotes.

 

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

 

The stated policy of H.M.Revenue & Customs is that the tax neutrality of securitisation specialpurpose companies in general should not be disrupted as a result of thetransition to IFRS or new UK GAAP and that they are working with participantsin the securitisation industry to identify appropriate means of preventing anysuch disruption. The Finance Act 2005 enables regulations to be made toestablish such a regime. However, if measures are not introduced by H.M.Revenue & Customs to deal with the corporation tax position of suchcompanies in respect of accounting periods ending on or after January 1, 2007,then profits or losses could arise in the issuer and/or Funding 1 as a resultof the application of IFRS or new UK GAAP which could have tax effects notcontemplated 

 

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in the cashflows for the transaction and as such adversely affect theissuer and/or Funding 1 and therefore payments on the issuer notes.

 

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

 

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

 

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

** **

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

 

It is possible that priorto the maturity of the issuer notes the United Kingdom may become aparticipating member state in the European economic and monetary union and thatthe euro may become the lawful currency of the United Kingdom. In that event,(a) all amounts payable in respect of any issuer notes denominated in sterlingmay become payable in euro; (b) applicable provisions of law may allow orrequire the issuer to re-denominate such issuer notes into euro and takeadditional measures in respect of such issuer notes; and (c) the introductionof the euro as the lawful currency of the United Kingdom may result in thedisappearance of published or displayed rates for deposits in pounds sterlingused to determine the rates of interest on such issuer notes or changes in theway 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 certaintywhat effect, if any, adoption of the euro by the United Kingdom will have oninvestors in the issuer notes.

 

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

** **

The structure of theissue of the issuer notes and the ratings which are assigned to them are basedon English law and (in relation to the Scottish loans) Scots law in effect asat the date of this prospectus. The issuer cannot provide assurance as to theimpact of any possible change to English or Scots law or administrativepractice in the United Kingdom after the date of this Form 20-F.

 

*InsolvencyAct 2000*. Significant changes to the UK insolvency regimehave been enacted in past years, including the Insolvency Act 2000. TheInsolvency Act 2000 allows certain “small” companies to seek protection fromtheir creditors for a period of 28 days, for the purposes of putting together acompany voluntary arrangement, with the option for creditors to extend themoratorium for a further two months. A “small” company is defined as one whichsatisfies, in any financial year, two or more of the following criteria: (i)its turnover is not more than £5.6 million, (ii) its balance sheet total is notmore than £2.8 million and (iii) the number of employees is not more than 50.Whether or not a company is a “small” company may change from period to periodand consequently no assurance can be given that the issuer, the mortgagestrustee or Funding 1 will not, at any given time, be determined to be a “small”company. The Secretary of State for Trade and Industry may by regulation modifythe eligibility requirements for “small” companies and can make differentprovisions 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 hasnow been enacted which excludes certain special purpose companies in relationto capital markets transactions from the optional moratorium provisions. Suchexceptions include (amongst other matters) (i) a company which is a party to anagreement which is or forms part of a capital market arrangement (as defined inthe secondary legislation) under which (a) a party has incurred or when theagreement was entered into was expected to incur a debt of at least £10 

 

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million under the arrangement and (b) the arrangement involves theissue of a capital markets investment (also defined, but generally, a rated,listed or traded bond) and (ii) a company which at the date of filing for amoratorium has incurred a liability (including a present, future or contingentliability) of at least £10 million. While the issuer, the mortgages trustee andFunding 1 should fall within the exceptions, there is no guidance as to how thelegislation will be interpreted and the Secretary of State for Trade andIndustry may by regulation modify the exception. No assurance may be given thatany modification of the eligibility requirements for “small” companies and/orthe exceptions will not be detrimental to the interests of the noteholders.

 

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

 

*EnterpriseAct 2002*. On September 15, 2003, the corporate insolvencyprovisions of the Enterprise Act 2002 came into force, amending certainprovisions of the Insolvency Act 1986 (as amended, the “Insolvency Act”). Theseprovisions introduced significant reforms to corporate insolvency law. Inparticular the reforms restrict the right of the holder of a floating chargecreated after September 15, 2003 to appoint an administrative receiver (unlessan exception applies) and instead gives primacy to collective insolvencyprocedures (in particular, administration).

 

The holder of a floatingcharge created before September 15, 2003 over the whole or substantially thewhole of the assets of a company (such as the security trustee under theFunding 1 deed of charge) retains the ability to block the appointment of anadministrator by appointing an administrative receiver, who will primarily actin the interests of the floating charge holder.

 

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

 

The Insolvency Act also containsa new out-of-court route into administration for a qualifying floating chargeholder, the directors or the company itself. The relevant provisions providefor a notice period during which the holder of the floating charge can eitheragree to the administrator proposed by the directors of the company or appointan alternative administrator, although the moratorium will take effectimmediately after notice is given. If the qualifying floating charge holderdoes not respond to the directors’ notice of intention to appoint, thedirectors’, or as the case may be, the company’s appointee will automaticallytake office after the notice period has elapsed. Where the holder of aqualifying floating charge within the context of a capital market transaction retainsthe power to appoint an administrative receiver, such holder may prevent theappointment of an administrator (either by the new out-of-court route or by thecourt based procedure), by appointing an administrative receiver prior to theappointment of the administrator being completed.

 

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The new administrationprovisions of the Insolvency Act give primary emphasis to the rescue of thecompany as a going concern. The purpose of realizing property to make adistribution to one or more secured creditors is subordinated to the primarypurposes of rescuing the company as a going concern or achieving a betterresult for the creditors as a whole than would be likely if the company werewound up. No assurances can be given that the primary purposes of the newprovisions will not conflict with the interests of noteholders were the issuerever subject to administration.

 

In addition to theintroduction of a prohibition on the appointment of an administrative receiveras set out above, section 176A of the Insolvency Act provides that in relationto floating charges created after September 15, 2003 any receiver (including anadministrative receiver), liquidator or administrator of a company is requiredto make a “prescribed part” of the company’s “net property” available for thesatisfaction of unsecured debts in priority to the claims of the floatingcharge holder. The company’s “net property” is defined as the amount of thechargor’s property which would be available for satisfaction of debts due tothe holder(s) of any debentures secured by a floating charge and so refers toany floating charge realizations less any amounts payable to the preferentialcreditors or in respect of the expenses of the liquidation or administration.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 floating charge realizations plus 20 per cent. of the floatingcharge realizations thereafter, provided that such amount may not exceed£600,000.

 

This obligation does notapply if the net property is less than a prescribed minimum and the relevantofficeholder is of the view that the cost of making a distribution to unsecuredcreditors would be disproportionate to the benefits. The relevant officeholdermay also apply to court for an order that the provisions of section 176A of theInsolvency Act should not apply on the basis that the cost of making adistribution would be disproportionate to the benefits.

 

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

 

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

 

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

 

•                  result in payment delays on theissuer notes because the issuer will be sending distributions on the issuernotes to DTC, Euroclear or Clearstream, Luxembourg instead of directly to thenoteholders;

 

•                  make it difficult for the noteholdersto pledge the issuer notes if issuer notes in physical form are required by theparty demanding the pledge; and

 

•                  hinder the noteholders’ ability toresell the issuer notes because some investors may be unwilling to buy issuernotes 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 tosubmit to the non-exclusive jurisdiction of the courts of England, and it maybe necessary for noteholders to bring a suit in England to enforce their rightsagainst the issuer.

 

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

 

The Basel Committee onBanking Supervision published the text of the new framework on June 26, 2004under the title “Basel II: International Convergence of Capital Measurement andCapital Standards: a Revised Framework”. This new framework (the “Framework”),which places enhanced emphasis on market discipline and sensitivity to risk,will serve as the basis for national rule-making and approval processes tocontinue and for banking organizations to complete their preparations forimplementation of the Framework. The Committee confirmed that it is currentlyintended that the various approaches under the Framework will be implemented instages, some from year-end 2006, the most advanced at year-end 2007. As andwhen implemented (including through the EU Capital Requirements Directive), theFramework could affect the risk—weighting of the issuer notes in respect ofcertain investors if those investors are subject to the Framework following itsimplementation. Consequently, investors should consult their own advisers as tothe consequences to and effect on them of the proposed implementation of theFramework. No predictions can be made as to the precise effects of potentialchanges which might result upon the implementation of the Framework.

 

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

 

**Item 4.  Information on the Company**

 

A.            *History andDevelopment of the Company*

 

Not applicable.

 

B.            *Business Overview*

 

Not applicable.

 

C.            *OrganizationalStructure*

 

Not applicable.

 

D.            *Property, Plants andEquipment*

 

The issuer

 

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

 

Funding 1

 

The property of Funding 1consists primarily of its interest in the trust property held by the mortgagestrustee (which entitles Funding 1 to receive certain payments of principal andinterest from the trust property according to the terms of the mortgages trustdeed) and amounts available under a reserve fund.

 

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The mortgagestrustee

 

The trust propertyincludes the initial portfolio of loans and their related security assigned tothe mortgages trustee by the seller on June 14, 2002, and on several subsequentdates, including March 6, 2003, 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 borrower makinga drawing under any flexible loan, any interest, principal and other amounts(excluding third party amounts) paid by borrowers on their loans and theirrelated security, the rights under the insurance policies that are assigned tothe mortgages trustee or of which the mortgages trustee has the benefit, andamounts on deposit and interest earned on the mortgages trustee guaranteedinvestment contract. Any actual losses in relation to the loans, any actualreductions occurring in respect of the loans and distributions of principalmade from time to time to the beneficiaries or the mortgages trust will bededucted from the trust property. The composition of the trust property willfluctuate as drawings under flexible loans and new loans are added, as borrowerstake payment holidays or make underpayments under a loan and as the loans thatwere previously part of the trust property are repaid, mature, default or arerepurchased by the seller.

 

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

 

A.*            Operating Results*

 

Not applicable.

 

B.*            Liquidity and Capital Resources*

 

Not applicable.

 

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

 

Not applicable.

 

D*.            Trend Information*

 

Not applicable.

 

E.*             Off-balance Sheet Arrangements*

 

Not applicable.

 

F.*             Tabular Disclosure of ContractualObligations*

 

Not applicable.

 

G*.            Safe Harbor*

 

Not applicable.

 

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

 

A.*            Directors and Senior Management*

 

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

 

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The issuer

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

 

Funding 1

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

 

The mortgagestrustee

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

 

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

 

B.*           Compensation*

 

The issuer

 

In accordance with theissuer corporate services agreement entered into between the issuer, theseller, the security trustee, the note trustee, Holdings and Structured FinanceManagement Limited (“SFM”), the seller and SFM will each provide directors andother corporate services for the issuer in 

 

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consideration for a payment of a separate fee payable by the issuer toSFM. No other remuneration is paid to any director or officer in connectionwith such director’s or officer’s activities on behalf of the issuer.

 

Funding 1

 

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

 

The mortgagestrustee

 

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

 

C.            *Board Practices*

 

Not applicable.

 

D.            *Employees*

 

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

 

E.             *Share Ownership*

 

Not applicable.

 

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

 

A.            *Major Shareholders*

 

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

 

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

 

Neither SFM Corporate norSFM Offshore is affiliated with Halifax plc.

 

B.            *Related Party Transactions*

 

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

 

C.            *Interests of Experts andCounsel*

 

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Not applicable to annualreports filed on Form 20-F.

 

**Item 8.  Financial Information**

 

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

 

The issuer, Funding 1 andthe mortgages trustee know of no material legal or arbitration proceedingsinvolving their respective companies that may have significant effects on theregistrants’ financial position or profitability, including governmental proceedingspending or known to be contemplated and any material proceeding in which anydirector or affiliate is either a party adverse to a registrant or has amaterial interest adverse to a registrant.

 

**Item 9.  The Offer and Listing**

 

A.*            Offer and Listing Details*

 

Not applicable.

 

B.*            Plan of Distribution*

 

Not applicable to annualreports filed on Form 20-F.

 

C.*            Markets*

 

The principal tradingmarket for each class of the issuer notes is the London Stock Exchange. Theissuer notes have been listed on the London Stock Exchange since March 6, 2003.

 

D.*            Selling Shareholders*

 

Not applicable to annualreports filed on Form 20-F.

 

E.*             Dilution*

 

Not applicable to annualreports filed on Form 20-F.

 

F.*             Expenses of the Issue*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 10.  Additional Information**

 

A.*            Share Capital*

 

Not applicable to annualreports filed on Form 20-F.

 

B.*            Memorandum and Articles ofAssociation*

 

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

 

C.            *Material Contracts*

 

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Not applicable other thanwith respect to contracts relating to the issuer notes, which were described inthe Registration Statement.

 

D.*            Exchange Controls*

 

None.

 

E.*             Taxation*

 

**UnitedKingdom Taxation**

 

The following sectionsummarizes the material UK tax consequences of the purchase, ownership anddisposition of the issuer notes based on current law and practice in the UK.The summary assumes that the profit in Funding 1’s profit and loss account willnot exceed 0.01 per cent. of the Funding 1 available revenue receipts andthat the profit in the issuer’s profit and loss account will not exceed0.01 per cent. of the interest on the issuer term advances under theissuer intercompany loan and any interest earned by the issuer on its sharecapital proceeds are correct. It further assumes that all payments madepursuant to the final documentation are calculated on arm’s length terms. Thesummary does not purport to be a complete analysis of all tax considerations ofthe purchase, ownership and disposition of the issuer notes. It relates to theposition of persons who are the absolute beneficial owners of issuer notes andmay not apply to certain classes of persons such as dealers or personsconnected with the issuer. Noteholders who may be subject to tax in ajurisdiction other than the UK or who may be unsure as to their tax positionshould seek their own professional advice.

 

**Taxationof US residents**

 

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

 

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

 

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

 

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

 

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

 

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

 

**Withholdingtax**

 

There will be no UKwithholding tax in relation to interest payments on the issuer notes providedthat, so far as concerns deduction by the issuer or its paying agents, theissuer notes are listed on a “recognised stock exchange”, as defined inSection 841 of the Income and Corporation Taxes Act 1988 (“ICTA”). TheLondon Stock Exchange is currently a recognised stock exchange for thispurpose. If the issuer notes cease to be listed on a “recognised stockexchange”, an amount must be withheld on account of UK income tax at the lowerrate (currently 20 per cent.) from interest paid on them, subject to anydirection to the contrary by H.M. Revenue & Customs in respect of suchrelief as may be available pursuant to the provisions of an applicable doubletaxation treaty or to the interest being paid to persons (including companieswithin the charge to UK corporation tax) and in circumstances specified inSection 349A to 349D of the ICTA.

 

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

 

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

 

Interest on the issuernotes has a UK source. Accordingly, payments of interest on the issuer noteswill in principle be within the charge to UK tax even if paid withoutwithholding or deduction. However, other than where the provisions of theTreaty apply to allow certain interest paid to residents of the US to be taxedin the UK, such payments will not be chargeable to UK tax in the hands of anoteholder who is not resident for tax purposes in the UK unless suchnoteholder carries on a trade, profession or vocation through a branch oragency (or, in the case of a noteholder which is a 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 whichcase (subject to exemptions for interest received by certain categories ofagent such as some brokers and investment managers) tax may be levied on the UKbranch or agency or permanent establishment.

 

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

 

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

 

**Taxationof returns: other noteholders**

 

Noteholders who are not withinthe charge to UK corporation tax and who are resident or ordinarily resident inthe UK for tax purposes or who carry on a trade, profession or vocation in theUK through a branch or agency in connection with which interest on the issuernotes is 

 

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received or to which the issuer notes are attributable will generallybe liable to UK tax on the amount of any interest received in respect of theissuer notes. As the series 2 issuer notes and series 4 class A issuer notesare denominated in US dollars and the series 3 issuer notes, series 4 class Bissuer notes and series 4 class C issuer notes are denominated in euro, theywill not be regarded by H.M. Revenue & Customs as constituting “qualifyingcorporate bonds” within the meaning of Section 117 of the Taxation ofChargeable Gains Act 1992. Accordingly, a disposal of any of these issuer notesmay give rise to a chargeable gain or an allowable loss for the purpose of theUK taxation of chargeable gains.

 

It is expected that theseries 5 issuer notes will be regarded by H.M. Revenue & Customs asconstituting “qualifying corporate bonds” within the meaning of Section 117 ofthe Taxation of Chargeable Gains Act 1992. Accordingly, a disposal of any of theseissuer notes is not expected to give rise to a chargeable gain or an allowableloss for the purpose of the UK taxation of chargeable gains.

 

A disposal of the issuernotes by such noteholders as described above may also give rise to a charge totax on income in respect of an amount representing interest accrued on theissuer notes since the preceding payment date. For the issuer notes whichconstitute variable rate securities, taxation in respect of such a disposalwill be computed on the basis that such amount as H.M. Revenue & Customsconsiders to be just and reasonable will be treated as accrued income. However,the transferee of a variable rate security will not be entitled to any reliefon such amount. All of the issuer notes will constitute variable rate issuernotes for this purpose.

 

**Stampduty and stamp duty reserve tax**

 

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

 

**UKtaxation of Funding 1 and the issuer**

 

Funding 1 and the issuerwill generally be subject to UK corporation tax, currently at a rate of30 per cent., on the profit reflected in their respective profit and lossaccounts as increased by the amounts of any non-deductible expenses or losses.In respect of Funding 1, the profit in the profit and loss account will notexceed 0.01 per cent. of the Funding 1 available revenue receipts. Inrespect of the issuer, the profit in the profit and loss account will notexceed 0.01 per cent. of the interest on the issuer term advances underthe issuer intercompany loan and any interest earned by the issuer on its ShareCapital proceeds.

 

**UKtaxation of the mortgages trustee**

 

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

 

**EUSavings Directive**

 

On June 3, 2003, the European Union (“EU”) Council ofEconomics and Finance Ministers adopted a directive on the taxation of savingsincome in the form of interest payments (the “EU Savings Tax Directive”). It isproposed that, subject to a number of important conditions being met, each EUMember State will, from July 1, 2005, be required to provide to the taxauthorities of another EU Member State details of payments of interest (orother similar income) paid by a person within its jurisdiction to or for thebenefit of an individual resident in that other EU Member State. However,Austria, Belgium and Luxembourg will instead (unless during that period theyelect otherwise) apply a withholding system for a transitional period inrelation to such payments (the ending of such 

 

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transitionalperiod being dependent upon the conclusion of certain other agreements relatingto information exchange with certain other countries).

 

Jersey is not a member of the EU and therefore is not requiredto implement 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 retentiontax 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 retention 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 would be entitled to request a payingagent not to retain tax from such payments but instead to apply a system bywhich the details of such payments are communicated to the tax authorities ofthe EU Member State in which the beneficial owner is resident.

 

**UnitedStates Federal Income Taxation**

 

The following sectionsummarizes the material US federal income tax consequences of the purchase,ownership and disposition of the series 2 issuer notes and series 4 class Aissuer notes (the “US notes”). In general, the summary assumes that a holderacquires the US notes at original issuance and holds the US notes ascapital assets. It does not purport to be a comprehensive descriptionof all the tax considerations that may be relevant to a decisionto purchase the US notes. In particular, it does not discuss special taxconsiderations that may apply to certain types of taxpayers, including,without limitation, the following: (i) financial institutions; (ii) insurancecompanies; (iii) dealers or traders in stocks, securities, notional principalcontracts or currencies; (iv) tax-exempt entities; (v) regulated investmentcompanies; (vi) persons that will hold the US notes as part of a “hedging” or“conversion” transaction or as a position in a “straddle” for US federal incometax purposes; (vii) persons that own (or are deemed to own) 10 per cent. ormore of the voting shares of the issuer; (viii) persons who hold US notesthrough partnerships or other pass-through entities; and (ix) persons that havea “functional currency” other than the US dollar. In addition, this summarydoes not address alternative minimum tax consequences, nor does it describe anytax consequences arising under the laws of any taxing jurisdiction otherthan the US federal government.

 

This summary is based onthe US Internal Revenue Code of 1986, as amended (the “Code”), US Treasuryregulations and judicial and administrative interpretations thereof, in eachcase as in effect or available on the date of filing of this Form 20-F. All ofthe foregoing are subject to change, and any change may apply retroactively andcould affect the tax consequences described below.

 

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

 

As used in this section,the term “United States holder” means a beneficial owner of US notes that isfor US federal income tax purposes: (i) a citizen or resident of theUnited States; (ii) a corporation (or other entity treated as a corporation) orpartnership, created or organized in or under the laws of the United States orany state thereof (including the District of Columbia); (iii) any estate theincome of which is subject to US federal income tax regardless of the source ofits income; or (iv) any trust if a court within the United States is able toexercise primary supervision over the administration of the trust and one ormore United States persons have the authority to control all substantial decisionsof the trust. If a partnership holds US notes, the tax treatment of a partnerwill generally depend upon the status of the partner and upon the activities ofthe partnership. Partners of partnerships holding US notes should consult theirown tax advisers. A “Non-United States holder” is a beneficial owner of USnotes that is not a United States holder.

 

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

 

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

 

**Characterizationof the US notes**

 

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

 

The US notes will not bequalifying real property loans in the hands of domestic savings and loanassociations, real estate investment trusts, or REMICs under sections7701(a)(19)(C), 856(c) or 860G(a)(3) of the Code, respectively.

 

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

 

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

 

It is possible thatinterest on the US notes that are class B and class C issuer notes could betreated as OID because such interest is subject to deferral in certain limitedcircumstances. A United States holder of a US note issued with OID must includeOID in income over the term of such US note under a constant yield method thattakes into account the compounding of interest. Under the Code, OID is calculatedand accrued using prepayment assumptions where payments on a debt instrumentmay be accelerated by reason of prepayments of other obligations securing suchdebt instrument. Moreover, the legislative history to the provisions providethat the same prepayment assumptions used to price a debt instrument be used tocalculate OID, as well as to accrue market discount and amortize premium. Here,prepayment of the mortgage loans is not expected to alter the scheduledprincipal payments on the US notes that are class B and class C issuer notesand, accordingly, the issuer intends to assume that such US notes will havetheir principal repaid according to the schedule for purposes of accruing anyOID. No representation is made that the mortgage loans will pay on the basis ofsuch prepayment assumption or in accordance with any other prepayment scenario.

 

As an alternative to theabove treatments, United States holders may elect to include in gross incomeall interest with respect to the US notes, including stated interest,acquisition discount, OID, *de minimis* OID,market discount, *de minimis* market discount, andunstated interest, as adjusted by 

 

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any amortizable bond premium or acquisition premium, using the constantyield method described above.

 

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

 

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

 

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

 

Subject to the backupwithholding rules discussed below, a Non-United States holder generally shouldnot be subject to US federal income or withholding tax on any payments on a USnote and gain from the sale, redemption or other disposition of a US noteunless: (i) that payment and/or gain is effectively connected with the conductby that Non-United States holder of a trade or business in the United States;(ii) in the case of any gain realized on the sale or exchange of a US note byan individual Non-United States holder, that holder is present in the UnitedStates for 183 days or more in the taxable year of the sale, exchange orretirement and certain other conditions are met; or (iii) the Non-United Statesholder is subject to tax pursuant to provisions of the Code applicable tocertain expatriates. **Non-United States holdersshould consult their own tax advisors regarding the US federal income and othertax consequences of owning US notes.**

 

**Alternativecharacterization of the US notes**

 

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

 

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

 

If a United States holderwere treated as owning an equity interest in a PFIC, unless a United Statesholder makes a “QEF election” or “mark to market election”, a United Statesholder will be 

 

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subject to a special tax regime (i) in respect of gains realized on thesale or other disposition of the relevant notes, and (ii) in respect ofdistributions on the relevant notes held for more than one taxable year to theextent those distributions constitute “excess distributions”. Although not freefrom doubt, the PFIC rules should not apply to gain realized in respect of any notesdisposed of during the same taxable year in which such notes are acquired. Anexcess distribution generally includes dividends or other distributionsreceived from a PFIC in any taxable year to the extent the amount of suchdistributions exceeds 125 per cent. of the average distributions for the threepreceding years (or, if shorter, the investor’s holding period). Because the USnotes 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 the PFIC rules, aUnited States holder will be required to allocate such excess distributions andany gain realized on a sale of its notes to each day during the United Statesholder’s holding period for the notes, and will be taxable at the highest rateof taxation applicable to the notes for the year to which the excessdistribution or gain is allocable (without regard to the United States holder’sother items of income and loss for such taxable year) (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**

 

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

 

Payments of principal orinterest made to or through a foreign office of a custodian, nominee or otheragent acting on behalf of a beneficial owner of a US note generally will not besubject to backup withholding. However, if such custodian, nominee or otheragent is (i) a United States person (as defined in section 7701(a)(30) of theCode), (ii) a controlled foreign corporation (as defined in section 957(a) ofthe Code), (iii) a foreign person 50 per cent. or more of whose gross income iseffectively connected with a US trade or business for a specified three-yearperiod, or (iv) a foreign partnership if (A) at any time during its tax year,one or more of its partners are United States persons (as defined in applicableTreasury regulations) who in the aggregate hold more than 50 per cent. of theincome or capital interest in the partnership or (B) at any time during itstaxable year, it is engaged in a US trade or business (each of (i) through(iv), a “US Connected Holder”), such custodian, nominee or other agent may besubject to certain information reporting requirements with respect to suchpayment unless it has in its records documentary evidence that the beneficialowner is not a United States holder and certain conditions are met or thebeneficial owner otherwise establishes an exemption. Principal and interestpaid by the US office of a custodian, nominee or agent will be subject to bothbackup withholding and information reporting unless the beneficial ownercertifies its non-US status under penalties of perjury or otherwise establishesan exemption. Payments of proceeds on the sale of a US note made to or througha foreign office of a broker will not be subject to backup withholding.However, if such broker is a US Connected Holder, information reporting will berequired unless the broker has in its records documentary evidence that thebeneficial owner is not a United States holder and certain conditions are metor the beneficial owner otherwise establishes an exemption. Payments ofproceeds on the sale of a US note made to or through the US office of a 

 

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broker will be subject to backup withholding and information reportingunless the beneficial owner certifies, under penalties of perjury, that it isnot a US holder or otherwise establishes an exemption.

 

Backup withholding is notan additional tax. Any amounts withheld under the backup withholding rules willbe refunded or credited against the United States holder’s US federal incometax liability, provided that the required information is furnished to the IRS. **Holders of US notes should consult their tax advisors as to theirqualification for exemption from backup withholding and the procedure forobtaining an exemption.**

 

**MaterialJersey (Channel Islands) Tax Considerations**

 

The mortgages trustee isresident in Jersey for taxation purposes and will be liable to income tax inJersey at a rate of 20 per cent. in respect of the profits it makes from actingas trustee of the mortgages trust. The mortgages trustee will not be liable forany income tax in Jersey in respect of any income it receives in its capacityas mortgages trustee on behalf of the beneficiaries of the mortgages trust.

 

F.             *Dividends and PayingAgents*

 

Not applicable to annualreports filed on Form 20-F.

 

G.            *Statement by Experts*

 

Not applicable to annualreports filed on Form 20-F.

 

H.            *Documents on Display*

 

The issuer, Funding 1 andthe mortgages trustee are subject to the information requirements of the U.S.Securities Exchange Act of 1934, as amended, and are therefore required to filereports, including annual reports on Form 20-F, and other information with theSEC. These materials, including this annual report and the exhibits thereto,may be inspected and copied at the SEC’s public reference rooms in Washington,DC, New York, NY and Chicago, IL. Please call the SEC at +1-800-732-0330 forfurther information on the public reference rooms. Any filings made by theissuer, Funding 1 or the mortgages trustee will be made available to the publicover the Internet at the SEC’s web site at http://www.sec.gov.

 

I.              *Subsidiary Information*

 

Not applicable to annualreports filed on Form 20-F.

 

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

 

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

 

•                  Funding 1 swap: to hedge against thepossible variance between the mortgages trustee variable base rate payable onthe variable rate loans, the rates of interest payable on the tracker rateloans and the fixed rates of interest payable on the fixed rate loans and aLIBOR based rate for three-month sterling deposits;

 

•                  issuer dollar currency swaps: toprotect the issuer against changes in the sterling to US dollar exchange ratefollowing the closing date and the possible variance between a LIBOR based ratefor three-month sterling deposits and a LIBOR based rate for 

 

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three-month dollardeposits, applicable to the series 2 issuer notes and the series 4 class Aissuer notes; and

 

•                  issuer euro currency swaps: toprotect the issuer against changes in the sterling to euro exchange ratefollowing the closing date and the possible variance between a LIBOR based ratefor three-month sterling deposits and a EURIBOR based rate for three month eurodeposits applicable to the series 3 issuer notes, series 4 class B issuer notesand series 4 class C issuer notes.

 

**TheFunding 1 swap**

 

Some of the loans in theportfolio pay a variable rate of interest for a period of time which may eitherbe linked to the mortgages trustee variable base rate or linked to a variableinterest rate other than the mortgages trustee variable base rate, such as arate set by the Bank of England. Other loans pay a fixed rate of interest for aperiod of time. However, the interest rate payable by Funding 1 with respect tothe issuer term advances is calculated as a margin over LIBOR for three-monthsterling deposits. To provide a hedge against the possible variance between:

 

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

 

(2)           a LIBORbased rate for three-month sterling deposits,

 

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

 

•                  has a notional amount that is sizedto hedge against any potential interest rate mismatches in relation to thecurrent issues; and

 

•                  provides for the notional amount tobe increased as appropriate to hedge against similar potential interest ratemismatches in relation to any new issues.

 

Under the Funding 1 swap,on each calculation date, the following amounts will be calculated:

 

•                  the amount produced by applying LIBORfor three-month sterling deposits (as determined in respect of thecorresponding interest period under the intercompany loans) plus a spread forthe relevant calculation period to the notional amount of the Funding 1 swap asdescribed later in this section (known as the “calculation period swap provideramount”); and

 

•                  the amount produced by applying arate equal to the weighted average of:

 

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

 

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

 

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

 

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

 

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

 

•                  the sum of each of the calculationperiod swap provider amounts calculated during the preceding interest period;and

 

•                  the sum of each of the calculationperiod Funding 1 amounts calculated during the preceding interest period.

 

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

 

•                  if the first amount is greater thanthe second amount, then the Funding 1 swap provider will pay the difference toFunding 1;

 

•                  if the second amount is greater thanthe first amount, then Funding 1 will pay the difference to the Funding 1 swapprovider; and

 

•                  if the two amounts are equal, neitherparty will make a payment to the other.

 

If a payment is to bemade by the Funding 1 swap provider, that payment will be included in theFunding 1 available revenue receipts and will be applied on the relevantFunding 1 interest payment date according to the relevant order of priority ofpayments 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 ofthe Funding 1 swap in respect of a calculation period will be an amount insterling equal to:

 

•                  the aggregate principal amountoutstanding of all intercompany loans on the first day of the relevantcalculation period, less

 

•                  the balance of the principaldeficiency ledger attributable to all intercompany loans on the first day ofthe relevant calculation period, less

 

•                  the amount of the principal receiptsin the Funding 1 GIC account attributable to all intercompany loans on thefirst day of the relevant calculation period.

 

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

 

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**Theissuer currency swaps**

 

The issuer intercompanyloan is denominated in sterling, and interest payable by Funding 1 to theissuer under the issuer term advances is calculated as a margin over LIBOR forthree-month sterling deposits. However, some of the issuer notes aredenominated in US dollars and accrue interest at either a LIBOR based rate forone-month US dollar deposits or a LIBOR based rate for three-month US dollardeposits. In addition, the series 3 issuer notes, series 4 class B issuer notesand series 4 class C issuer notes are denominated in euro and accrue interestat a EURIBOR based rate for three-month euro deposits. To deal with thepotential interest rate and/or currency mismatch between (i) its receipts andliabilities in respect of the issuer intercompany loan and (ii) its receiptsand liabilities under the issuer notes, the issuer has, pursuant to the termsof the issuer currency swaps, swapped its receipts and liabilities in respectof all euro denominated issuer notes and all US dollar denominated issuer notesinto sterling on terms that match the issuer’s obligations under the US dollardenominated issuer notes or the euro denominated issuer notes, as applicable.

 

The currency amount ofeach issuer swap is the principal amount outstanding under the issuer notes towhich the relevant issuer currency swap relates. Subject, in the case of theclass B and C issuer swaps, to certain deferral of interest provisions thatwill apply when payment of interest under the corresponding offered issuernotes is deferred in accordance with the terms and conditions of such offeredissuer notes, the issuer swap providers will pay to the issuer amounts in USdollars or euro, as applicable that are equal to the amounts of interest to bepaid on each of the classes of the offered issuer notes and the issuer will payto the issuer swap providers the sterling interest amounts received on theissuer term advances corresponding to the classes of the offered issuer notes.In order to allow for the effective currency amount of each issuer currencyswap to amortize at the same rate as the relevant class of issuer notes, eachissuer currency swap agreement provides that as and when the issuer notes amortize,a corresponding portion of the relevant issuer swap so terminated will beswapped from sterling into US dollars at the relevant dollar currency exchangerate or into euro at the euro currency exchange rate, as applicable.

 

The payment obligationsof the series 4 issuer swap provider under the relevant issuer swaps areguaranteed by the series 4 issuer swap guarantor pursuant to a guarantee (the“series 4 issuer swap guarantee”).

 

In the event that anyissuer currency swap is terminated prior to the service of an issuer noteacceleration notice or the final redemption of the relevant US dollardenominated or euro denominated issuer notes, as applicable, the issuer shallenter into a replacement issuer currency swap in respect of that class andseries of issuer notes. Any replacement issuer swap must be entered into onterms acceptable to the rating agencies, the issuer and the security trusteeand with a replacement issuer currency swap provider whom the rating agencieshave previously confirmed in writing to the issuer and the security trusteewill not cause the then current ratings of the issuer notes to be downgraded,withdrawn or qualified. If the issuer is unable to enter into any replacementissuer currency swaps on terms acceptable to the rating agencies, this mayaffect amounts available to pay amounts due under the issuer notes.

 

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

 

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**Ratingsdowngrade of swap providers**

 

Under each of the swapagreements, in the event that the relevant rating(s) of a swap provider, or itsrespective guarantor, as applicable, is or are, as applicable, downgraded by arating agency below the rating(s) specified in the relevant swap agreement (inaccordance with the requirements of the rating agencies) for such swap provider,and, as a result of the downgrade, the then current ratings of the currentnotes, in respect of the Funding 1 swap, or the issuer notes corresponding tothe relevant issuer swap, in respect of the relevant issuer swap, would or may,as applicable, be severely affected, the relevant swap provider will inaccordance with the Funding 1 swap or the relevant issuer swap, as applicable,be required to take certain remedial measures which may include providingcollateral for its obligations under the relevant swap, arranging for itsobligations under the relevant swap to be transferred to an entity withrating(s) required by the relevant rating agency as specified in the relevantswap agreement (in accordance with the requirements of the rating agency),obtaining a guarantee from a satisfactory third party or procuring anotherentity with rating(s) required by the relevant rating agency as specified inthe relevant swap agreement (in accordance with the requirements of the ratingagency), to become co-obligor in respect of its obligations under the relevantswap, or taking such other action as it may agree with the relevant ratingagency.

 

**Terminationof the swaps**

 

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

 

Each issuer swapother than the series 2 class A issuer swap, the series 3 class A issuer swapand the series 4 class A issuer swap will terminate on the earlier of theinterest payment date falling in June 2042 and the date on which all of therelevant class and series of issuer notes are redeemed in full. The series 2class A issuer swap will terminate on the earlier of the interest payment datefalling in September 2007 and the date on which the series 2 class A issuernotes are redeemed in full. The series 3 class A issuer swap will terminate onthe earlier of the interest payment date falling in December 2032 and the dateon which the series 3 class A issuer notes are redeemed in full. The series 4class A issuer swap will terminate on the earlier of the interest payment datefalling in December 2009 and the date on which the series 4 class A issuernotes are redeemed in full.

 

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

 

•                  if there is a failure by a party topay any amounts due under that swap and any applicable grace period hasexpired;

 

•                  in respect of the issuer swaps, if anevent of default under the relevant class of issuer notes occurs and thesecurity trustee serves an issuer note acceleration notice;

 

•                  in respect of the Funding 1 swap, ifan event of default under any intercompany loan occurs and the security trusteeserves an intercompany loan acceleration notice;

 

•                  in respect of the issuer swaps, atthe option of the issuer, and in respect of the Funding 1 swap, at the optionof Funding 1 if certain tax representations by the relevant issuer swapprovider prove to have been untrue or misleading in any material respect;

 

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

 

•                  in respect of the issuer swaps, atthe option of the issuer, and in respect of the Funding 1 swap, at the optionof Funding 1, upon the occurrence of an insolvency of the relevant swapprovider, or its guarantor, as applicable, or the merger of the relevant swapprovider

 

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without anassumption of its obligations under the relevant swap agreement, or if amaterial misrepresentation is made by the swap provider under the relevant swapagreement, or if the relevant swap provider defaults under an over-the-counterderivatives transaction under another agreement between the issuer and suchswap provider; or if a breach of a provision of the relevant swap agreement bythe swap provider is not remedied within the applicable grace period, or, ifapplicable, if the guarantor of the relevant swap provider fails to comply withits obligations under the guarantee;

 

•                  if a change in law results in theobligations of one of the parties becoming illegal;

 

•                  if the relevant swap provider or its guarantor,as applicable, is downgraded and fails to comply with the requirements of theratings downgrade provision contained in the relevant swap agreement; and

 

•                  in the case of the series 4 issuerswaps, at the option of the series 4 issuer swap provider but subject toobtaining the consent of the security trustee, if withholding taxes are imposedon payments made by the series 4 issuer swap guarantor under the series 4issuer swap guarantee.

 

Upon the occurrence of aswap early termination event, the issuer or the relevant issuer swap providermay be liable to make a termination payment to the other party (in the case ofthe issuer swap) and/or Funding 1 or the Funding 1 swap provider may be liableto make a termination payment to the other party (in the case of the Funding 1swap). This termination payment will be calculated and made in sterling. Theamount of any termination payment will be based on the market value of theterminated swap based on market quotations of the cost of entering into a swapwith the same terms and conditions that would have the effect of preserving therespective full payment obligations of the parties (or based upon a good faithdetermination of total losses (or gains) if an insufficient number ofquotations can be obtained or if basing the valuation on quotations would notproduce a commercially reasonable result). Any such termination payment couldbe substantial.

 

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

 

If the issuer receives atermination payment from an issuer swap provider, then the issuer shall usethose funds towards meeting its costs in effecting currency exchanges at theapplicable spot rate of exchange until a replacement issuer currency swap isentered into and/or to acquire a replacement issuer currency swap.

 

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

 

**Transferof the swaps**

 

Each swap provider may,subject to certain conditions specified in the relevant swap agreement,including (without limitation) the satisfaction of certain requirements of therating agencies, transfer its obligations under any of the swaps to anotherentity.

 

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**Taxation**

 

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

 

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

 

The series 4 issuer swapguarantor will be obliged to gross up payments made by it to the issuer ifwithholding taxes are imposed on payments under the series 4 issuer swapguarantee. However if the series 4 issuer swap guarantor is required to grossup a payment under the series 4 issuer swap guarantee in respect of a relevantissuer currency swap, the series 4 issuer swap provider may, subject to theconsent of the security trustee, terminate the relevant issuer currency swap.

 

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

 

Not applicable to annualreports filed on Form 20-F.

 

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**PART II**

 

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

 

None.

 

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

 

None.

 

**Item 15.  Controls and Procedures**

 

Not applicable.

 

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

 

Not applicable.

 

**Item 16B.  Code of Ethics**

 

Not applicable.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

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

 

Not applicable.

 

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**PART III**

 

**Item 17.  Financial Statements**

 

Not applicable.

 

**Item 18.  Financial Statements**

 

Not applicable.

 

**Item 19.  Exhibits**

 

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

 

Exhibit 1: a copy of theMemorandum and Articles of Association of each of the issuer, Funding 1 and themortgages trustee is incorporated by reference from the Registration Statement.

 

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

 

Exhibit 12: Section 302certification.

 

Exhibit 15.1: Investor’sReport for the month of January 2004 (incorporated by reference from the Form6-K previously filed on February 13, 2004).

 

 Exhibit 15.2: Investor’s Report for the monthof February 2004 (incorporated by reference from the Form 6-K previously filedon March 11, 2004 and revised March 16, 2004).

 

Exhibit 15.3: Investor’sReport for the month of March 2004 (incorporated by reference from the Form 6-Kpreviously filed on April 9, 2004 and revised July 13, 2004).

 

Exhibit 15.4: Investor’sReport for the month of April 2004 (incorporated by reference from the Form 6-Kpreviously filed on May 13, 2004 and revised July 13, 2004).

 

Exhibit 15.5: Investor’sReport for the month of May 2004 (incorporated by reference from the Form 6-Kpreviously filed on June 14, 2004 and revised July 13, 2004).

 

Exhibit 15.6: Investor’sReport for the month of June 2004 (incorporated by reference from the Form 6-Kpreviously filed on July 13, 2004).

 

Exhibit 15.7: Investor’sReport for the month of July 2004 (incorporated by reference from the Form 6-Kpreviously filed on August 12, 2004).

 

Exhibit 15.8: Investor’sReport for the month of August 2004 (incorporated by reference from the Form6-K previously filed on September 9, 2004).

 

Exhibit 15.9: Investor’sReport for the month of September 2004 (incorporated by reference from the Form6-K previously filed on October 13, 2004).

 

Exhibit 15.10: Investor’sReport for the month of October 2004 (incorporated by reference from the Form6-K previously filed on November 17, 2004).

 

Exhibit 15.11: Investor’sReport for the month of November 2004 (incorporated by reference from the Form6-K previously filed on December 8, 2004).

 

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Exhibit 15.12: Investor’sReport for the month of December 2004 (incorporated by reference from the Form6-K previously filed on January 14, 2005 and revised January 18, 2005).

 

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**SIGNATURES**

 

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

 
|                | PERMANENT FINANCING  (NO. 2) PLC     |
|---------------------|--------------------------------------|
|                |                                 |   |
|                |                                 |   |
|                | By:                                  | /s/ David Balai |   |
|                | Name:                                | David Balai |
|                | Title:                               | Director |
|                |                                 |   |
|                | PERMANENT FUNDING (NO.  1) LIMITED   |
|                |                                 |   |
|                |                                 |   |
|                | By:                                  | /s/ David Balai |   |
|                | Name:                                | David Balai |
|                | Title:                               | Director |
|                |                                 |   |
|                | PERMANENT MORTGAGES  TRUSTEE LIMITED |
|                |                                 |   |
|                |                                 |   |
|                | By:                                  | /s/ David Balai |   |
| Date: June 30, 2005 | Name:                                | David Balai |
|                | Title:                               | Director |

 

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