**As filed with the Securities and Exchange Commissionon June 30, 2004**

 

**UNITEDSTATESSECURITIES 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, 2003** |
|                                                  |
| **or**                                                |
|                                                  |
| **o**                                                 | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**For thetransition period from                      to                      **

 

**Commission file number:  333-102040**

 

| **PERMANENT  FINANCING (NO. 2) PLC**                                                         |
|----------------------------------------------------------------------------------------------|
| (Exact Name of  Registrant 1 as specified in its charter)                                    |
|                                                                                         |
| **United Kingdom**                                                                           |
| (Jurisdiction of  Incorporation or Organization)                                             |
|                                                                                         |
| **Blackwell House, Guildhall Yard,  London EC2V 5AE, United Kingdom, (011 44 20) 7556 0972** |
| (Address of Principal Executive Offices)                                                     |
|                                                                                         |
| **PERMANENT  FUNDING (NO. 1) LIMITED**                                                       |
| (Exact Name of  Registrant 2 as specified in its charter)                                    |
|                                                                                         |
| **United Kingdom**                                                                           |
| (Jurisdiction of  Incorporation or Organization)                                             |
|                                                                                         |
| **Blackwell House, Guildhall Yard,  London EC2V 5AE, United Kingdom, (011 44 20) 7556 0972** |
| (Address of Principal Executive Offices)                                                     |
|                                                                                         |
| **PERMANENT  MORTGAGES TRUSTEE LIMITED**                                                     |
| (Exact Name of  Registrant 3 as specified in its charter)                                    |
|                                                                                         |
| **Jersey, Channel Islands**                                                                  |
| (Jurisdiction of  Incorporation or Organization)                                             |
|                                                                                         |
| **47 Esplanade, St. Helier, Jersey  JE1 0BD, (011 44 1534) 510 924**                         |
| (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.**

 

 

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

 

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 thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes ýNo o

 

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

 

Not applicable.

 

 

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(1)               These items havenot been offered directly to investors. Permanent Mortgages Trustee Limited isthe registrant for the Funding 1 interest in the mortgages trust and is holdingthe Funding interest in the mortgages trust on behalf of Permanent Funding (No.1) Limited. The Funding 1 interest in the mortgages trust will be the primarysource of payments on the term advances listed. Permanent Funding (No. 1)Limited is the registrant for the term advances and has issued the termadvances to Permanent Financing (No. 2) PLC. The term advances are the primarysource of payments on the series 2 notes and the series 4 notes. PermanentFinancing (No. 2) PLC is the registrant for the series 2 notes and the series 4notes.

 

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**PRESENTATION OF 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”):

 

•                  $1,750,000,000series 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

 

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:

 

•                  £1,018,016,000series 2 term AAA advance

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

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

•                  £1,107,250,000series 4 term AAA advance

 

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 subsequent dates,including March 6, 2003 (the “closing date”), any new loans and their newrelated security assigned to the mortgages trustee by the seller after theclosing date, any increase in the outstanding principal balance of a loan dueto the borrower taking payment holidays or making underpayments under a loan ora borrower making a drawing under any flexible loan, any interest, principaland other amounts (excluding third party amounts) paid by borrowers on theirloans and their related security, the rights under the insurance policies thatare assigned 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.  Themortgages trustee guaranteed investment contract, or GIC, account is the bankaccount in which the mortgages trustee holds any cash that is part of the trustproperty until it is distributed to the beneficiaries.  Any actual losses in relation to the loans,any actual reductions occurring in respect of the loans and distributions ofprincipal made from time to time to the beneficiaries or the mortgages trustwill be deducted from the trust property. The composition of the trust propertywill fluctuate as drawings under flexible loans and new loans are added and asthe loans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

On March 31, 2003,both State Street Bank and Trust Company and U.S. Bank National Associationgave notice of their retirement as co-note trustees and co-security trustees,The Bank of New York was appointed as replacement note trustee and securitytrustee in June 2003.  See “Item 14 —Material Modifications to the Rights of Security Holders and Use of Proceeds”.

 

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, as used in this filing, “Notapplicable to annual reports filed on Form 20-F” means that the response to thereferenced item is omitted in reliance on the instructions to Form 20-Fpublished by

 

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the United StatesSecurities and Exchange Commission (the “SEC”) as of the date of this annualreport that specifically state that the item is inapplicable to annual reportsfiled on Form 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, “NotApplicable” means the response to the reference item is omitted in reliance onthe procedures outlined in numerous no-action letters issued by the staff ofthe SEC with respect to issuers of substantially similar asset-backedsecurities that file annual reports on Form 10-K, or that the referenced itemis otherwise not applicable.

 

**FORWARD-LOOKING STATEMENTS**

 

This annual reportincludes forward-looking statements including, but not limited to, statementsmade under the “Risk Factors” section. These forward-looking statements can be identified by the use offorward-looking terminology, such as the words “believes”, “expects”, “may”,“intends”, “should” or “anticipates”, or the negative or other variations ofthose terms.  These statements involveknown and unknown risks, uncertainties and other important factors that couldcause the actual results and performance of the issuer notes, the seller or theUK residential mortgage industry to differ materially from any future resultsor performance expressed or implied in the forward-looking statements.  These risks, uncertainties and other factorsinclude, among others: general economic and business conditions in the UK;currency exchange and interest fluctuations; government, statutory, regulatoryor administrative initiatives affecting the seller, changes in businessstrategy, lending practices or customer relationships and other factors thatmay be referred to in this annual report.

 

Some of the 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.

 

**INCORPORATION OF CERTAIN DOCUMENTS BYREFERENCE**

 

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 ofDirectors, Senior Management and Advisers**

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 2.  OfferStatistics and Expected Timetable**

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 3.  KeyInformation**

 

A.*                          SelectedFinancial 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’sReport for the month of March 2003

•                  Investor’sReport for the month of April 2003

•                  Investor’sReport for the month of May 2003

•                  Investor’sReport for the month of June 2003

•                  Investor’sReport for the month of July 2003

•                  Investor’sReport for the month of August 2003

•                  Investor’sReport for the month of September 2003

•                  Investor’sReport for the month of October 2003

•                  Investor’sReport for the month of November 2003

•                  Investor’sReport for the month of December 2003

 

B.*                            Capitalizationand Indebtedness*

 

Not applicable to annualreports filed on Form 20-F.

 

C.*                            Reasonsfor the Offer and Use of Proceeds*

 

Not applicable to annualreports filed on Form 20-F.

 

D*.**                           RiskFactors*

 

*This section describes theprincipal risk factors associated with an investment in the issuer notes.Investors considering purchasing the issuer notes should carefully read andthink about all the information contained in this document, including the riskfactors set out here, prior to making any investment decision.*

 

**Noteholders cannot rely on any personother than the issuer to make payments on the issuer notes**

 

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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**The issuer has a limited set ofresources available to it to make payments on the issuer 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 rely on the issuer dollar currency swaps andthe issuer euro currency swaps to provide payments on the issuer notesdenominated in US dollars and euro, respectively.  Noteholders should note that there is no liquidity facilitydirectly available to the issuer, although Funding 1 has the benefit of aliquidity facility to pay interest on the issuer term advances corresponding tothe issuer notes and to pay principal on the class A issuer notes other thanthe series 3 class A issuer notes (save as described below) and the series 5class A issuer notes.  The ability ofFunding 1 to draw on the Funding 1 liquidity facility is subject to satisfyingcertain conditions precedent.  TheFunding 1 liquidity facility will be available to repay principal due on theissuer term advance corresponding to the series 3 class A issuer notes 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 a drawing is made under the Funding 1liquidity facility to enable Funding 1 to meet its obligations to the previousissuer or to new issuers, then that may affect the amount of funds available toFunding 1 to meet its obligations to the 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 1 is not obliged to makepayments on the issuer term advances if it does not have enough money to do so,which could adversely affect payments on the issuer notes**

 

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

 

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

 

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

 

•                  theamount of funds credited to the reserve fund;

 

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

 

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

 

According to the terms 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.  The mortgages trustee is obliged to payFunding 1 principal receipts on the loans by crediting those amounts to theFunding 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

 

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repaying amounts rankingin priority to the issuer (including repaying any higher ranking new termadvances).

 

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.

 

**Failure by Funding 1 to meet itsobligations under the issuer intercompany loan agreement would adversely affectpayments 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.  If Funding 1 does not pay amounts under theissuer intercompany loan because it does not have enough money available, thoseamounts will be deemed not to be due and payable, so there will not be an eventof default under the issuer intercompany loan, and the issuer will not haverecourse to the assets of Funding 1 in that instance.

 

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

 

The transaction has beenstructured in the expectation that on the final repayment date of the issuerintercompany loan in June 2042, the interest and principal due and payableon the 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 theissuer term AA advances and the issuer term BBB advances, then the shortfallwill be deemed to be not due and payable under the issuer intercompany loanagreement and the issuer will not have any claim against Funding 1 for theshortfall.

 

If there is 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.

 

**Enforcement of the issuer security isthe only remedy for a default in the issuer’s obligations, and the proceeds ofthat enforcement may not be enough to make payments on the issuer notes**

 

The only remedy forrecovering amounts on the issuer notes is through the enforcement of the issuersecurity.  The issuer has no recourse tothe assets of Funding 1 unless Funding 1 has also defaulted on its obligationsunder the issuer intercompany loan and the Funding 1 security has beenenforced.

 

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.

 

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**The transaction has been structuredin the expectation that the series 2 issuer notes will be redeemed before theseries 3 issuer notes and so on**

 

The transaction has beenstructured in the expectation that:

 

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

 

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

 

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

 

This means, among 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 3 class B issuer notes and the series 3class C issuer notes are expected to be redeemed before the series 4 class Aissuer notes and the series 5 class A issuer 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 notesis ultimately dependent on, among other things, repayment and redemptions onthe loans and on the term advance rating of the issuer 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,then payments of principal will be made on the class A issuer notes in priorityto payments of principal on the class B issuer Notes and the class C issuernotes.  Similarly, if on any interestpayment date, amounts are payable in respect of the class B issuer notes of anyseries and the class C issuer notes of any series, then payments of principalwill be made on the class B issuer notes in priority to payments of principalon the class C issuer notes.

 

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

 

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 certain circumstances,the security trustee can make amendments to the documents without the noteholders’prior consent.

 

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

 

Pursuant to the terms ofthe Funding 1 deed of charge and the issuer deed of charge, the securitytrustee may, without the consent or sanction of Funding 1’s secured creditorsor the issuer’s

 

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secured creditors, concurwith any person in making or sanctioning any modifications to the transactiondocuments:

 

•                  whichin the opinion of the security trustee it may be expedient to make, providedthat the security trustee is of the opinion that the modification will not bematerially prejudicial to the interests of the secured creditors or, if it isnot of that opinion in relation to any secured creditor, the secured creditorhas given its written consent to the modification; or

 

•                  whichin the opinion of the security trustee is made to correct a manifest error oris of a formal, minor or technical nature.

 

The security trustee 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 Funding 1deed of charge, the Funding 1 liquidity facility agreement, the Funding 1 swapagreement, 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 addition of newissuers and / or other relevant creditors to the transaction and / or the issueof new types of notes by new issuers;

 

(ii) the inclusion ofPermanent Funding (No. 2) PLC (“Funding 2”) as a beneficiary of the mortgagestrust and / or the issue of new notes by Funding 2;

 

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

 

(iv) changes to be madeto the reserve fund required amount and / or the manner in which the reservefund is funded;

 

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

 

(vi) the addition of anadditional Funding 1 liquidity facility;

 

and provided furtherthat:

 

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

 

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

 

The modificationsrequired to give effect to the matters listed in paragraphs (i) to (vi) abovemay include, *inter alia*, amendments to the provisions of the Funding 1deed of charge relating to the application of monies. Accordingly, there can beno assurance that the effect of the modifications to the transaction documentswill not ultimately adversely affect the noteholders’ interests. As

 

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applicable, anymodifications to the documents described above will require the actual consentof the Funding 1 liquidity facility provider, the Funding 1 swap provider andeach of the issuer swap providers, such consent not to be unreasonably withheldand to be deemed given if no response (affirmative or negative) is given withinten business days after the request for consent is sent to each party.

 

**There may be a conflict between theinterests of the holders of class A issuer notes, the holders of class B issuernotes and the holders of class C issuer notes, and the interests of one classof noteholders may prevail over the interests of other 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:

 

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

 

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

 

**There may be a conflict between theinterests of the holders of each series of the class A issuer notes, the holdersof each series of the class B issuer notes and the holders of each series ofthe class C issuer notes, and the interests of one series of noteholders mayprevail over the interests of other series of noteholders**

 

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 where the interests of the class Bnoteholders of one series of the issuer notes conflict with the interests ofthe class B noteholders of another series of the issuer notes or the interestsof the class C noteholders of one series of the issuer notes conflict with theinterests of the class C noteholders of another series of the issuer notes.

 

The issuer trust deed 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 resolution may only be passed at a singlemeeting of noteholders of each series of the relevant class if the note trusteeis, in its absolute discretion, satisfied that there is no conflict betweenthem.

 

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 a result of repayments of principalfirst to the series 2 issuer notes, then to the series 3 issuer notes, then tothe series 4 issuer notes and then to the series 5 issuer notes, the principalamount outstanding of each series of the issuer notes will change after theclosing date.

 

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**Permanent Holdings Limited(“Holdings”) has established another company, Funding 2, which may become anadditional 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 Funding 2 of an interest in thetrust property, the seller and Funding 1, as existing beneficiaries of themortgages trust, would be required to agree to a decrease in their beneficialinterests in the trust property (which would require a partial release ofsecurity 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 each distribution date the mortgagestrustee would distribute interest and principal receipts to one, two or allthree beneficiaries, depending on the terms of the mortgages trust.

 

It is anticipated thatFunding 2 will issue notes directly to investors from time to time backed byits share of the trust property. Noteholders would not have a direct or indirect interest in Funding 2’sshare 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 without limitation), amendments would be madeto:

 

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

 

•                  themortgages trust deed (i) to establish Funding 2 as a beneficiary of the trust,(ii) to enable the acquisition by Funding 2 of an interest in the trustproperty from time to time (and vice versa) and (iii) to regulate thedistribution of interest and principal receipts in the trust property toFunding 2 and the other beneficiaries; and

 

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

 

There may be conflicts 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 maynot prevail, which may adversely affect the noteholders’ interests.

 

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

 

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

 

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

 

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

 

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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.

 

**If Funding 1 enters into newintercompany loan agreements, then the new term advances may rank ahead ofissuer term advances as to payment, and accordingly new notes may rank ahead ofthe 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.  The proceeds of each new issue will be usedby the new issuer to make a new intercompany loan to Funding 1.  Funding 1 will use the proceeds of the newintercompany loan either to:

 

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

 

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

 

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

 

•                  depositsome of those proceeds in the reserve fund.

 

The current payment andsecurity priorities of the issuer notes relative to each other as set out inthe issuer deed of charge and the issuer cash management agreement will not beaffected as a result of an issue of new notes by a new issuer, because that newissue will be separately documented. However, Funding 1 may be required to repay to a new issuer amountsowing under a new term advance ahead of or in the same order of priority asamounts owing to the issuer on the issuer term advances, depending on the termadvance rating, the scheduled repayment date of that new term advance and certainother rules regarding the repayment of principal by Funding 1.  If this is the case, then the relevant newnoteholders will be paid before the noteholders.

 

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 newnotes.  Similarly, the terms of theFunding 1 transaction documents (including the mortgage sale agreement, themortgages trust deed, the Funding 1 deed of charge, the definitions of thetrigger events, the criteria for the assignment of new loans to the mortgagestrustee and the amount available to be drawn under the Funding 1 liquidityfacility) may be amended to reflect the new issue.  Noteholders’ consent to these changes will not be required. Therecan be no assurance that these changes will not affect the cashflows availableto pay amounts due on the issuer notes.

 

Before issuing new notes,however, a new issuer will be required to satisfy a number of conditions,including:

 

•                  obtaininga written confirmation from each of the rating agencies that the then currentratings of the notes outstanding at that time will not be adversely affectedbecause of the new issue;

 

•                  providingwritten certification to the security trustee that no event of default underany of the intercompany loan agreements outstanding at that time has occurredwhich has not

 

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been remedied or waivedand no event of default will occur as a result of the issue of the new notes;and

 

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

 

**Funding 1 has entered into otherintercompany loan agreements with other issuers, and some of the term advancesin the other intercompany loans rank ahead of some of the issuer term advancesin the issuer intercompany loan as to payment, and accordingly some of thenotes issued by the other issuers rank ahead of some of the issuer notes as topayment**

 

Theother issuers issued notes to investors, the equivalent net issue proceeds ofwhich were used by the other issuers to make intercompany loans to Funding1.  Funding 1 used most of the proceedsof these intercompany loans to pay the seller for the initial loans (togetherwith their related security) that it assigned to the mortgages trustee on theinitial closing date, which comprised Funding 1’s original share of the trustproperty.

 

Thecurrent payment and security priorities of the issuer notes relative to eachother as set out in the issuer deed of charge and the issuer cash managementagreement are not affected as a result of the issue of notes by the otherissuers, because the other issues were separately documented.  However, Funding 1 may be required to pay tothe other issuers amounts that are owing under one or more term advances aheadof or in the same order of priority as amounts owing to the issuer on theissuer term advances, depending on the term advance rating, the scheduledrepayment date of that term advance and other rules regarding the payment ofinterest and the repayment of principal by Funding 1.  If this is the case then the other note holders will be paidbefore you.

 

**Other creditors will share in thesame security granted by Funding 1 to the issuer, and this may adversely affectpayments 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.  If required by the ratingagencies, Funding 1 will use part of the proceeds of the new start-up loan tofund further the existing reserve funds.

 

Similarly, if necessary,Funding 1 will also enter into a new Funding 1 swap with either the Funding 1swap provider or a 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, the liabilities owed to theFunding 1 liquidity facility provider and the Funding 1 swap provider which aresecured by the Funding 1 deed of charge may increase each time that Funding 1enters into a new intercompany loan agreement. Those factors could ultimately cause a reduction in the paymentsnoteholders receive on the issuer notes. Noteholders’ consent to the requisite changes to the transition documentswill not be obtained.

 

**There may be conflicts between theissuer and any new issuers, and the issuer’s interests may not prevail, whichmay 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.

 

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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 issueris not in the group representing that largest principal amount, then itsinterests may not prevail.  This couldultimately cause a reduction in the payments the noteholders receive on theissuer notes.

 

**As new loans are assigned to themortgages trustee, the characteristics of the trust property may change fromthose existing at the closing date, and those changes may adversely affectpayments on the issuer notes**

 

There is no guaranteethat any new loans assigned to the mortgages trustee will have the samecharacteristics as the loans in the initial portfolio as of the closingdate.  In particular, new loans may havedifferent payment characteristics than the loans in the initial portfolio as ofthe closing date.  The ultimate effectof this could be to delay or reduce the payments the noteholders receive on theissuer notes.

 

**The yield to maturity of the issuernotes may be adversely affected by prepayments or redemptions 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 yieldto maturity of the issuer notes of each class may be adversely affected by ahigher or lower than anticipated rate of prepayments 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 CPR of the loans in the trustproperty is greater than 15 per cent. and certain other conditions aremet.  This means that there may be nocorresponding repayments of principal on the series 5 class A issuer notes, theclass B issuer notes or the class C issuer notes.

 

The extent to 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 able to save enough money during a cashaccumulation period or does not receive enough money from its share in themortgages trust on a scheduled repayment date to repay the relevant issuer termAAA advance (and if it is unable to make a drawing on the Funding 1 liquidityfacility or the reserve fund to make good the shortfall) so that the issuer canredeem the class A issuer notes of the corresponding series on their respectivescheduled redemption date(s), then Funding 1 will be required to pay to theissuer on those scheduled redemption dates only the amount that it has actuallysaved or received.  Any shortfall willbe deferred and paid on subsequent Funding 1 interest payment dates whenFunding 1 has money available to make the payment.  In these circumstances, unless Funding 1 is able to make adrawing on the Funding 1 liquidity facility, there will be a variation in theyield to maturity of the relevant class of issuer notes.

 

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**The issuer’s ability to redeem theseries 2 class A issuer notes and / or the series 3 class A issuer notes and /or the series 4 class A issuer notes on their scheduled redemption dates isaffected 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 to borrowers refinancing their loans andsales of properties by borrowers (either voluntarily or as a result ofenforcement action taken).  In addition, if theseller is required to repurchase a loan or loans under a mortgageaccount and their related security because, for example, one of the loansdoes not comply with the loan warranties in the mortgage sale agreement, then thepayment received by the mortgages trustee will have the same effect as aprepayment of all of the loans under the mortgage account.  Because these factors are not within itscontrol or the control of Funding 1 or the mortgages trustee, the issuer cannotgive any assurances as to the level of prepayments that the portfolio mayexperience.

 

Variation in the rate 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.  If prepayments on the loans occur lessfrequently than anticipated, then there may not be sufficient funds availableto redeem the series 2 class A issuer notes and / or the series 3 class Aissuer notes and / or the series 4 class A issuer notes in full on their respectivescheduled redemption dates.

 

**The seller may change the lendingcriteria relating to loans that are subsequently assigned to the mortgagestrustee, which could affect the characteristics of the trust property and whichmay 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 criteriaconsider a variety of factors such as a potential borrower’s credit history,employment history and status and repayment ability, as well as the value ofthe property to be mortgaged.  In theevent of the assignment of any new loans and new related security to themortgages trustee, the seller will warrant that those new loans and new relatedsecurity were originated in accordance with the seller’s lending criteria atthe time of their origination.  However,the seller retains the right to revise its lending criteria as determined fromtime to time, and so the lending criteria applicable to any loan at the time ofits origination may not be or have been the same as those when other loans wereoriginated.  If new loans that have beenoriginated under revised lending criteria are assigned to the mortgagestrustee, the characteristics of the trust property could change.  This could lead to a delay or a reduction inthe payments received on the issuer notes.

 

**The seller has adopted proceduresrelating to investigations and searches for remortgages which could affect thecharacteristics of the trust property and which may adversely affect paymentson the issuer notes**

 

The seller does notrequire a solicitor or licensed conveyancer to conduct a full investigation ofthe title to a property in all cases. 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 in England and Wales by a solicitor conducting a fullinvestigation of the title to a property. Properties which have undergone such a limited investigation may besubject to matters which would have been revealed by a full investigation oftitle and which may have been remedied or, if incapable of remedy, may haveresulted in the properties not being accepted as security for a loan had thematters been revealed, though to mitigate against this risk search indemnityinsurance is obtained in respect of the properties.  The introduction of loans secured by the properties into thetrust property could result in a change of the characteristics of the trustproperty.  This could lead to a delay ora reduction in the payments received on the issuer notes.

 

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**The timing and amount of payments onthe loans could be affected by various factors that may adversely affectpayments on the issuer notes**

 

The loans are affected bycredit, liquidity and interest rate risks. Various factors influence mortgage delinquency rates, prepayment rates,repossession frequency and the ultimate payment of interest and principal, suchas changes in the national or international economic climate, regional economicor housing conditions, changes in tax laws, interest rates, inflation, theavailability of financing, yields on alternative investments, politicaldevelopments and government policies. Other factors in borrowers’ individual, personal or financialcircumstances may affect the ability of borrowers to repay loans.  Loss of earnings, illness, divorce and othersimilar factors may lead to an increase in delinquencies by and bankruptcies ofborrowers, and could ultimately have an adverse impact on the ability ofborrowers 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.

 

In addition, the mortgageloan industry in the United Kingdom is highly competitive.  This competitive environment may affect therate at which the seller originates new loans and may also affect the level ofattrition 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 sourceof income for repayment by Funding 1 of the issuer intercompany loan is itsinterest in the loans held on trust by the mortgages trustee for Funding 1 andthe 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 occurrence of trigger events andenforcement of the issuer security may adversely affect the scheduled redemptiondates of the series 2 class A issuer notes, series 3 class 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 class A issuer notes and / or series 3 class A issuer notes and/ or series 4 class A issuer notes before their respective scheduled redemptiondates.

 

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,then the relevant classes of issuer notes outstanding will not be repaid ontheir scheduled redemption dates but will be repaid on each interest paymentdate from monies received from Funding 1 on the issuer term AAA advances of thecorresponding series as described in the following three risk factors.

 

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

 

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 has occurred, Funding 1 will repay (aftermaking requisite payments to the Funding 1 liquidity facility provider and toreplenish the reserve fund):

 

*first*, the issuerterm AAA advances of each series proportionally and equally, until all of thoseterm AAA term advances are fully repaid;

 

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*second*, the issuerterm AA advances of each series proportionally and equally, until all of thoseterm AA term advances are fully repaid; and

 

*third*, the issuerterm BBB advances of each series proportionally and equally, until all of thoseterm BBB term advances are fully repaid, until all of those term BBB termadvances are fully repaid.

 

This order of priority ofpayments may change if Funding 1 enters into new intercompany loan agreementsand if an issuer’s security is enforced. If an asset trigger event occurs, any series 2 class A issuer notes and/ or series 3 class A issuer notes and / or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates, and thereis also a risk that they will not be repaid by their final maturity dates.

 

**If a non-asset trigger event occurs,any series 2 class A issuer notes, series 3 class A issuer notes and / orseries 4 class A issuer notes then outstanding will not be repaid on theirscheduled redemption dates**

 

If a non-asset triggerevent has occurred, the mortgages trustee will distribute all principalreceipts to Funding 1 until the Funding 1 share percentage of the trustproperty is zero.  When a non-assettrigger event has occurred, Funding 1 will repay (after making requisitepayments to the Funding 1 liquidity facility provider and to replenish thereserve fund):

 

*first*, the termAAA advance with the earliest final repayment date, then to repay the term AAAadvance with the next earliest final repayment date, and so on until the termAAA advances in respect of the issuer intercompany loan , the previous issuerintercompany loan and any new issuer intercompany loans are fully repaid;

 

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

 

*finally*, the termBBB advances respect of the issuer intercompany loan, the previous issuerintercompany loan and any new issuer intercompany loans, until each of thoseterm 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 the issuer security is enforced,any series 2 class A issuer notes, series 3 class A issuer notes and / orseries 4 class A issuer notes then outstanding will not be repaid on theirscheduled 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 2 class A issuer notes, series 3class A issuer notes and / or series 4 class A issuer notes then outstandingwill not be repaid on their scheduled redemption dates and there is also a riskthat those class A issuer notes may not be repaid by their final maturitydates.

 

**Loans subject to further advanceswill be repurchased by the seller from the mortgages trustee, which will affectthe prepayment rate of the loans, and this may affect the yield to maturity ofthe 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

 

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loan under the relevantmortgage account and its related security from the mortgages trustee save forany loan in arrears at a price equal to the outstanding principal balance ofthose loans together with any accrued and unpaid interest and expenses to thedate of purchase.  The yield to maturityof the issuer notes may be affected by the repurchase of loans subject tofurther advances.

 

**In limited circumstances, loanssubject to product switches 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**

 

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 dateto but excluding the date when those conditions precedent have been satisfied,the seller will be required to repurchase any loans and their related securitythat are subject to product switches. 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:

 

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

 

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

 

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

 

•                  anyvariation imposed by statute;

 

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

 

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

 

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

 

**Ratings assigned to the issuer notesmay be lowered or withdrawn after the noteholders purchase 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 of principal on the final maturity date of each class ofthe issuer notes.  Any rating agency maylower its rating or withdraw its rating if, in the sole judgment of the ratingagency, the credit quality of the issuer notes has declined or is inquestion.  If any rating assigned to theissuer notes is lowered or withdrawn, the market value of the issuer notes maybe 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.

 

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**Subordination of the other noteclasses 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 Cissuer notes are subordinated in right of payment of interest to the class Bissuer notes.  However, the transactionhas been 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 originalpass-through notes will be deferred in some circumstances**

 

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

 

If on a Funding 1interest payment date;

 

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

 

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

 

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

 

then to the extent 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 AAadvance remains outstanding (whether or not such term AA advance is then dueand payable) after the allocation of principal on that Funding 1 interestpayment date to those term advances, the issuer term BBB advances will not beentitled to principal repayments until the relevant circumstance as describedabove has been remedied or otherwise ceases to exist.  This means that payments of principal on the class C issuer notesof all series and, as applicable, the class B issuer notes of all series willbe deferred until the earlier of the time when the relevant circumstancedescribed in this risk factor has been remedied (if ever) and the finalmaturity date of the relevant notes.

 

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

 

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

 

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

 

•                  thereis a cash accumulation shortfall at that time,

 

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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 3issuer notes, series 4 issuer notes and series 5 issuer notes may be subject torisk if the trust property deteriorates after repayment of previous series ofthe 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 / orthe series 4 issuer notes and / or the series 5 issuer notes may not be repaidin full.

 

**Noteholders may be subject toexchange rate risks on the series 2 issuer notes, the series 3 issuer notes andthe 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 issuerunder the issuer intercompany loan will be in sterling.

 

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 obliged only to make payments under anissuer swap as long as the issuer make payments under the same.  If an issuer swap provider is not obliged tomake payments, 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.  Unless a replacement issuer swap is enteredinto, the issuer may have insufficient funds to make payments due on the issuernotes of any class and any series that are then outstanding.

 

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, the series 4 issuerswap guarantor may terminate the series 4 issuer swap guarantee if it isobliged to gross up payments to it made by the issuer.  If the series 4 issuer swap guarantorterminates the series 4 issuer swap guarantee it will not be obliged to makepayments that it would, but for the termination of the series 4 issuer swapguarantee be obliged to make to the issuer, this may adversely affect theissuers ability to make payments due on the issuer notes of any class and anyseries then outstanding.

 

**The mortgages trustee GIC provider orthe Funding 1 GIC provider may cease to satisfy certain criteria to provide themortgages trustee GIC 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 bythe FSA from time to time) in order to continue to receive deposits in themortgages trustee GIC account and the Funding 1 GIC account respectively.  If either the mortgages trustee GIC provideror the Funding 1 GIC provider

 

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ceases to satisfy thosecriteria the relevant account would need to be transferred to another entitythat does satisfy those criteria.  Inthese circumstances the new GIC provider may not offer a GIC on terms asfavorable as those provided by the mortgages trustee GIC provider or theFunding 1 GIC provider.

 

**Termination payments on the issuerswaps may adversely affect the funds available to make payments on the issuernotes**

 

If any of the issuerswaps terminates, the issuer may as a result be obliged to pay a terminationpayment to the relevant issuer swap provider. The amount of the termination payment will be based on the cost ofentering into a replacement issuer swap. Under the issuer intercompany loan agreement, Funding 1 will be requiredto pay the issuer an amount equal to any termination payment due by the issuerto the relevant issuer swap provider. Funding 1 will also be obliged to pay the issuer any extra amounts thatthe issuer may be required to 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 theissuer give noteholders any assurance that it will be able to enter into areplacement issuer swap, or, if one is entered into, that thecredit rating of the replacement issuer swap provider will besufficiently high to prevent a downgrading of the then current ratings of theissuer notes by the rating agencies.

 

Except where 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 to which the relevant swap relates but also with payments due to theholders of any other series and class of the issuer notes to which the relevantswap relates.  Any additional amountsrequired to be paid by the issuer following termination of the relevant issuerswap (including any extra costs incurred (for example, from entering into“spot” currency or interest rate swaps) if the issuer cannot immediately enterinto a replacement swap) will also rank equally not only with payments due tothe holders of the series and class of the issuer notes to which the relevantissuer swap relates but also with payments due to the holder of any other seriesand class of the issuer notes which rank equally with the series and class ofthe issuer notes to which the relevant swap relates.  Furthermore, any termination payment or additional payment oradditional amounts required to be paid by the issuer following termination ofan issuer swap will rank ahead of payments due to the holders of any series andclass of the issuer notes which ranks below the series and class of the issuernotes to which the relevant issuer swap relates.  Therefore, if the issuer is obliged to make a termination paymentto the relevant issuer swap provider or to pay any other additional amount as aresult of the termination of the relevant issuer swap, this may affect thefunds which the issuer has available to make payments on the issuer notes ofany class and any series.

 

**Risks associated with the Funding 1swap**

 

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.  IfFunding 1 fails to make timely payments under the Funding 1 swap, it will havedefaulted under the Funding 1 swap.  TheFunding 1 swap provider is obliged only to make payments under the Funding 1swap as long as Funding 1 makes payments under the same.  If the Funding 1 swap provider is notobliged to make payments, or defaults in its obligation to make payments underthe Funding 1 swap, Funding 1 will be exposed to the variance between the ratesof interest payable on the loans and the rate of interest payable by it underthe intercompany loans unless a replacement Funding 1 swap is enteredinto.  If the Funding 1 swap terminates,Funding 1 may as a result be obliged to pay a termination payment to theFunding 1 swap provider.  Any variance betweenthe rates of interest payable on the loans and the rate of interest

 

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payable by Funding 1under the intercompany loans and any termination payment payable by it to theFunding 1 swap provider may adversely affect the ability of Funding 1 to meetits obligations under the issuer intercompany loan agreement.

 

Funding 1 will receiveinterest on the variable rate loans, which is based on HVR 1 orHVR 2.  The payment obligations ofFunding 1 under the Funding 1 swap will, among other things, be based on theaverage of the standard variable mortgage rates or their equivalent charged toexisting borrowers on residential mortgage loans as published from time totime, after excluding the highest and the lowest rate, of Abbey National plc,HSBC Bank plc, Lloyds TSB plc, National Westminster Bank Plc, NationwideBuilding Society, Northern Rock plc and Woolwich plc (and where those bankshave more than one standard variable rate, the highest of those rates).  While it is anticipated that the averagerate will broadly track both HVR 1 and HVR 2, the variance between the averagerate and HVR 1 and HVR 2 respectively may affect the ability of Funding 1 tomeet its payment obligations under the Funding 1 swap agreement.

 

**The issuer relies on third parties toperform services in relation to the issuer notes, and the noteholders may beadversely affected if they fail to perform their 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 swap providers have agreed to provide theirswaps, the corporate services provider has agreed to provide corporate servicesand the paying agents and the agent bank have agreed to provide payment andcalculation services in connection with the issuer notes.  In the event that any of these parties wereto fail to perform their obligations under the respective agreements to whichthey are a party, the noteholders may be adversely affected.

 

**The issuer may be unable to pay, infull or at all, interest due on the issuer notes if there is an income orprincipal 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 themortgages trust 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 theclosing date, the relevant term advances with the lowest term advance ratinginclude the issuer term BBB advances. If Funding 1 uses principal to repay interest and senior expenses inthis manner, there will be less principal available to repay the issuer termBBB advances.

 

Funding 1 will be obligedto keep a ledger that records any principal applied to pay interest and seniorexpenses.  When the amount recorded onthe ledger is equal to the principal amount outstanding of the term BBBadvances, then Funding 1 will use principal receipts that would have beenapplied to repay the term advance with the next lowest ranking term advancerating to pay interest on the term advances and senior expenses where there isa shortfall of money to pay those amounts. At the closing date, the term advances with the next lowest term advancerating include the issuer term AA advances. 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 be recoupedfrom subsequent excess revenue receipts and amounts standing to the credit ofthe reserve fund.  The revenue receiptsand the reserve fund monies will be applied first to cover any

 

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principal deficiency inrespect of the term advances with the highest term advance rating (at theclosing date, these include the issuer term AAA advances), and then the termadvances with the next highest ranking term advance rating (at the closingdate, these include the issuer term AA advances), 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:

 

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

 

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

 

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

 

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

 

**The seller share of the trustproperty does not provide credit enhancement for the issuer 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’s share of the trust propertytherefore does not provide credit enhancement for the Funding 1 share of thetrust property or the issuer notes. Losses on the loans in the trust property are allocated proportionatelybetween the seller and Funding 1 depending on their respective shares in thetrust property.

 

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

 

After an issuer intercompanyloan acceleration notice under the issuer intercompany loan is given, thesecurity trustee may, but shall not be obliged to, sell the Funding 1 share ofthe trust property.  There is noassurance that a buyer would be found or that a sale would realize enough moneyto repay amounts due and payable under the issuer intercompany loan agreement.

 

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

 

The issuer, Funding 1,the mortgages trustee and the security trustee will not 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

 

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new loan, is materiallyuntrue on the date the new loan is assigned to the mortgages trustee, then theseller will be required to remedy the breach within 20 London business days ofthe seller becoming aware of the same or of receipt by it of a notice from themortgages trustee.

 

If the seller fails 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 and accrued and unpaidinterest and expenses.  There can be noassurance that the seller will have the financial resources to repurchase theloan or loans under the relevant mortgage account and their relatedsecurity.  However, if the seller doesnot repurchase those loans and their related security when required, then theseller’s share of the trust property will be deemed to be reduced by an amountequal to the principal amount outstanding of those loans together with anyarrears of interest and accrued and unpaid interest and expenses.

 

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

 

**There can be no assurance that aborrower will repay principal at the end of the term on an interest-only loan,which may adversely affect repayments on the issuer notes**

 

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

 

The ability of a 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 assurance that the borrowerwill have the funds required to repay the principal at the end of theterm.  If a borrower cannot repay theloan and a loss occurs on the loan, then this may affect repayments ofprincipal on the issuer notes if that loss cannot be cured by amounts standingto the credit of the reserve fund or the application of excess Funding 1available revenue receipts.

 

**There may be risks associated withthe fact that the mortgages trustee has no legal title to the mortgages, whichmay adversely affect payments on the issuer notes**

 

The sale by the seller tothe mortgages trustee of the mortgages will take effect in equity only.  This means that legal title to the loans inthe trust property remains with the seller, but the mortgages trustee hasall the other rights and benefits relating to ownership of each loan andits related security (which rights and benefits are subject to the trust infavor of the beneficiaries).  Themortgages trustee has the right to demand that the seller give it legal titleto the loans and the related security in certain circumstances and until thenthe mortgages trustee will not apply to H.M. Land Registry or the Central LandCharges Registry to register or record its equitable interest in the mortgages.

 

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

 

•                  first,if the seller wrongly sold a loan to another person which has already beenassigned to the mortgages trustee, and that person acted in good faith and didnot have notice of the

 

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interests of themortgages trustee or the beneficiaries in the loan, then she or he might obtaingood title to the loan, free from the interests of the mortgages trustee andthe beneficiaries.  If this occurredthen the mortgages trustee would not have good title to the affected loan andits related security and it would not be entitled to payments by a borrower inrespect of that loan.  This may affectthe ability of the issuer to repay the issuer notes; and

 

•                  second,the rights of the mortgages trustee and the beneficiaries may be subject to therights of the borrowers against the seller, such as the rights of set-off whichoccur in relation to transactions or deposits made between some borrowers andthe seller and the rights of borrowers to redeem their mortgages by repayingthe loan directly to the seller.  Ifthese rights were exercised, the mortgages trustee may receive less money thananticipated from the loans, which may affect the ability of the issuer to repaythe 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 is exhausted, then the amount of anyset-offs would be applied to reduce the Funding 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 and further rights of independent set-off wouldcease to accrue from that date and no new rights of independent set-off couldbe asserted following that notice. Set-off rights arising under transaction set-off (which are set-offclaims arising out of a transaction connected with the loan) will not beaffected by that notice.

 

**Set-off risks in relation to flexibleloans and delayed cashbacks may adversely affect the funds available to theissuer to repay the issuer notes**

 

The seller has made, andin the future may make, an equitable assignment of the mortgages to themortgages trustee, with legal title being retained by the seller.  Therefore, the rights of the mortgagestrustee may be subject to the direct rights of the borrowers against theseller, including rights of set-off existing prior to notification to theborrowers of the assignment of the mortgages. Although the seller does not currently offer flexible loans or delayedcashbacks, it may offer products in the future with those features, and thoseloans may be added to the mortgages trust. Set-off rights may occur if the seller fails to advance to a borrower adrawing under a flexible loan when the borrower is entitled to draw additionalamounts under a flexible loan or if the seller fails to pay to a borrower anydelayed cashback which the seller had agreed to pay to that borrower aftercompletion of the relevant loan.

 

If the seller fails toadvance the drawing or pay the delayed cashback, then the relevant borrower mayset off any damages claim arising from the seller’s breach of contract againstthe seller’s (and, as assignee of the mortgages, the mortgages trustee’s) claimfor payment of principal and / or interest under the loan as and when itbecomes due.  These set-off claims willconstitute transaction set-off as described in the immediately preceding riskfactor.

 

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: the borrower mayobtain a loan elsewhere in which case the damages would be equal to anydifference in the borrowing costs together with any consequential losses,namely the associated costs of obtaining alternative funds (for example, legalfees and survey fees).  If the borroweris unable to obtain an alternative loan, he or she may have a claim in respectof other losses arising from the seller’s breach of contract where there arespecial circumstances communicated by the borrower to the seller at the timethe mortgage was taken out.

 

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In respect of a delayedcashback, the claim is likely to be in an amount equal to the amount due underthe delayed cashback together with interest and expenses and consequentiallosses (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. 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, theamounts set off will be applied to reduce the seller share of the trustproperty only.  Further there may becircumstances in which:

 

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

 

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

 

The minimum seller sharehas been sized in an amount expected to cover this risk, although there is noassurance that it will.  If the minimumseller share is not sufficient in this respect then there is a risk thatnoteholders may not receive all amounts due on the issuer notes.

 

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

 

The seller has beenappointed by the mortgages trustee and the beneficiaries as servicer to servicethe loans.  If the servicer breaches theterms of the servicing agreement, then the mortgages trustee, Funding 1 and /or the security trustee will be entitled to terminate the appointment of theservicer and appoint a new servicer in its place.

 

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.  The ability of a substitute servicer fullyto perform the required services would depend, among other things, on the information,software and records available at the time of the appointment.  Any delay or inability to appoint asubstitute servicer may affect payments on the loans and hence the issuer’sability to make payments when due on the issuer notes.

 

The noteholders shouldnote that the servicer has no obligation itself to advance payments thatborrowers fail to make in a timely fashion.

 

**Funding 1 may not receive the benefitof any claims made on the buildings insurance which could adversely affectpayments on the issuer notes**

 

No assurance can be giventhat Funding 1 will always receive the benefit of any claims made under anyapplicable insurance contracts.  Thiscould reduce the principal receipts received by Funding 1 according to theFunding 1 share percentage and could adversely affect its ability to redeem theissuer notes.  The noteholders shouldnote that buildings insurance is renewed annually.

 

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**Possible regulatory changes by theOffice of Fair Trading, the Financial Services Authority and any otherregulatory authorities may have an impact on the seller, the issuer, theservicer and / or the loans and may adversely affect the issuer’s ability tomake payments when due on the issuer notes**

 

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, the CCA,related consumer credit regulations and other consumer protectionlegislation.  The OFT may reviewbusinesses and operations, provide guidelines to follow and take actions whennecessary with regard to the mortgage 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.

 

In July 2001, the UKDepartment of Trade and Industry (“DTI”) published a consultation paper onmodernizing the CCA that invited views on which aspects of the CCA are to bereviewed.  The DTI has since published consultationpapers on specific aspects of the CCA to be reviewed including,March 2002, on the financial limit and exempt agreements under the CCA.

 

In November 2002,the DTI announced its intention that a credit agreement will be regulated bythe CCA where, for credit agreements made after this change is implemented: (a)the borrower is or includes an individual, save for partnerships of four ormore partners; (b) irrespective of the amount of credit although inJuly 2003, the DTI announced its intention that the financial limit willremain for certain business-to-business lending); and (c) the credit agreementis not an exempt agreement.  If thischange is implemented, then any loan or further advance originated or variedbilaterally after this time, other than a regulated mortgage contract under theFSMA or an exempt agreement under the CCA, will be regulated by the CCA.  Such loan or further advance will have tocomply with requirements as to form and content of the credit agreement and, ifit does not comply, will be unenforceable against the borrower.

 

In December 2003,the DTI published a White Paper on its review of the CCA, accompanied by aconsultation on (among other things) draft regulations on form and content ofcredit agreements regulated by the CCA that may come into force as early as October 31,2004.

 

The UK’s FinancialServices and Markets Act 2000 (“FSMA”) regulates a wide range of financialactivities under a single statutory-based regime.  FSMA is not yet in full effect, and will be brought into effectin stages.  The first stage (known as“N2”) came into effect December 1, 2001. Mortgage regulation will come into effect at a later stage (known as(“N(M)”) currently expected to be October 2004.

 

FSMA applies to any“regulated activity”.  After N(M) thefollowing four activities: (i) entering into; (ii) in certain circumstancesadministering; (iii) arranging; and (iv) advising on, a “regulated mortgagecontract”, will be regulated activities. Agreeing to carry on any of the activities will also be a regulatedactivity.

 

The main effect of theintroduction of mortgage regulation is that each entity carrying on a regulatedactivity with respect to regulated mortgage contracts will ordinarily berequired to hold authorization and permission from the FSA to carry on thatactivity.  Generally, each financialpromotion will have to be issued or approved by a person holding authorizationand permission from the FSA unless an exemption applies.  If requirements as to authorization of theoriginator and brokers or as to advertising are not complied with, theregulated mortgage contract will be unenforceable against the borrower exceptwith approval of a court.

 

The seller will berequired to hold authorization and permission to enter into and to administerand, where applicable, to advise on regulated mortgage contracts.  Brokers (in certain circumstances) will berequired to hold authorization and permission to arrange and, where applicable,to advise on regulated mortgage contracts.

 

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Under the terms of theregulatory regime under FSMA, the issuer and mortgages trustee will not carryon any regulated activity in relation to the regulated mortgage contracts thatare administered pursuant to an administration agreement by an entity havingthe required authorization and permission. If such administration agreement terminates, however, the issuer andmortgages trustee will have a period of not more than one month in which toarrange for mortgage administration to be carried out by a replacement administratorhaving the required authorization and permission.

 

In October 2003, theFSA published a Policy Statement containing its final conduct of businessrules.  These rules are set out in theMortgages: Conduct of Business Source Book (“MCOB”) cover conduct of businessrequirements for authorized persons. The rules provide for, *inter alia*,certain pre-origination matters, such as financial promotions and draftpre-application illustrations, start of contract disclosures, post-saledisclosures (annual statements), rules on contract charges and arrears andrepossessions.  The MCOB comes intoforce on N(M).  Further, inMarch 2003, the FSA published a consultation paper covering the changesthe FSA is proposing to make to the FSA Handbook relating to the prudential andauthorization-related requirements placed on authorized persons in respect ofregulated mortgage activities.  TheFSA’s Policy Statement and near-final rules on the prudential and otherrequirements were published in September 2003, and the FSA made thoserules on January 15, 2004.

 

The FSA has stated inConsultation Paper 146 (Chapter 4, paragraph 4.24) that to avoid dualregulation once the new regulatory regime applies, all mortgages regulated bythe FSA will not be covered by the CCA. This carve-out only affects mortgages entered into after the newregulatory regime is effective (i.e. N(M)). Before that date, the CCA will continue to be the relevantlegislation.  A court order undersection 126 of the CCA is necessary to enforce a mortgage securing a loanto the extent that it is regulated by the CCA or to be treated as such, andwill also be necessary to enforce a mortgage securing a regulated mortgagecontract.

 

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 or compliance cost may have a materialadverse effect on the seller, the issuer and / or the servicer and theirrespective businesses and operations. This may adversely affect the issuer’s ability to make payments in fullon the issuer notes when due.

 

Meanwhile, in the UnitedKingdom, self-regulation of the mortgage business exists under the MortgageCode (the “CML Code”) issued by the Council of Mortgage Lenders (the“CML”).  Halifax currently subscribes tothe CML Code.  Membership of the CML andcompliance with the CML code are voluntary. The CML Code sets out minimum standards of good mortgage businesspractice, from marketing to lending procedures and dealing with borrowersexperiencing financial difficulties. Since April 30, 1998, lender-subscribers to the CML Code may notaccept mortgage business from intermediaries who are not registered with(before November 1, 2000) the Mortgage Code Register of Intermediaries or(on and after November 1, 2000) the Mortgage Code Compliance Board.

 

In March 2001, theEuropean Commission published a Recommendation to member states urging theirmembers to subscribe to the code issue by the European Mortgage Federation (the“EMF Code”).  On July 26, 2001 theCML decided to subscribe to the code collectively on behalf of itsmembers.  Lenders had untilSeptember 30, 2002 to implement the EMF Code, an important element ofwhich is provision to consumers of a “European Standardized Information Sheet”(an “ESIS”) similar to the pre-application illustration proposed by the FSA.  However, UK lenders generally are not in aposition to begin to provide an ESIS to consumers until N(M).  The CML has discussed this with the EuropeanCommission and the European Mortgage Federation.  While compliance with the EMF Code is voluntary, if the EMF Codeis not effective, the European Commission is likely to see further pressurefrom consumer bodies to issue a directive on mortgage credit or to extend itsproposal for a directive on consumer credit to all mortgage credit.

 

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In September 2002,the European Commission published a proposal for a directive of the EuropeanParliament and of the Council on the harmonization of the laws, regulations andadministrative provisions of the member states concerning credit for consumersand surety agreements entered into by consumers.  In its current form, the proposal does not include a thresholdamount for regulated agreements (unlike the existing Directive 87/102/EEC, asamended, which provides that (subject to certain exceptions) loans notexceeding €20,000 are regulated by such Directive) and requires specifiedrequirements to be met in respect of certain mortgage loan products (includingnew credit agreements for further drawings under certain flexible mortgages andfor further advances and amortization tables for repayment mortgages).  If the proposal comes into force in itscurrent form, mortgage loans that do not comply with these requirements may beunenforceable.  Significantly, theproposal provides that it does not apply retrospectively (subject to certainexemptions including in respect of new drawings or further advances made inrespect of existing agreements) and does not apply to residential mortgageloans except those that include an equity release component.  The proposal is unlikely to come into forceuntil 2006 as the co-decision procedure of the European Parliament and of theCommission, from the publication of the proposal to the coming into force ofthe new consumer credit directive, is likely to take at least two years andmember states will then have a further two years in which to bring nationalimplementing legislation into force. The DTI is currently in consultation with consumer and industryorganizations in relation to this proposal.

 

There has beensignificant opposition from the European Parliament to the current form of theproposed directive, and it may be substantially amended before it is ultimatelybrought into effect.  Until the finaltext of the directive is decided and the details of the United Kingdomimplementing legislation are published, it is not certain what effect theadoption and implementation of the directive would have on the seller, theissuer and / or the servicer and their respective businesses and operations.  This may adversely affect the issuer’sability to make payments in full on the issuer notes when due.

 

**Regulations in the United Kingdomcould lead to some terms of the loans being unenforceable, which may adverselyaffect payments on the issuer notes**

 

In the United Kingdom,the Unfair Terms in Consumer Contracts Regulations 1999 as amended (the“UTCCR”), which together with the Unfair Terms in Consumer ContractsRegulations 1994 apply to agreements made on or after July 1, 1995 andaffect all or almost all of the loans, provide that:

 

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

 

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

 

The UTCCR will 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 a lender to vary the interest rate (as the servicer 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 issuer or the mortgages trustee, to claimrepayment of the extra interest amounts paid or to set-off the amount of theclaim against the amount owing by the borrower under the loan.  Any non-recovery, claim or set-offultimately may adversely affect the issuer’s ability to make payments on theissuer notes.

 

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In February 2000,the OFT issued a guidance note on what the OFT considers to be fair terms andunfair terms for interest variation in mortgage contracts.  Where the interest variation term does notprovide for precise and immediate tracking of an external rate outside thelender’s control, and if the borrower is locked-in by an early repayment chargethat is considered to be a penalty, the term is likely to be regarded as unfairunder the UTCCR unless the lender (i) notifies the borrower in writing at least30 days before the rate change and (ii) permits the borrower to repay the wholeloan during the next three months after the rate change, without paying theearly repayment charge.  The seller hasreviewed the guidance note and has concluded that its compliance with it willhave no material adverse effect on the loans or its business.  The guidance note is under review by the OFTand FSA, but there is no indication as to when this review is likely to beconcluded or what changes, if any, may arise from it.

 

In August 2002, theLaw Commission for England and Wales and the Scottish Law Commission issued ajoin consultation LCCP No. 166 / SLCDP 119 on proposals to rationalize the UK’sUnfair Contracts Act 1977 and the UTCCR into a single piece of legislation, anda final report is expected by the end of 2003. The Law Commissions have a duty under section 3 of the UK’s LawCommissions Act 1965 to keep the law under review for a number of purposes,including its simplification.  Theproposals are primarily to simplify the 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 the legislation should not affect core terms in so far asthey are not substantially different from what the borrower should reasonablyexpect and are transparent.  It is tooearly to tell how the proposals, if enacted, would affect the loans.

 

**Decisions of the Ombudsman could leadto some terms of the loans being varied, which may adversely affect payments onthe issuer notes**

 

Under FSMA, the FinancialOmbudsman Service is required to make decisions on, among other things,complaints relating to the terms in agreements on the basis of what, in theOmbudsman’s opinion, would be fair and reasonable in all circumstances of thecase, taking into account, among other things, law and guidance.  Complaints brought before the FinancialOmbudsman Service for consideration must be decided on a case by case basis,with reference to the particular facts of any individual case.  Each case would first be adjudicated by anadjudicator.  Either party to the casemay appeal against the adjudication.  Inthe event of an appeal, the case proceeds to a final decision by the Ombudsman.

 

In January 2002, theOmbudsman made a determination on the seller’s appeal to an earlier decision byan adjudicator at the Financial Ombudsman Service concerning a case involvingHVR 1 and HVR 2.  In March 2001,two joint borrowers with a capped rate loan originated when the seller offeredonly a single standard variable base rate contacted the seller and requestedthat their loan be linked to HVR 2.  Theseller informed the borrowers that, because they were still in their productperiod, they could either transfer to HVR 2 when their product period expiredor transfer to HVR 2 immediately and pay the applicable early repaymentfee.  The borrowers complained to theFinancial Ombudsman Service and, on January 29, 2002, on appeal by theseller, the Ombudsman determined in the borrowers’ favor and recommended thatthe seller recalculate the borrowers’ mortgage by reference to HVR 2 from thedate when the seller should have granted their request in March 2001,refund any overpayments and pay £150 for any inconvenience caused.  HVR 2 was withdrawn and ceased to beavailable to new borrowers with effect from February 1, 2002.

 

The Ombudsman’s decisiononly applies to the two borrowers and their particular circumstances, thoughother borrowers may also complain to the Ombudsman.  In March 2002, the seller announced that borrowers underloans who were in similar circumstances and who had asked to be transferred toHVR 2 when it was available would be invited to make a product switch to HVR 2and to obtain a refund for all overpayments of interest since the date they hadasked to be transferred.  For each ofthose loans, the borrowers would also receive £150 for any inconveniencecaused.  The

 

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borrowers under loans whorequested to be transferred after HVR 2 was withdrawn and before theannouncement in March 2002 were not offered a switch or a refund, thoughthe seller has given or will give each of these customers an *ex gratia*payment of £100.

 

Since then, furtherdecisions by the Ombudsman in similar cases have confirmed that affectedborrowers were only entitled to a refund of overpayments of interest from thedate when they asked to be transferred to HVR 2 and not from the date where 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 the ability of the issuer to meet itsobligations on the issuer 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.  Anynon-recovery, claim or set-off ultimately may adversely affect the issuer’sability to make payments on the issuer notes, as described above.

 

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.

 

**Tax payable by Funding 1 or theissuer may adversely affect the issuer’s ability to make payments on the issuernotes**

 

Funding 1 and the issuerwill generally be subject to UK corporation tax, currently at a rate of 30per cent., on the profit reflected in their respective profit and loss accountsas increased by the amount of any non-deductible expenses or losses.  If the tax payable by Funding 1 or theissuer is greater than expected because, for example, non-deductible expensesor losses are greater than expected, the funds available to make payments onthe noteholders’ issuer notes will be reduced and this may adversely affect theissuer’s ability to make payments on the issuer notes.

 

**Noteholders’ interests may be adverselyaffected by a change of law in relation to withholding tax**

 

In the event that amountsdue under the issuer notes are subject to withholding tax, we will not beobliged to pay additional amounts in relation thereto.  The issuer may, in certain circumstances,redeem the issuer notes.

 

**Noteholders’ interests may beadversely affected if the United Kingdom joins the European Monetary 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 inrespect of any issuer notes denominated in sterling may become payable in euro;(b) applicable provisions of law may allow or require us to re-denominate therequisite issuer notes into euro and take additional measures in respect ofsuch issuer notes; and (c) the introduction of the euro as the lawful currencyof the United Kingdom may result in the disappearance of published or displayedrates for deposits in

 

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sterling used todetermine the rates of interest on the issuer notes or changes in the way thoserates are calculated, quoted and published or displayed.  The introduction of the euro could also beaccompanied by a volatile interest rate environment, which could adverselyaffect a borrower’s ability to repay its loan as well as adversely affectinvestors.  It cannot be said withcertainty what effect, if any, adoption of the euro by the United Kingdom wouldhave on investors in the issuer notes.

 

**Changes of law may adversely affectnoteholders’ interests**

 

The structure of theissue of the issuer notes and the ratings which are assigned to them are basedon English law in effect as at the date of the prospectus relating to theissuer notes.  No assurance can be givenas to the impact of any possible change to English law or administrativepractice in the United Kingdom or to the law or administrative practice of anyother relevant jurisdiction after the date of this Form 20-F.

 

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

 

Secondary legislationhas now been enacted which exclude certain special purpose companies inrelation to capital market transactions from the operational moratoriumprovisions.  Such exceptions include(amongst other matters): (i) a company that is party to an agreement that is orforms part of a capital market arrangement (as defined in the secondarylegislation) under which (a) a party has incurred or when the agreement wasentered into was expected to incur a debt of at least £10 million under thearrangement and (b) the arrangement involves the issue of a capital marketsinvestment (also defined, but generally, a rated, listed or traded bond); and(ii) a company which has incurred a liability (including a present, future orcontingent liability) of at least £10 million. While the issuer, the mortgages trustee and Funding 1 should fall withinthe exceptions, there is no guidance as to how the legislation will beinterpreted and the Secretary of State for Trade and Industry may be regulationmodify the exception.  No assurance maybe given that any modification of the eligibility requirements for “small”companies and / or the exceptions will not be detrimental to the interests ofthe noteholders.

 

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

 

*Enterprise Act 2002.*OnSeptember 15, 2003, the corporate insolvency provisions of the EnterpriseAct 2002 came into force, amending certain provisions of the Insolvency Act1986 (as amended, the “Insolvency Act”). These provisions introduced significant reforms to corporate insolvencylaw.  In particular the reforms restrictthe right of the holder of a floating charge created after September 15,2003 to appoint an administrative receiver (unless an exception applies) andinstead gives primacy to collective insolvency procedures (in particular,administration).

 

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The holder of a floatingcharge created before September 15, 2003 over the whole or substantiallythe whole of the assets of a company (such as the security trustee under theFunding 1 deed of charge) retains the ability to block the appointment ofadministrator 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 exemptionprovides that the right to appoint an administrative receiver is retained forcertain types of security (such as the issuer security) that form part of acapital markets arrangement (as defined in the Insolvency Act) that involvediindebtedness of at least £50 million (or, when the relevant security documentwas entered into (being in respect of the transactions described in theprospectus relating to the issuer notes and the issued deed of charge), a partyto the relevant transaction (such as the issuer) was expected to incur a debtof at least £50 million) and the issue of a capital markets investment (alsodefined, but generally, a rated, listed or traded bond).  The Secretary of State for Trade andIndustry may, by secondary legislation, modify the capital market exception and/ or provide that the exception shall cease to have effect.  No assurance can be given that any suchmodification or provision in respect of the capital market exception, or itsceasing to be applicable to the transactions described in this document willnot adversely affect payments on the issuer notes.  In addition, as the provisions of the Enterprise Act have neverbeen considered judicially, no assurance can be given as to whether theEnterprise Act could have a detrimental effect on the transaction described inthe prospectus relating to the issuer notes or in the interests of thenoteholders.

 

The Insolvency Act alsocontains a new out-of-court route into administration for a qualifying floatingcharge holder, the directors or the company itself.  The relevant provisions provide for a notice period during whichthe holder of the floating charge can either agree to the administratorproposed by the directors of the company or appoint an alternativeadministrator, although the moratorium will take effect immediately afternotice is given.  If the qualifyingfloating charge holder does not respond to the directors’ notice of intentionto appoint, the directors, or as the case may be, the company’s appointee willautomatically take office after the notice period has elapsed.  Where the holder of a qualifying floatingcharge within the context of a capital market transaction retains the power toappoint an administrative receiver, such holder may prevent the appointment ofan administrator (either by the new out-of-court route or by the court basedprocedure), by appointing an administrative receiver prior to the appointmentof the administrator being completed.

 

The new provisions of theInsolvency Act give primary emphasis to the rescue of the company as a goingconcern.  The purpose of realizingproperty to make a distribution to one or more creditors is subordinated to theprimary purposes of rescuing the company as a going concern or achieving abetter result for the creditors as a whole than would be likely than if thecompany were wound up.  No assurancescan be given that the primary purposes of the new provisions will not conflictwith the interests of the noteholders were the issuer ever subject toadministration.

 

In addition to theintroduction of a prohibition on the appointment of an administrative receiveras set out above, section 176A of the Insolvency Act provides that inrelation to floating charges created after September 15, 2003 any receiver(including an administrative receiver), liquidator or administrator of acompany is required to make a “prescribed part” of the company’s “net property”available for the satisfaction of unsecured debts in priority to the claims ofthe floating charge holder.  Thecompany’s “net property” is defined as the amount of the chargor’s propertythat would be available for satisfaction of debts due to the holder(s) of anydebentures secured by a floating charge and so refers to any floating chargerealizations less any amounts payable to the preferential creditors in respectof 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 percent. of the first £10,000 of floating charge realizations plus 20 per cent. ofthe floating charge realizations thereafter, provided that such amount may notexceed £600,000.

 

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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 officeholder may also apply to court for an orderthat the provisions of section 176A of the Insolvency Act should not applyon the basis that the cost of making a distribution would be disproportionateto the benefits.

 

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

 

**The noteholders will not receiveissuer notes in physical form, which may cause delays in distributions andhamper the noteholders’ ability to pledge or resell the 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 ofthe issuer notes in physical form could, among other things:

 

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

 

•                  makeit difficult for the noteholders to pledge the issuer notes if the issuer notesin physical form are required by the party demanding the pledge; and

 

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

 

**If the noteholders have a claimagainst the issuer it may be necessary for the noteholders to bring suitagainst the issuer in England to enforce the noteholders’ 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.

 

**Proposed changes to the Basel CapitalAccord and the risk-weighted asset framework may result in changes to therisk-weighting of the issuer notes or permit the issuer to redeem or purchasethe issuer notes**

 

The Basel Committee onBanking Supervision has issued proposals for reform of the 1988 Capital Accordand has proposed a framework that places enhanced emphasis on market disciplineand sensitivity to risk.  The thirdconsultative paper on the New Basel Capital Accord was issues on April 29,2003 with the consultation period ending on July 31, 2003.  The Committee intends to finalize the NewBasel Capital Accord by no later than the middle of 2004, allowing forimplementation of the new framework in each country at year end 2006.  If implemented in accordance with theircurrent form, the proposals could affect the risk-weighting of the issuer notesin respect of certain investors if those investors are subject to the newframework following the implementation of the New Basel Capital Accord.  Consequently, investors should consult theirown advisers as to the consequences to and effect on investors of the proposedimplementation of the New Basel Capital Accord.  The issuer cannot predict the precise effects of potentialchanges that might result if the proposals were adopted in their current form.

 

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

 

**Item 4.  Informationon the Company**

 

A.*                          Historyand Development of the Company*

 

Not applicable.

 

B.*                            BusinessOverview*

 

Not applicable.

 

C.*                            OrganizationalStructure*

 

Not applicable.

 

D.*                           Property,Plants and Equipment*

 

The issuer

 

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

 

Funding 1

 

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

 

The mortgages trustee

 

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 borrowermaking a drawing under any flexible loan, any interest, principal and otheramounts (excluding third party amounts) paid by borrowers on their loans andtheir related security, the rights under the insurance policies that areassigned to the mortgages trustee or of which the mortgages trustee has thebenefit, and amounts on deposit and interest earned on the mortgages trusteeguaranteed investment contract.  Anyactual losses in relation to the loans, any actual reductions occurring in respectof the loans and distributions of principal made from time to time to thebeneficiaries or the mortgages trust will be deducted from the trustproperty.  The composition of the trustproperty will fluctuate as drawings under flexible loans and new loans areadded, as borrowers take payment holidays or make underpayments under a loanand as the loans that were previously part of the trust property are repaid,mature, default or are repurchased by the seller.

 

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

 

A.*                          OperatingResults*

 

Not applicable.

 

B.*                            Liquidityand Capital Resources*

 

Not applicable.

 

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

 

Not applicable.

 

D*.**                           TrendInformation*

 

Not applicable.

 

E.*                             Off-balanceSheet Arrangements*

 

Not applicable.

 

F.*                             TabularDisclosure of Contractual Obligations*

 

Not applicable.

 

G*.**                            SafeHarbor*

 

Not applicable.

 

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

 

A.*                          Directorsand Senior Management*

 

The following sets 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 isorganized as a special purpose company and will be largely passive, it isexpected that the directors of each entity in that capacity will manage itsoperations to the extent necessary.

 

The issuer

 
| **Name**                       |   | **Business  Address**                                             |   | **Business  Occupation**                             |   |
|--------------------------------|--------|-------------------------------------------------------------------|--------|------------------------------------------------------|--------|
| SFM Directors Limited          |   | Blackwell House  Guildhall Yard  London EC2V 5AE                  |   | Provision of directors to  special purpose companies |   |
|                           |   |                                                              |   |                                                 |   |
| SFM Directors (No. 2)  Limited |   | Blackwell House  Guildhall Yard  London EC2V 5AE                  |   | Provision of directors  to special purpose companies |   |
|                           |   |                                                              |   |                                                 |   |
| David Balai                    |   | HBOS Treasury Services  plc  33 Old Broad Street  London EC2N 1HZ |   | Head of Mortgage  Securitisation and Covered Bonds   |   |

 

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Funding 1

 
| **Name**                       |   | **Business  Address**                                             |   | **Business  Occupation**                             |   |
|--------------------------------|--------|-------------------------------------------------------------------|--------|------------------------------------------------------|--------|
| SFM Directors Limited          |   | Blackwell House  Guildhall Yard  London EC2V 5AE                  |   | Provision of directors to  special purpose companies |   |
|                           |   |                                                              |   |                                                 |   |
| SFM Directors (No. 2)  Limited |   | Blackwell House  Guildhall Yard  London EC2V 5AE                  |   | Provision of directors  to special purpose companies |   |
|                           |   |                                                              |   |                                                 |   |
| David Balai                    |   | HBOS Treasury Services  plc  33 Old Broad Street  London EC2N 1HZ |   | Head of Mortgage  Securitisation and Covered Bonds   |   |

 

The mortgages trustee

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

 

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

 

B.*                            Compensation*

 

The issuer

 

In accordance with theissuer corporate services agreement entered into between the issuer, theseller, the security trustee, the note trustee, Holdings and Structured FinanceManagement Limited (“SFM”), the seller and SFM will each provide directors andother corporate services for the issuer in consideration for a payment of aseparate fee payable by the issuer to SFM. No other remuneration is paid to 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 otherremuneration is paid to any director or officer in connection with suchdirector’s or officer’s activities on behalf of Funding 1.

 

The mortgages trustee

 

In accordance with themortgages trustee corporate services agreement entered into between themortgages trustee, the security trustee, the note trustee and SFM OffshoreLimited (“SFM

 

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Offshore”), the sellerand SFM Offshore will each provide directors and SFM Offshore will provideother corporate services for the mortgages trustee in consideration for apayment of a separate fee payable by the mortgages trustee to SFMOffshore.  No other remuneration is paidto any director or officer in connection with such director’s or officer’sactivities on behalf of the mortgages trustee.

 

C.                            *BoardPractices*

 

Not applicable.

 

D.                           *Employees*

 

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

 

E.                             *ShareOwnership*

 

Not applicable.

 

**Item 7.  MajorShareholders and Related Party Transactions**

 

A.                          *MajorShareholders*

 

The issuer and Funding 1are wholly owned by Permanent Holdings Limited, a company incorporated underthe laws of England and Wales.  SFMCorporate holds all of the beneficial interest in the issued shares of Holdingson a discretionary trust for the benefit of The National Society for thePrevention of Cruelty to Children in the United Kingdom and for othercharitable 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.                            *RelatedParty 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 ofExperts and Counsel*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 8.  FinancialInformation**

 

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 governmentalproceedings pending or known to be contemplated and any material proceeding inwhich any director or affiliate is either a party adverse to a registrant orhas a material interest adverse to a registrant.

 

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**Item 9.  The Offer andListing**

 

A.*                          Offerand Listing Details*

 

Not applicable.

 

B.*                            Planof Distribution*

 

Not applicable to annualreports filed on Form 20-F.

 

C.*                            Markets*

 

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

 

D.*                           SellingShareholders*

 

Not applicable to annualreports filed on Form 20-F.

 

E.*                             Dilution*

 

Not applicable to annualreports filed on Form 20-F.

 

F.*                             Expensesof the Issue*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 10.  AdditionalInformation**

 

A.*                          ShareCapital*

 

Not applicable to annualreports filed on Form 20-F.

 

B.*                            Memorandumand Articles of Association*

 

The memorandum andarticles of association for each of the issuer, Funding 1 and the mortgagestrustee are incorporated by reference from the Registration Statement.  Please also see the description of theissuer, Funding 1 and the mortgages trustee set forth in the RegistrationStatement.

 

C.                            *MaterialContracts*

 

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

 

D.*                           ExchangeControls*

 

None.

 

E.*                             Taxation*

 

**United Kingdom Taxation**

 

The followingsection summarizes the material UK tax consequences of the purchase, ownershipand disposition of the issuer notes based on current law and practice in theUK. The summary assumes that the profit in Funding 1’s profit and loss accountwill not exceed 0.01 per cent. of the Funding 1 available revenue receiptsand that 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.  It furtherassumes that all payments made pursuant to the final documentation arecalculated on arm’s length terms.  Thesummary does not purport to be a complete analysis of all tax

 

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considerations of thepurchase, ownership and disposition of the issuer notes.  It relates to the position of persons whoare the absolute beneficial owners of issuer notes and may not apply to certainclasses of persons such as dealers or persons connected 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.

 

**Taxation of US residents**

 

As discussed in moredetail below, no UK withholding tax will be required in relation to interestpayments on the issuer notes provided that the issuer notes are listed on a recognised stock exchange, whichincludes the London Stock Exchange.  Ifthe issuer notes cease to be listed on a “recognised stock exchange”, an amountmust be withheld on account of UK income tax at the lower rate (currently 20per cent.), subject to any direction to the contrary from the Inland Revenue inrespect of such relief as may be available pursuant to the provisions of anapplicable 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 residentholders of the issuer notes to UK tax on interest**” below, a noteholder who is resident in theUS for US tax purposes and who is not resident in the UK for UK tax purposeswill not be subject to UK tax in respect of any payments on the issuer notesunless they are held by or for a trade, profession or vocation carried on byhim 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.

 

**Withholding tax**

 

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 “recognized stock exchange”, as defined inSection 841 of the Income and Corporation Taxes Act 1988 (“ICTA”).  The London Stock Exchange is current arecognized stock exchange for this purpose. If the issuer notes cease to be listed on a “recognized stock exchange”,an amount must be withheld on account of UK income tax at the lower rate(currently 20 per cent.) from interest paid on them, subject to any directionto the contrary by the Inland Revenue in respect of such relief as may beavailable pursuant to the provisions of an applicable double taxation treaty orto the interest being paid to persons (including companies within the charge toUK corporation tax) and in circumstances specified in Section 349A to 349Dif the ICTA.

 

Noteholders who areindividuals may wish to note that the Inland Revenue 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 the Inland Revenue with the taxauthorities of other jurisdictions.

 

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**Direct assessment of non-UK residentholders 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.

 

**Taxation of returns: companies withinthe 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.  Any such profits and gains will generallyfall to be calculated in accordance with the statutory accounting treatment ofthe issuer notes in the hands of the relevant noteholder, and will generally becharged to tax as income in respect of each accounting period to which they areallocated, in accordance with that accounting treatment.  Relief may be available in respect of lossesor for related expenses on a similar basis.

 

**Taxation of returns: othernoteholders**

 

Noteholders who are notwithin the charge to UK corporation tax and who are resident or ordinarilyresident in the UK for tax purposes or who carry on a trade, profession orvocation in the UK through a branch or agency in connection with which intereston the issuer notes is received or to which the issuer notes are attributablewill generally be liable to UK tax on the amount of any interest received inrespect of the issuer notes.  As theseries 2 issuer notes and series 4 class A issuer notes are denominated in USdollars and the series 3 issuer notes, series 4 class B issuer notes and series4 class C issuer notes are denominated in euro, they will not be regarded bythe Inland Revenue as constituting “qualifying corporate bonds” within themeaning of Section 117 of the Taxation of Chargeable Gains Act 1992.  Accordingly, a disposal of any of theseissuer notes may give rise to a chargeable gain or an allowable loss for thepurpose of the UK taxation of chargeable gains.

 

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

 

A disposal of the 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 which constitute variable rate securities, taxationin respect of such a disposal will be computed on the basis that such amount asthe Inland Revenue considers to be just and reasonable will be treated asaccrued income.  However, the transfereeof a variable rate security will not be entitled to any relief on suchamount.  All of the issuer notes willconstitute variable rate issuer notes for this purpose.

 

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**Stamp duty 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 a note in definitive form.

 

**UK taxation of Funding 1 and theissuer**

 

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 orlosses.  Examples of non-deductibleexpenses and losses include general provisions for bad debts.  In respect of Funding 1, the profit in theprofit and loss account will not exceed 0.01 per cent. of the Funding 1available revenue receipts. In respect of the issuer, the profit in the profitand loss account will not exceed 0.01 per cent. of the interest on theissuer term advances under the issuer intercompany loan.

 

**UK taxation of the mortgages trustee**

 

The mortgages trustee willhave no liability to UK tax in respect of any income, profit or gain arisingunder these arrangements.  Accordingly,the mortgages trustee will have no liability to UK tax in relation to amountsthat it receives on behalf of Funding 1 or the seller under the mortgagestrust.

 

**EU Savings Directive**

 

On June 3, 2003, theEuropean Council of Economics and Finance Ministers adopted a Directive on thetaxation of savings income (the “EU Savings Tax Directive”) under which MemberStates will be required from a date not earlier than January 1, 2005 toprovide to the tax authorities of other Member States details of payments ofinterest and other similar income paid by a person to an individual in anotherMember State, except that Austria, Belgium and Luxembourg will instead berequired (unless during that period they elect otherwise) to operate awithholding system in relation to such payments (the ending of suchtransitional period being dependent upon the conclusion of certain otheragreements relating to information exchange with certain other countries).

 

Jersey is not a member ofthe European Union and therefore is not required to implement the EU SavingsTax Directive. However, the Policy & Resources Committee of the States ofJersey has announced that, in keeping with Jersey’s policy of constructiveinternational engagement, Jersey, in line with steps proposed by other relevantthird countries proposes to introduce a withholding tax system in respect ofpayments of interest, or other similar income, made to an individual beneficialowner resident in an EU Member State by a paying agent situated in Jersey (theterms “beneficial owner” and “paying agent” for this purpose are as defined inthe EU Savings Tax Directive). The withholding tax system would apply for atransitional period prior to the implementation of a system of automaticcommunication to EU Member States of information regarding such payments.During this transitional period, such an individual beneficial owner residentin an EU Member State will be entitled to request a paying agent not towithhold tax from such payments but instead to apply a system by which thedetails of such payments are communicated to the tax authorities of the EUMember State in which the beneficial owner is resident.

 

The States ofJersey have not yet adopted measures to implement these proposals but areexpected to adopt such measures on the same timetable as EU Member States andother relevant third countries.

 

**United States Federal Income Taxation**

 

The followingsection summarizes the material US federal income tax consequences of thepurchase, ownership and disposition of the series 2 issuer notes and series 4class A issuer notes (the “US notes”). In general, the summary assumes that a holder acquires the US notesat original issuance and holds the US notes as capital assets.  It does not purport to be acomprehensive description of all the tax considerations that may be relevant toa decision to purchase the US notes. In particular, it does not discuss special tax considerations thatmay apply to certain types of taxpayers, including, without limitation,the following: (i) financial institutions; (ii) insurance companies; (iii)dealers or

 

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traders in stocks,securities, notional principal contracts or currencies; (iv) tax-exemptentities; (v) regulated investment companies; (vi) persons that will hold theUS notes as part of a “hedging” or “conversion” transaction or as a position ina “straddle” for US federal income tax purposes; (vii) persons that own (or aredeemed to own) 10 per cent. or more of the voting shares of the issuer; (viii)persons who hold US notes through partnerships or other pass-through entities;and (ix) persons that have a “functional currency” other than the USdollar.  In addition, this summary doesnot address alternative minimum tax consequences, nor does it describe any taxconsequences 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 of the foregoing are subject to change,and any change may apply retroactively and could affect the tax consequencesdescribed below.

 

**Investors should consult their owntax advisors as to the US federal income tax consequences of the purchase,ownership and disposition of the US notes, including the possible applicationof state, local, non-US or other tax laws, and other US tax issues affectingthe transaction.**

 

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

 

**Tax status 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.  Assumingcompliance with these covenants, none of the issuer, Funding 1 or the mortgagestrustee acting in its capacity as trustee of the mortgages trust will besubject to US federal income tax.  Noelections will be made to treat the issuer, Funding 1 or the mortgages trusteeor any of their assets as a REMIC or a FASIT (two types of securitisationvehicles having a special tax status under the Code).

 

**Characterization of 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.  The issuer intends to treat the US notes asindebtedness of the issuer for all purposes, including US tax purposes.  The discussion in the nextsection assumes this 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)(5)(C) or 860G(a)(3) of the Code, respectively.

 

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**Taxation of United States holders ofthe US notes**

 

*Qualified Stated Interest and OriginalIssue Discount.*The issuer intends to treat interest on theUS notes as “qualified stated interest” under US Treasury regulations relatingto original issue discount (hereafter the “OID regulations”).  As a consequence, discount on the US notesarising from an issuance at less than par will only be required to be accruedunder the OID regulations if such discount exceeds a statutorily defined *de minimis*amount.  Qualified stated interest,which generally must be unconditionally payable at least annually, is taxedunder a holder’s normal method of accounting as ordinary interest income.  *Deminimis* OID is included in income on a *pro rata* basis as principalpayments are made on the US notes.

 

It is possiblethat interest on the class B and class C US notes could be treated as originalissue discount (“OID”) because such interest is subject to deferral in certainlimited circumstances.  A United Statesholder of a US note issued with OID must include OID in income over the term ofsuch US note under a constant yield method that takes into account thecompounding of interest.  Under theCode, OID is calculated and accrued using prepayment assumptions where paymentson a debt instrument may be accelerated by reason of prepayments of otherobligations securing such debt instrument. Moreover, the legislative history to the provisions provide that thesame 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 isnot expected to alter the scheduled principal payments on the class B and classC US notes and, accordingly, the issuer intends to assume that the class B andclass C US notes will have their principal repaid according to the schedule forpurposes of accruing any OID.  Norepresentation is made that the mortgage loans will pay on the basis of suchprepayment 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 class B and class C US notes, including statedinterest, acquisition discount, OID, *de minimis* OID, market discount, *de minimis*market discount, and unstated interest, as adjusted by any amortizable bondpremium or acquisition premium, using the constant yield method describedabove.

 

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 on foreign taxes eligible forthe US foreign tax credit is calculated separately with respect to specificclasses of income.  For this purpose,the interest on the US notes should generally constitute “passive income” or,in the case of certain United States holders, “financial services income”.

 

*Sales and Retirement.*In general, a United States holder of a US note will have a basis in such USnote equal to the cost of the US note to such holder, and reduced by anypayments thereon other than payments of stated interest.  Upon a sale or exchange of the US note, aUnited States holder will generally recognize gain or loss equal to thedifference between the amount realized (less any accrued interest, which wouldbe taxable as such) and the holder’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 consult their own tax advisors withrespect to the treatment of capital gains (which may be taxed at lower ratesthan ordinary income for taxpayers who are individuals, trusts or estates thathold the US notes for more than one year) and capital losses (the deductibilityof which is subject to limitations).**

 

**Taxation of Non-United States holdersof 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 US

 

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note and gain from thesale, redemption or other disposition of a US note unless: (i) that payment and/ or gain is effectively connected with the conduct by that Non-United Statesholder of a trade or business in the United States; (ii) in the case of anygain realized on the sale or exchange of a US note by an individual Non-UnitedStates holder, that holder is present in the United States for 183 days or morein the taxable year of the sale, exchange or retirement and certain otherconditions are met; or (iii) the Non-United States holder is subject to taxpursuant to provisions of the Code applicable to certain expatriates.  **Non-United States holders should consult their own taxadvisors regarding the US federal income and other tax consequences of owningUS notes.**

 

**Alternative characterization of theUS 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 issuerintends to treat the US notes as debt for all US federal income tax purposes. Investorsshould consult their own tax advisors with respect to the potential impact ofan alternative characterization of 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 other class of US notes were treated as equity,United States holders of such notes would be treated as owning equity in apassive foreign investment company (“PFIC”) which, depending on the level ofownership of such United States holder and certain other factors, might alsoconstitute an interest in a controlled foreign corporation for such UnitedStates holder.  This would have certaintiming and character consequences for United States holders and could requirecertain elections and disclosures that would need to be made shortly afteracquisition to avoid potentially adverse US tax consequences.

 

If a United States holderwere treated as owning an equity interest in a PFIC, unless a United Statesholder makes a “QEF election” or “mark to market election”, a United Statesholder will be subject to a special tax regime (i) in respect of gains realizedon the sale 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 free from doubt, the PFIC rulesshould not apply to gain realized in respect of any notes disposed of duringthe same taxable year in which such notes are acquired.  An excess distribution generally includesdividends or other distributions received from a PFIC in any taxable year tothe extent the amount of such distributions exceeds 125 per cent. of theaverage distributions for the three preceding years (or, if shorter, theinvestor’s holding period).  Because theUS notes pay interest at a floating rate, it is possible that a US holder willreceive “excess distributions” as a result of fluctuations in the rate ofUSD-LIBOR over the term of the US notes. In general, under PFIC rules, a United States holder will be required toallocate such excess distributions and any gain realized on a sale of its notesto each day during the United States holder’s holding period for the notes, andwill be taxable at the highest rate of taxation applicable to the notes for theyear to which the excess distribution or gain is allocable (without regard tothe United States holder’s other items of income and loss for such taxableyear) (the “deferred tax”).  Thedeferred tax (other than the tax on amounts allocable to the year ofdisposition or receipt of the distribution) will then be increased by aninterest charge computed by reference to the rate generally applicable tounderpayments of tax (which interest charge generally will be non-deductibleinterest expense for individual taxpayers).

 

**Backup withholding and informationreporting**

 

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.  Theissuer, its agent, a broker, or any paying agent, as the case may be, may berequired to withhold tax from any payment that is subject to backup withholdingif the United States holder fails to furnish the United States holder’staxpayer identification number (usually on IRS Form W-9), to certify that such

 

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United States holder isnot subject to backup withholding, or to otherwise comply with the applicablerequirements of the backup withholding rules.  Certain United Statesholders (including, among others, corporations) are not subject to the backupwithholding and information reporting requirements.  Non-United States holders may be required to comply withapplicable certification procedures (usually on IRS Form W-8BEN) to establishthat they are not United States holders in order to avoid the application ofsuch information reporting requirements 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) ofthe Code), (ii) a controlled foreign corporation (as defined insection 957(a) of the Code), (iii) a foreign person 50 per cent. or moreof whose gross income is effectively connected with a US trade or business fora specified three-year period, or (iv) a foreign partnership if (A) at any timeduring its tax year, one or more of its partners are United States persons (asdefined in applicable Treasury regulations) who in the aggregate hold more than50 per cent. of the income or capital interest in the partnership or (B) at anytime during its taxable year, it is engaged in a US trade or business (each of(i) through (iv), a “US Connected Holder”), such custodian, nominee or otheragent may be subject to certain information reporting requirements with respectto such payment unless it 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. Principal andinterest paid by the US office of a custodian, nominee or agent will be subjectto both backup withholding and information reporting unless the beneficialowner certifies its non-US status under penalties of perjury or otherwiseestablishes an exemption. Payments of proceeds on the sale of a US note made toor through a foreign office of a broker will not be subject to backupwithholding. However, if such broker is a US Connected Holder, informationreporting will be required unless the broker has in its records documentaryevidence that the beneficial owner is not a United States holder and certainconditions are met or the beneficial owner otherwise establishes an exemption.Payments of proceeds on the sale of a US note made to or through the US officeof a broker will be subject to backup withholding and information reportingunless the beneficial owner certifies, under penalties of perjury, that it is nota US holder or otherwise establishes an exemption.

 

Backup withholding is notan additional tax.  Any amounts withheldunder the backup withholding rules will be refunded or credited against theUnited States holder’s US federal income tax liability, provided that therequired information is furnished to the IRS. **Holdersof US notes should consult their tax advisors as to their qualification forexemption from backup withholding and the procedure for obtaining an exemption.**

 

**Material Jersey (Channel Islands) TaxConsiderations**

 

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.  Themortgages trustee will not be liable for any income tax in Jersey in respect ofany income it receives in its capacity as mortgages trustee on behalf of thebeneficiaries of the mortgages trust.

 

F.                             *Dividendsand Paying Agents*

 

Not applicable to annualreports filed on Form 20-F.

 

G.                            *Statement byExperts*

 

Not applicable to annualreports filed on Form 20-F.

 

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H.                           *Documents onDisplay*

 

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 thisannual report and the exhibits thereto, may be inspected and copied at theSEC’s public reference rooms in Washington, DC, New York, NY and Chicago,IL.  Please call the SEC at+1-800-732-0330 for further information on the public reference rooms.  Any filings made by the issuer, Funding 1 orthe mortgages trustee will be made available to the public over the Internet atthe SEC’s web site at http://www.sec.gov.

 

I.   *Subsidiary Information*

 

Not applicable to annualreports filed on Form 20-F.

 

**Item 11.  Quantitativeand Qualitative Disclosures About Market Risk**

 

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

 

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

 

•                  issuerdollar currency swaps: to protect the issuer against changes in the sterling todollar exchange rate following the closing date and the possible variancebetween a LIBOR based rate for three-month sterling deposits and a LIBOR basedrate for three-month dollar deposits, applicable to the series 2 issuer notesand the series 4 class A issuer notes; and

 

•                  issuereuro currency swaps: to protect the issuer against changes in the sterling toeuro exchange rate following the closing date and the possible variance betweena LIBOR based rate for three-month sterling deposits and a EURIBOR based ratefor three month euro deposits applicable to the series 3 issuer notes, series 4class B issuer notes and series 4 class C issuer notes.

 

**The Funding 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.  Otherloans pay a fixed rate of interest for a period of time.  However, the interest rate payable by Funding1 with respect to the issuer term advances is calculated as a margin over LIBORfor three-month sterling deposits.  Toprovide 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,

 

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Funding 1, the Funding 1swap provider and the security trustee have entered into the Funding 1 swap asamended and restated on November 25, 2003.  The Funding 1 swap:

 

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

 

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

 

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

 

•                  theamount produced by applying LIBOR for three-month sterling deposits (asdetermined in respect of the corresponding interest period under theintercompany loans) plus a spread for the relevant calculation period to thenotional amount of the Funding 1 swap as described later in thissection (known as the “calculation period swap provider amount”); and

 

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

 

(i)                                     theaverage of the standard variable mortgage rates or their equivalent charged toexisting borrowers on residential mortgage loans as published from time totime, after excluding the highest and the lowest rate, of Abbey National plc,HSBC Bank plc, Lloyds TSB plc, National Westminster Bank Plc, NationwideBuilding Society, Northern Rock plc and Woolwich plc (and where those bankshave more than one standard variable rate, the highest of those rates);

 

(ii)      the rates of interestpayable on the tracker rate loans; and

 

(iii)   the rates of interest payableon the fixed 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 the first day (or if not a LondonBusiness Day, the next succeeding London Business Day) of each month and anyother day on which Funding 1 acquires a further interest in the trust propertyfrom and including the calculation date immediately preceding the effectivedate.  “London Business Day” is definedas a day (other than a Saturday or Sunday) on which banks are generally openfor business in London.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

If a payment is to bemade by the Funding 1 swap provider, that payment will be included in 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 isto be made by Funding 1, it will be made according to the relevant order ofpriority of payments of Funding 1.

 

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

 

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

 

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

 

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

 

In the event that theFunding 1 swap is terminated prior to the service of any issuer intercompanyloan acceleration notice or final repayment of any intercompany loan, Funding 1shall enter into a new 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 a new Funding 1 swap on termsacceptable to the rating agencies, this may affect amounts available to payinterest on the intercompany loans.

 

**The issuer 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 are denominated in US dollars and accrue interest ateither a LIBOR based rate for one-month US dollar deposits or a LIBOR basedrate for three-month US dollar deposits. 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 the potential interest rate and/ or currency mismatch between (i) its receipts and liabilities in respect ofthe issuer intercompany loan and (ii) its receipts and liabilities under theissuer notes, the issuer has, pursuant to the terms of the issuer currencyswaps, swapped its receipts and liabilities in respect of all euro denominatedissuer notes and all US dollar denominated issuer notes into sterling on termsthat match the issuer’s obligations under the US dollar denominated issuernotes or the euro denominated issuer notes, as applicable.

 

The currency amount ofeach issuer swap is the principal amount outstanding under the term advance forthe issuer notes to which the relevant issuer currency swap relates.  In order to allow for the effective currencyamount of each issuer currency swap to amortize at the same rate as therelevant class of issuer notes, each issuer currency swap agreement providesfor a number of conditional mini-swaps intended to ensure that as and when theissuer notes amortize, a portion of the relevant issuer swap so terminated willbe

 

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swapped from sterlinginto US dollars at the relevant dollar currency exchange rate or into euro atthe euro currency exchange rate, as applicable.

 

The obligations of theseries 4 issuer swap provider under the relevant issuer swaps are guaranteed bythe issuer currency swap guarantor pursuant to a guarantee (the “series 3issuer 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 replacementissuer swap must be entered into on terms acceptable to the rating agencies,the issuer and the security trustee and with a replacement issuer currency swapprovider whom the rating agencies have previously confirmed in writing to theissuer and the security trustee will not cause the then current ratings of theissuer notes to be downgraded, withdrawn or qualified.  If the issuer is unable to enter into anyreplacement issuer currency swaps on terms acceptable to the rating agencies,this may affect amounts available to pay amounts due under the issuer notes.

 

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

 

**Ratings downgrade of swap providers**

 

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

 

**Termination of the swaps**

 

The Funding 1 swap willterminate on the date on which the aggregate principal amount outstanding underall intercompany loans is reduced to zero.

 

Each issuer swap otherthan the series 2 class A issuer swap, the series 3 class A issuer swap and theseries 4 class A issuer swap will terminate on the earlier of the interestpayment date falling in June 2042 and the date on which all of the relevantclass and series of issuer notes are redeemed in full.  The series 2 class A issuer swap willterminate on the earlier of the interest payment date falling inSeptember 2007 and the date on which the series 2 class A issuer notes areredeemed in full.  The series 3 class Aissuer swap will terminate on the earlier of the interest payment date fallingin December 2032 and the date on which the series 3 class A issuer notesare 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.

 

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

 

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

 

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

 

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

 

•                  inrespect of the issuer swaps, at the option of the issuer, if certain taxrepresentations by the relevant issuer swap provider prove to have been untrueor misleading in any material respect;

 

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

 

•                  uponthe occurrence of an insolvency of the relevant swap provider or its guarantor,as applicable, or the merger of one of the relevant swap providers without anassumption of the obligations under the relevant swap agreement or changes inlaw resulting in the obligations of one of the parties becoming illegal; and

 

•                  ifthe relevant swap provider or its guarantor, as applicable, is downgraded andfails to comply with the requirements of the ratings downgrade provision containedin the relevant swap agreement.

 

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 beliable to make a termination payment to the other party (in the case of theFunding 1 swap).  This terminationpayment will be calculated and made in sterling.  The amount of any termination payment will be based on the marketvalue of the terminated swap based on market quotations of the cost of enteringinto a swap with the same terms and conditions that would have the effect ofpreserving the respective full payment obligations of the parties (or basedupon a good faith determination of total loses (or gains) if an insufficientnumber of quotations can be obtained or if basing the valuation on quotationswould not produce a commercially reasonable result).  Any such termination payment could be substantial.

 

If any issuer swap isterminated early and a termination payment is due by the issuer to an issuerswap provider, then, pursuant to its obligations under the issuer intercompanyloan, Funding 1 shall pay to the issuer an amount equal to the terminationpayment due to the relevant issuer swap provider less, any amount received bythe issuer under any replacement issuer swap agreement.  These payments will be made by Funding 1only after paying interest amounts due on the issuer term advances and afterproviding for any debit balance on the principal deficiency ledger.  The issuer shall apply amounts received fromFunding 1 under the issuer intercompany loan in accordance with the issuerpre-enforcement revenue priority of payments or, as the case may be, the issuerpost-enforcement priority of payments. The application by the issuer of termination payments due to an issuerswap provider may affect the funds available to pay amounts due to noteholders.

 

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 thespot rate of exchange until a replacement issuer currency swap is entered intoand / or to acquire a replacement issuer currency swap.  Noteholders will not receive extra amounts(over and above interest and principal payable on the issuer notes) as a resultof the issuer receiving a termination payment.

 

**Transfer of the swaps**

 

Each issuer swap providermay, at its option, transfer its obligations under any of the issuer swaps toany of its affiliates.  Any suchtransfer is subject to certain conditions, including among other things (i)that the transferee is rated (long-term) at least AA– by Standard & Poor’s,Aa3 by Moody’s

 

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and AA– by Fitch, or itsperformance under the relevant issuer swap will be guaranteed in full by therelevant issuer swap provider, (ii) that the transfer must not cause an eventof default or a swap early termination event under the relevant issuer swap and(iii) that the rating agencies have confirmed that the transfer will not resultin the then current rating of the relevant series and class of issuer notesbeing downgraded.

 

**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 swaps.

 

A swap provider will beobliged to gross up payments made by it to Funding 1 or the issuer ifwithholding taxes are imposed on payments made under the 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, the series 4 issuerswap guarantor may terminate the series 4 issuer swap guarantee if it isobliged to gross up payments made by it to the issuer.

 

**Item 12.  Descriptionof Securities Other than Equity Securities**

 

Not applicable to annualreports filed on Form 20-F.

 

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**PART II**

 

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

 

None.

 

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

 

On March 31, 2003,both State Street Bank and Trust Company and U.S. Bank National Associationgave notice of their retirement as co-note trustees and co-securitytrustees.  The Bank of New York wasappointed as replacement note trustee and security trustee in June 2003.

 

**Item 15.  Controls andProcedures**

 

Not applicable.

 

**Item 16A.  AuditCommittee Financial Expert**

 

Not applicable.

 

**Item 16B.  Code ofEthics**

 

Not applicable.

 

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

 

Not applicable.

 

**Item 16D.  Exemptionsfrom the Listing Standards for Audit Committees**

 

Not applicable.

 

**Item 16E.  Purchasesof Equity Securities by the Issuer and Affiliated Purchasers**

 

Not applicable.

 

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**PART III**

 

**Item 17.  FinancialStatements**

 

Not applicable.

 

**Item 18.  FinancialStatements**

 

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 302 certification.

 

Exhibit 15.1: Investor’sReport for the month of March 2003 (incorporated by reference from theForm 6-K previously filed on May 23, 2003).

 

Exhibit 15.2: Investor’sReport for the month of April 2003 (incorporated by reference from the Form6-K previously filed on May 23, 2003).

 

Exhibit 15.3: Investor’sReport for the month of May 2003 (incorporated by reference from the Form 6-Kpreviously filed on June 19, 2003).

 

Exhibit 15.4: Investor’sReport for the month of June 2003 (incorporated by reference from the Form6-K previously filed on July 11, 2003).

 

Exhibit 15.5: Investor’sReport for the month of July 2003 (incorporated by reference from the Form6-K previously filed on August 8, 2003).

 

Exhibit 15.6: Investor’sReport for the month of August 2003 (incorporated by reference from theForm 6-K previously filed on September 8, 2003).

 

Exhibit 15.7: Investor’sReport for the month of September 2003 (incorporated by reference from theForm 6-K previously filed on October 10, 2003).

 

Exhibit 15.8: Investor’sReport for the month of October 2003 (incorporated by reference from theForm 6-K previously filed on November 13, 2003).

 

Exhibit 15.9: Investor’sReport for the month of November 2003 (incorporated by reference from theForm 6-K previously filed on December 8, 2003).

 

Exhibit 15.10: Investor’sReport for the month of December 2003 (incorporated by reference from theForm 6-K previously filed on January 22, 2004).

 

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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 |
|                |
| Date: June 30, 2004 | By:                                  | /s/ David Balai |   |
|                | Name:                                | David Balai |
|                | Title:                               | Director |

 

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