**As filed with the Securities and ExchangeCommission on June 30, 2005**

 

 

**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 |
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| or                                               |
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| ý                                           |   | Annual report pursuant  to Section 13 or 15(d) of the Securities Exchange Act of 1934                   |
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| For the fiscal year ended December 31, 2004 |
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| or                                               |
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| o                                                |   | Transition report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934              |

 

For the transition period from               to               

 

Commission file number: 333-111850

 

**PERMANENTFINANCING (NO. 4) PLC***(Exact Name of Registrant 1 as specified in itscharter)*

 

**United Kingdom**

*(Jurisdiction of Incorporation or Organization)*

 

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

*(Address of Principal Executive Offices)*

 

**PERMANENTFUNDING (NO. 1) LIMITED***(Exact Name of Registrant 2 as specified in itscharter)*

 

**United Kingdom**

*(Jurisdiction of Incorporation orOrganization)*

 

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

*(Address of Principal Executive Offices)*

 

**PERMANENTMORTGAGES TRUSTEE LIMITED***(Exact Name of Registrant 3 as specified inits charter)*

 

**Jersey, Channel Islands**

*(Jurisdiction of Incorporation orOrganization)*

 

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

*(Address of Principal Executive Offices)*

 

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

 

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

 

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

 

Title of each class

 

$2,400,000,000 series 2 class A notes due March 2009

 

$100,700,000 series 2 class B notes due June 2042

 

$59,900,000 series 2 class M notes due June 2042

 

$82,200,000 series 2 class C notes due June 2042

 

$1,700,000,000 series 3 class A notes due March 2024

 

$75,800,000 series 3 class B notes due June 2042

 

$40,400,000 series 3 class M notes due 2042

 

$55,400,000 series 3 class C notes due June 2042

 

Series 2 term AAA advance(1)

 

Series 2 term AA advance(1)

 

Series 2 term A advance(1)

 

Series 2 term BBB advance(1)

 

Series 3 term AAA advance(1)

 

Series 3 term AA advance(1)

 

Series 3 term A advance(1)

 

Series 3 term BBB advance(1)

 

Funding 1 interest in the mortgages trust(1)

 

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

 

Not applicable.

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes ý No o

 

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

 

Not applicable.

 

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(1) These items have notbeen offered directly to investors. Permanent Mortgages Trustee Limited is theregistrant for the Funding 1 interest in the mortgages trust and is holding theFunding interest in the mortgages trust on behalf of Permanent Funding (No. 1)Limited. The Funding 1 interest in the mortgages trust is the primary source ofpayments on the term advances listed. Permanent Funding (No. 1) Limited isthe registrant for the term advances and has issued the term advances toPermanent Financing (No. 4) PLC. The term advances are the primary sourceof payments on the series 2 notes and the series 3 notes. Permanent Financing (No. 4)PLC is the registrant for the series 2 notes and the series 3 notes.

 

 

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**PRESENTATION OF INFORMATION**

 

This annual report on Form 20-F relates to Permanent Financing (No. 4)PLC (the “issuer”) and the following securities (the “issuer notes”), whichwere issued pursuant to a trust deed dated March 12, 2004 (the “issuertrust deed”), between the issuer and The Bank of New York, as note trustee (the“note trustee”):

 

•                  $2,400,000,000series 2 class A notes due March 2009

•                  $100,700,000series 2 class B notes due June 2042

•                  $59,900,000series 2 class M notes due June 2042

•                  $82,200,000series 2 class C issuer notes due June 2042

•                  $1,700,000,000series 3 class A notes due March 2024

•                  $75,800,000series 3 class B notes due June 2042

•                  $40,400,000series 3 class M notes due June 2042

•                  $55,400,000series 3 class C issuer notes due June 2042

 

This annual report on Form 20-F also relates to the followingadvances made pursuant to the intercompany loan agreement dated March 12,2004 (the “issuer intercompany loan agreement”), between the issuer, PermanentFunding (No. 1) Limited (“Funding 1”), The Bank of New York, as securitytrustee (the “security trustee”) and Citibank, N.A., as agent bank:

 

•                  £1,286,174,000series 2 term AAA advance

•                  £53,966,000series 2 term AA advance

•                  £32,101,000series 2 term A advance

•                  £44,052,000series 2 term BBB advance

•                  £911,040,000series 3 term AAA advance

•                  £40,622,000series 3 term AA advance

•                  £21,651,000series 3 term A advance

•                  £29,690,000series 3 term BBB advance

 

This annual report on Form 20-F further relates to Funding 1’sinterest in the mortgages trust, comprising, among other things, the initialportfolio of loans and their related security assigned to Permanent MortgagesTrustee Limited (the “mortgages trustee”) by Halifax plc (the “seller”) on June 14,2002, and on several subsequent dates any new loans and their new relatedsecurity assigned to the mortgages trustee by the seller after March 12,2004 (the “closing date”), any increase in the outstanding principal balance ofa loan due to the borrower taking payment holidays or making underpaymentsunder a loan or a borrower making a drawing under any flexible loan, anyinterest, principal and other amounts (excluding third party amounts) paid byborrowers on their loans and their related security, the rights under theinsurance policies that are assigned to the mortgages trustee or of which themortgages trustee has the benefit, and amounts on deposit and interest earnedon the mortgages trustee guaranteed investment contract. The mortgages trusteeguaranteed investment contract, or GIC, account is the bank account in whichthe mortgages trustee holds any cash that is part of the trust property untilit is distributed to the beneficiaries. Any actual losses in relation to theloans, any actual reductions occurring in respect of the loans anddistributions of principal made from time to time to the beneficiaries or themortgages trust will be deducted from the trust property. The composition ofthe trust property will fluctuate as drawings under flexible loans and newloans are added and as the loans that were previously part of the trust propertyare repaid, mature, default or are repurchased by the seller.

 

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Certain terms used herein and not defined have the same meaningascribed to such terms in the Registration Statement filed on Form S-11(the “Registration Statement”) relating to the securities (file number 333-111850).

 

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

 

Certain items in Form 20-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 referenceditem is otherwise not applicable.

 

**FORWARD-LOOKING STATEMENTS**

 

This annual report includes forward-looking statements including, butnot limited to, statements made under the “Risk Factors” section. Theseforward-looking statements can be identified by the use of forward-lookingterminology, such as the words “believes”, “expects”, “may”, “intends”, “should”or “anticipates”, or the negative or other variations of those terms. Thesestatements involve known and unknown risks, uncertainties and other importantfactors that could cause the actual results and performance of the issuernotes, the seller or the UK residential mortgage industry to differ materiallyfrom any future results or performance expressed or implied in theforward-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 business strategy,lending practices or customer relationships and other factors that may bereferred to in this annual report.

 

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

 

**INCORPORATION OF CERTAIN DOCUMENTS BYREFERENCE**

 

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

 

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**PART I**

 

**Item 1.  Identity of Directors, SeniorManagement and Advisers**

 

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

 

**Item 2.  Offer Statistics andExpected Timetable**

 

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

 

**Item 3.  Key Information**

 

A.*            Selected FinancialData*

 

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

 

•                  Investor’sReport for the month of March 2004

•                  Investor’sReport for the month of April 2004

•                  Investor’sReport for the month of May 2004

•                  Investor’sReport for the month of June 2004

•                  Investor’sReport for the month of July 2004

•                  Investor’s Reportfor the month of August 2004

•                  Investor’sReport for the month of September 2004

•                  Investor’sReport for the month of October 2004

•                  Investor’sReport for the month of November 2004

•                  Investor’sReport for the month of December 2004

 

B.*            Capitalization andIndebtedness*

 

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

 

C.*            Reasons for the Offerand Use of Proceeds*

 

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

 

D*.**            RiskFactors*

 

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

 

**Noteholders cannot rely on any person other than the issuer to makepayments on the issuer notes**

 

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

 

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**The issuer has a limited set of resources available to it to makepayments on the issuer notes**

 

The issuer’s ability to make payments of principal and interest on theissuer notes and to pay it’s operating and administrative expenses will dependprimarily on the funds being received under the issuer intercompany loan. Inaddition, the issuer will rely on the issuer dollar currency swaps and theissuer euro currency swaps to provide payments on the issuer notes denominatedin US dollars and euro, respectively, and the issuer will rely on the series 5class A1 issuer interest rate swap to provide payments of interest on theseries 5 class A1notes up to and including the interest payment date falling inMarch 2011.

 

Funding 1 has entered into the Funding 1 liquidity facility, which isavailable (subject to satisfying certain conditions precedent) to pay certain amountsdue and payable on the term advances made by the issuer and the previousissuers. In the event that the seller suffers certain ratings downgrades,Funding 1 will be required to fund the liquidity reserve fund, though there canbe no assurance that Funding 1 will have sufficient resources to do so at suchtime, and Funding 1 may draw money from the liquidity reserve fund, to theextent it has been funded, to pay amounts due to the issuer.

 

The issuer will not have any other significant sources of fundsavailable to meet its obligations under the issuer notes and /or any otherpayments ranking in priority to the issuer notes.

 

**Funding 1 is not obliged to make payments on the issuer term advancesif it does not have enough money to do so, which could adversely affectpayments on the issuer notes**

 

Funding 1’s ability to pay amounts due on the issuer term advances willdepend upon:

 

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

 

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

 

•                  the amount offunds credited to the general reserve fund;

 

•                  the amount of funds credited to the liquidityreserve fund; and

 

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

 

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

 

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

 

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

 

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

 

**Failure by Funding 1 to meet its obligations under the issuerintercompany loan agreement would adversely affect payments on the issuer notes**

 

If Funding 1 does not make payments due and payable on the issuerintercompany loan, then the issuer may not have enough money to make paymentson the issuer notes, and in addition the issuer will have only limited recourseto the assets of Funding 1. If Funding 1 does not pay amounts under the issuerintercompany 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 the issuer intercompany loan anyoutstanding amounts in respect of the issuer term AA advances, the issuer termA advances and the issuer term BBB advances will be extinguished, which wouldcause a loss on any class B issuer notes, any class M issuer notes and anyclass C issuer notes still outstanding**

 

The transaction has been structured in the expectation that on thefinal repayment date of the issuer intercompany loan in June 2042, theinterest and principal due and payable on the issuer term AA advances, theissuer term A advances and the issuer term BBB advances will be in an amountequal to the sum available to pay all outstanding interest and/or principal(including interest and/or principal deferred and unpaid) on the issuer term AAadvances and the issuer term BBB advances (after paying amounts of a higherorder of priority as required by the Funding 1 priority of payments).

 

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

 

If there is such a shortfall in interest and/or principal paymentsunder the issuer intercompany loan agreement, the noteholders may not receivethe full amount of interest and/or principal which would otherwise be due andpayable on the class B issuer notes, the class M issuer notes or the class Cissuer notes outstanding.

 

**Enforcement of the issuer security is the only remedy for a default inthe issuer’s obligations, and the proceeds of that enforcement may not beenough to make payments on the issuer notes**

 

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The only remedy for recovering amounts on the issuer notes is throughthe enforcement of the issuer security. The issuer has no recourse to theassets 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 created as required by the issuer deed of charge isenforced, the proceeds of enforcement may be insufficient to pay all principaland interest due on the issuer notes.

 

**The transaction has been structured in the expectation that the series2 issuer notes will be redeemed before the series 3 issuer notes and so on**

 

The transaction has been structured in the expectation that:

 

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

 

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

 

•                  the series 4 issuernotes will be redeemed in full prior to the redemption of the series 5 issuernotes.

 

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

 

However, there is no assurance that the series 2 issuer notes will beredeemed in full before the series 3 issuer notes, the series 4 issuer notesand the series 5 issuer notes or that the series 3 issuer notes will beredeemed in full before the series 4 issuer notes and the series 5 issuer notesor that the series 4 issuer notes will be redeemed in full before the series 5.In each case, redemption of the issuer notes is ultimately dependent on, amongother things, repayment and redemptions on the loans and on the term advancerating of the issuer term advances.

 

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

 

**There may be conflicts between the noteholders’ interests and theinterests of any of the issuer’s other secured creditors, and the interests ofthose secured creditors may prevail over the noteholders’ interests**

 

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The issuer deed of charge requires the security trustee to consider theinterests of each of the issuer secured creditors in the exercise of all of itspowers, trusts, authorities, duties and discretions, but requires the securitytrustee, in the event of a conflict between the noteholders’ interests and theinterests of any of the other issuer secured creditors, to consider only thenoteholders’ interests. In certain circumstances, the security trustee can makeamendments to the documents without the noteholders’ prior consent.

 

**The security trustee may agree modifications to the issuer transactiondocuments without the noteholders’ prior consent, which may adversely affectthe noteholders’ interests**

 

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

 

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

 

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

 

The security trustee will be entitled to assume that the exercise ofits discretions will not be materially prejudicial to the noteholders’interests if each of the rating agencies has confirmed that the then currentrating by it of the notes would not be adversely affected by such exercise.

 

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

 

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

 

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

 

iii)           the issue of new notes by Funding 2;

 

iv)          the sale of new types of loans to themortgages trustee;

 

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

 

vi)          changes to be made to the definitions ofasset trigger event and non-asset trigger event; and

 

vii)       the inclusion of an additional Funding 1liquidity facility;

 

and provided further that:

 

•                  in respect ofthe matters listed in paragraphs (i) to (iv), the relevant conditionsprecedent have been satisfied; and

 

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

 

The modifications required to give effect to the matters listed inparagraphs (i) to (vii) above may include, amongst other matters,amendments to the provisions of the Funding 1 deed of charge relating to the applicationof monies. Accordingly, there can be no assurance that the effect of themodifications to the transaction documents will not ultimately adversely affectnoteholders’ interests. Any modifications to the documents described above willrequire the actual consent of the Funding 1 liquidity facility provider, theFunding 1 swap provider and each of the issuer swap providers (in respect ofeach document to which they are a party), as applicable, such consent not to beunreasonably withheld and to be deemed given if no written response(affirmative or negative) is given within 10 business days after the writtenrequest for consent is sent to each such party.

 

**There may be a conflict between the interests of the holders of class Aissuer notes, the holders of class B issuer notes, the holders of class Missuer notes and the holders of class C issuer notes, and the interests of oneclass of noteholders may prevail over the interests of other classes ofnoteholders**

 

The issuer trust deed and the terms of the issuer notes will providethat the note trustee is to have regard to the interests of the holders of allthe classes of issuer notes. There may be circumstances, however, where theinterests of one class of the noteholders conflict with the interests of anotherclass or classes of the noteholders. The issuer trust deed and the terms of theissuer notes will provide that where, in the sole opinion of the note trusteethere is such a conflict, then:

 

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

 

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

 

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

 

**There may be a conflict between the interests of the holders of eachseries of the class A issuer notes, the holders of each series of the class Bissuer notes, the holders of each series of the class M issuer notes and theholders of each series of the class C issuer notes, and the interests of oneseries of noteholders may prevail over the interests of other series ofnoteholders**

 

There may also be circumstances where the interests of the class Anoteholders of one series of the issuer notes conflict with the interests ofthe class A noteholders of another series of the issuer notes. Similarly, theremay be circumstances where the interests of the class B noteholders of oneseries of the issuer notes conflict with the interests of the class Bnoteholders of another series of the issuer notes, the interests of the class Mnoteholders of one series of the issuer notes conflict with the interests ofthe class M noteholders of another series of the issuer notes or the interestsof the class C noteholders of one series of the issuer notes conflicts with theinterests of the class C noteholders of another series of the issuer notes.

 

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

 

Similar provisions will apply in relation to requests in writing fromholders of a specified percentage of the principal amount outstanding of theissuer notes of each class within each series (the principal amount outstandingbeing converted into sterling for the purposes of making the calculation).Noteholders should note that, as a result of repayments of principal first tothe series 2 issuer notes, then to the series 3 issuer notes, then to theseries 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.

 

**Permanent Holdings Limited (“Holdings”) has established anothercompany, Funding 2, which may become an additional beneficiary under the mortgagestrust**

 

Holdings has established a separate entity, Funding 2, which may issuenotes from time to time and use the proceeds to pay for a direct interest inthe trust property rather than lending the proceeds to Funding 1.Simultaneously with the acquisition by Funding 2 of an interest in the trustproperty, the seller and Funding 1, as existing beneficiaries of the mortgagestrust, would be required to agree to a decrease in their beneficial interestsin the trust property (which would require a partial release of security byFunding 1 over its share in the trust property).

 

The seller, Funding 1 and Funding 2 would each have a joint andundivided interest in the trust property but their entitlement to the proceedsfrom the trust property would be in proportion to their respective shares ofthe trust property. On each distribution date the mortgages trustee woulddistribute interest and principal receipts to one, two or all threebeneficiaries, depending on the terms of the mortgages trust.

 

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It is anticipated that Funding 2 will issue notes directly orindirectly to investors from time to time backed by its share of the trustproperty. Noteholders would not have a direct or indirect interest in Funding 2’sshare of the trust property.

 

Amendments would be made to a number of the issuer transactiondocuments as a result of the inclusion of Funding 2 as a beneficiary of themortgages trust. In particular (but without limitation), amendments would bemade to:

 

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

 

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

 

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

 

•                  the servicingagreement to ensure that Funding 2 receives the benefit of the servicers dutiesunder that agreement; and

 

•                  the masterdefinitions and construction agreement.

 

In addition, Funding 1, Funding 2 and the seller may enter into newagreements to regulate the making of decisions between them.

 

There may be conflicts of interest between Funding 1 and Funding 2, inwhich case it is expected that the mortgages trustee will follow the directionsgiven by the relevant beneficiary (excluding the seller) that has the largestshare of the trust property at that time. The interests of Funding 1 may notprevail, which may adversely affect the noteholders’ interests.

 

Noteholders’ prior consent to the inclusion of Funding 2 as abeneficiary of the mortgages trust and the subsequent amendments to thedocuments and/or release of security by Funding 1 will not be required. Beforebecoming a beneficiary of the mortgages trust, however, Funding 2 will berequired to satisfy a number of conditions, including:

 

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

 

•                  providing writtencertification to the security trustee that no event of default under any ofFunding 1’s intercompany loan agreements outstanding at that time has occurredwhich has not been remedied or waived and no event of default will occur as aresult of 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 assurance that the inclusion of Funding 2 as abeneficiary of the mortgages trust would not affect cashflows available to payamounts due on the noteholders’ issuer notes and therefore adversely affect thenoteholders’ interests.

 

**If Funding 1 enters into new intercompany loan agreements, then the newterm advances may rank ahead of issuer term advances as to payment, andaccordingly new notes may rank ahead of issuer notes as to payment**

 

It is likely that Holdings will establish new issuers to issue newnotes to investors. The proceeds of each new issue will be used by the newissuer to make a new intercompany loan to Funding 1. Funding 1 will use theproceeds of the new intercompany loan to:

 

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

 

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

 

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

 

•                  deposit some ofthose proceeds in the general reserve fund.

 

The payment and security priorities of the issuer notes relative toeach other as set out in the issuer deed of charge and the issuer cashmanagement agreement will not be affected as a result of an issue of new notesby a new issuer, because the new issue will be separately documented. However,Funding 1 may be required to pay to a new issuer amounts owing under a new termadvance ahead of or in the same order of priority as amounts owing to theissuer on the issuer term advances, depending on the term advance rating, thescheduled repayment date of that new term advance and other rules regardingthe payment of interest and the repayment of principal by Funding 1. If this isthe case, then the relevant new noteholders will be paid before thenoteholders.

 

If Holdings establishes new issuers to make new intercompany loans toFunding 1, the noteholders will not have any right of prior review or consentwith respect to those new intercompany loans or the corresponding issuance bynew issuers of new notes. Similarly, the terms of the Funding 1 transactiondocuments (including the mortgage sale agreement, the mortgages trust deed, theFunding 1 deed of charge, the definitions of the trigger events, the criteriafor the sale of new loans to the mortgages trustee and the amount available tobe drawn under the Funding 1 liquidity facility) may be amended to reflect thenew 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.

 

However, before issuing new notes, a new issuer will be required tosatisfy a number of conditions, including:

 

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

 

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

 

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

 

**Funding 1 has entered into the other intercompany loan agreements withother issuers, and some of the term advances in other intercompany loans rankahead of some of the issuer term advances in the issuer intercompany loan as topayment, and accordingly some of the notes issued by the previous issuers rankahead of some of the issuer notes as to payment**

 

The other issuers issued notes to investors, the equivalent net issueproceeds of which were used by the other issuers to make intercompany loans toFunding 1. Funding 1 used most of the proceeds of these intercompany loans fromPermanent Financing (No. 1) PLC to pay the seller for the initial loans(together with their related security) sold to the mortgages trustee on theinitial closing date which comprised Funding 1’s original share of the trustproperty. Funding 1 used most of the proceeds of each other issuers’intercompany loan to pay the seller for loans (together with their relatedsecurity) sold to the mortgages trustee or to pay consideration to the sellerfor an increase in Funding 1’s share in the mortgages trust.

 

 The payment and securitypriorities of the issuer notes relative to each other as set out in the issuerdeed of charge and the issuer cash management agreement are not affected as aresult of the issue of the notes by the other issuers, because the other issueswere separately documented. However, Funding 1 may be required to pay to theprevious issuers amounts which are owing under one or more previous termadvances ahead of or in the same order of priority as amounts owing to theissuer on the issuer term advances, depending on the term advance rating, thescheduled repayment date of that previous term advance and other rules regardingthe payment of interest and the repayment of principal by Funding 1. If this isthe case, then the other noteholders will be paid before the holders of theissuer notes.

 

**Other creditors will share in the same security granted by Funding 1 tothe security trustee, and this may adversely affect payments on the issuernotes**

 

If Funding 1 enters into a new intercompany loan agreement, then ifrequired it will also enter into a new start-up loan agreement with a newstart-up loan provider and the security trustee.

 

If required by the rating agencies, Funding 1 will use part of theproceeds of the new start-up loan to fund further the general reserve fund.Similarly, if necessary, Funding 1 will also enter into a new Funding 1 swapwith either the Funding 1 swap provider or a new Funding 1 swap provider andthe security trustee.

 

The new issuer, any new start-up loan provider and any new Funding 1swap provider will become party to the Funding 1 deed of charge and will beentitled to share in the security granted by Funding 1 for our benefit (and thebenefit of the other Funding 1 secured creditors)

 

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under the Funding 1 deed of charge. In addition, the liabilities owedto the Funding 1 liquidity facility provider and the Funding 1 swap providerwhich are secured by the Funding 1 deed of charge may increase each time thatFunding 1 enters into a new intercompany loan agreement. These factors couldultimately cause a reduction in the payments noteholders receive on the issuernotes. Noteholders consent to the requisite changes to the transactiondocuments will not be required.

 

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

 

The security trustee will exercise its rights under the Funding 1 deedof charge only in accordance with directions given by the issuers (which couldbe the issuer, any previous issuer or if Funding 1 enters into new intercompanyloans, any new issuer) that have the highest-ranking outstanding term advancesat that time, provided that the security trustee is indemnified and/or securedto its satisfaction.

 

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

 

**As new loans are sold to the mortgages trustee, the characteristics ofthe trust property may change from those existing at the closing date, andthose changes may adversely affect payments on the issuer notes**

 

There is no guarantee that any new loans sold to the mortgages trusteewill have the same characteristics as the loans in the portfolio as of theclosing date. In particular, new loans may have different paymentcharacteristics than the loans in the initial portfolio. The ultimate effect ofthis could be to delay or reduce the payments the noteholders receive on theissuer notes.

 

**The yield to maturity of the issuer notes may be adversely affected byprepayments or redemptions on the loans**

 

The yield to maturity of the issuer notes of each class will dependmostly on (a) the amount and timing of payment of principal on the loansand (b) the price paid by the noteholders of each class of issuer notes.The yield to maturity of the issuer notes of each class may be adverselyaffected by a higher or lower than anticipated rate of prepayments on theloans.

 

No assurance can be given that Funding 1 will accumulate sufficientfunds during the cash accumulation period relating to the issuer series 2 termAAA advance, each scheduled amortization installment under the issuer series 3term AAA advance, and/or each scheduled amortization installment under 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 cash accumulation period for the issuer term advances andscheduled amortization installments, repayments of principal will only be madeon the issuer series 5 term AAA advances, the issuer term AA advances, theissuer term A advances or the issuer term BBB advances that are due and payableif the quarterly CPR of the loans in the trust property is greater

 

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than 15 per cent. and certain other conditions are met. This means thatthere may be no corresponding repayments of principal on the series 5 class Aissuer notes, the class B issuer notes, the class M issuer notes or the class Cissuer notes.

 

The extent to which sufficient funds are saved by Funding 1 during acash accumulation period or received by it from its share in the mortgagestrust for application on a scheduled repayment date will depend on whether theactual principal prepayment rate of the loans is the same as the assumedprincipal prepayment rate. If Funding 1 is not able to save enough money duringa cash accumulation period or does not receive enough money from its share inthe mortgages trust for application on a scheduled repayment date to repay therelevant issuer term AAA advance (and, if it is unable to make a drawing on thereserve funds to make good the shortfall) so that the issuer can redeem theclass A issuer notes of the corresponding series on their respective scheduledredemption date(s), then Funding 1 will be required to pay to the issuer on thosescheduled redemption dates only the amount that it has actually saved orreceived. Any shortfall will be deferred and paid on subsequent Funding 1interest payment dates when Funding 1 has money available to make the payment.In these circumstances, there will be a variation in the yield to maturity ofthe relevant class of issuer notes.

 

**The issuer’s ability to redeem the series 2 class A issuer notes and/orthe series 3 class A issuer notes and/or the series 4 class A issuer notes ontheir scheduled redemption dates is affected by the rate of prepayment on theloans**

 

The rate of prepayment of loans is influenced by a wide variety ofeconomic, social and other factors, including prevailing mortgage marketinterest rates, the availability of alternative financing programs, local andregional economic conditions and homeowner mobility. For instance, prepaymentson the loans may be due to borrowers refinancing their loans and sales ofproperties by borrowers (either voluntarily or as a result of enforcement actiontaken). In addition, if the seller is required to repurchase a loan or loansunder a mortgage account and their related security because, for example, oneof the loans does not comply with the representations and warranties in themortgage sale agreement, then the payment received by the mortgages trusteewill have the same effect as a prepayment of all of the loans under thatmortgage account. Because these factors are not within its control or thecontrol of Funding 1 or the mortgages trustee, we cannot give any assurances asto the level of prepayments that the portfolio may experience.

 

Variation in the rate of prepayments of principal on the loans mayaffect each class of issuer notes differently depending upon amounts alreadyrepaid by Funding 1 to the issuer under the issuer intercompany loan andwhether a trigger event has occurred, or a loan is subject to a product switchor a further advance or the security granted by the issuer under the issuerdeed of charge has been enforced. 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 A issuernotes and/or the series 4 class A issuer notes in full on their respectivescheduled redemption dates.

 

**The seller may change the lending criteria relating to loans that aresubsequently sold to the mortgages trustee, which could affect thecharacteristics of the trust property and which may adversely affect paymentson the issuer notes**

 

Each of the loans was originated in accordance with the seller’slending criteria at the time of origination. These lending criteria consider avariety of factors such as a potential borrower’s credit history, employmenthistory and status and repayment ability, as well as the

 

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value of the property to be mortgaged. In the event of the sale of anynew loans and new related security to the mortgages trustee, the seller willwarrant that those new loans and new related security were originated inaccordance with the seller’s lending criteria at the time of their origination.However, the seller retains the right to revise its lending criteria asdetermined from time to time, and so the lending criteria applicable to anyloan at the time of its origination may not be or have been the same as thosewhen other loans were originated.

 

If new loans that have been originated under revised lending criteriaare sold to the mortgages trustee, the characteristics of the trust propertycould change. This could lead to a delay or a reduction in the paymentsreceived on the issuer notes.

 

**The seller has adopted procedures relating to investigations andsearches for remortgages which could affect the characteristics of the trustproperty and which may adversely affect payments on the issuer notes**

 

The seller does not require a solicitor, licensed conveyancer or (inScotland) qualified conveyancer to conduct a full investigation of the title toa property in all cases. Where the borrower is remortgaging there will be alimited investigation to carry out some but not all of the searches andinvestigations which would normally be carried out by a solicitor conducting afull investigation of the title to a property. Properties which have undergonesuch a limited investigation may be subject to matters which would have beenrevealed by a full investigation of title and which may have been remedied or,if incapable of remedy, may have resulted in the properties not being acceptedas security for a loan had such matters been revealed, though to mitigateagainst this risk search indemnity insurance is obtained in respect of suchproperties. The introduction of loans secured by such properties into the trustproperty could result in a change of the characteristics of the trust property.This could lead to a delay or a reduction in the payments received on theissuer notes.

 

**The timing and amount of payments on the loans could be affected byvarious factors which may adversely affect payments on the issuer notes**

 

The loans are affected by credit, 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 financial circumstances may affect the ability of borrowers torepay loans. Loss of earnings, illness, divorce and other similar factors maylead to an increase in delinquencies by and bankruptcies of borrowers, andcould ultimately have an adverse impact on the ability of borrowers to repayloans.

 

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

 

Further, the mortgage loan industry in the United Kingdom is highlycompetitive. This competitive environment may affect the rate at which theseller originates new loans and may also affect the level of attrition of theseller’s existing borrowers.

 

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The principal source of income for repayment of the issuer notes by theissuer is the issuer intercompany loan. The principal source of income forrepayment by Funding 1 of the issuer intercompany loan is its interest in theloans held on trust by the mortgages trustee for Funding 1 and the seller. Ifthe timing and payment of the loans is adversely affected by any of the risksdescribed in this section, then the payments on the issuer notes could bereduced or delayed.

 

**The occurrence of trigger events and enforcement of the issuer securitymay adversely affect the scheduled redemption dates of the series 2 class Aissuer notes, series 3 class A issuer notes and/or series 4 class A issuernotes**

 

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

 

If a trigger event occurs or the issuer security is enforced inaccordance with the issuer deed of charge prior to the scheduled redemptiondates for the series 2 class A issuer notes, series 3 class A issuer notesand/or series 4 class A issuer notes, then the relevant classes of issuer notesoutstanding will not be repaid on their scheduled redemption dates but will berepaid on each interest payment date from monies received from Funding 1 on theissuer term AAA advances of the corresponding series as described in the followingthree risk factors.

 

**If an asset trigger event occurs, any series 2 class A issuer notes,series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates**

 

When an asset trigger event has occurred, the mortgages trustee willdistribute principal receipts on the loans to Funding 1 and the sellerproportionally and equally based on their percentage shares of the trustproperty (that is, the Funding 1 share percentage and the seller sharepercentage). When an asset trigger event has occurred, after making requisitepayments to the Funding 1 liquidity facility provider and replenishing thereserve funds, Funding 1 will repay:

 

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

 

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

 

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

 

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

 

If an asset trigger event occurs, any series 2 class A issuer notesand/or series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their

 

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scheduled redemption dates, and there is also a risk that they will notbe 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/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates**

 

If a non-asset trigger event has occurred but an asset trigger eventhas not occurred, the mortgages trustee will distribute all principal receiptsto Funding 1 until the Funding 1 share percentage of the trust property iszero. When a non-asset trigger event has occurred, after making requisitepayments to the Funding 1 liquidity facility provider and to replenish thereserve funds, Funding 1 will repay:

 

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

 

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

 

*then*, the term Aadvances in respect of the issuer intercompany loan, the previous intercompanyloans and any new intercompany loans, until each of those term A advances isfully repaid; and

 

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

 

If a non-asset trigger event occurs, any series 2 class A issuer notes,series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates.

 

**If the issuer security is enforced, any series 2 class A issuer notes,series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates**

 

If the issuer security is enforced, then the mortgages trustee willdistribute funds as required under the terms of the transaction agreements. Inthese circumstances, any series 2 class A issuer notes, series 3 class A issuernotes and/or series 4 class A issuer notes then outstanding will not be repaidon their scheduled redemption dates and there is also a risk that those class Aissuer notes may not be repaid by their final maturity dates.

 

**Loans subject to further advances will be repurchased by the seller fromthe mortgages trustee, which will affect the prepayment rate of the loans, andthis may affect the yield to maturity of the issuer notes**

 

If the servicer at its discretion decides to grant a borrower a furtheradvance under a loan which has been sold to the mortgages trustee, then theseller will be required to repurchase that loan under the relevant mortgageaccount and its related security from the mortgages trustee save

 

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for any loan in arrears at a price equal to the outstanding principalbalance of those loans together with any accrued and unpaid interest andexpenses to the date of purchase. The yield to maturity of the issuer notes maybe affected by the repurchase of loans subject to further advances.

 

**In limited circumstances, loans subject to product switches will berepurchased by the seller from the mortgages trustee, which will affect theprepayment rate of the loans, and this may affect the yield to maturity of theissuer notes**

 

Loans subject to product switches will not be repurchased unless on anydistribution date, the seller is in breach of the conditions precedent to thesale of new loans to the mortgages trustee. From and including that date to butexcluding the date when those conditions precedent have been satisfied, theseller will be required to repurchase any loans and their related security thatare subject to product switches. The seller will be required to repurchase therelevant loan or loans under the relevant mortgage account and their relatedsecurity from the mortgages trustee at a price equal to the outstandingprincipal balance of those loans together with accrued and unpaid interest andexpenses to the date of purchase.

 

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

 

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

 

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

 

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

 

•                  any variationimposed by statute;

 

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

 

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

 

The yield to maturity of the issuer notes may be affected by therepurchase of loans subject to product switches.

 

**Ratings assigned to the issuer notes may be lowered or withdrawn afterthe noteholders purchase the issuer notes, which may lower the market value ofthe issuer notes**

 

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

 

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

 

**Subordination of other note classes may not protect noteholders fromall risk of loss**

 

The class B issuer notes the class M issuer notes and the class Cissuer notes are subordinated in right of payment of interest to the class Aissuer notes. The class M issuer notes and the C issuer notes are subordinatedin right of payment of interest to the class B issuer notes. The class C issuernotes are subordinated in right of payment of interest to the class M issuernotes. However, the transaction has been structured in the expectation that theseries 2 issuer notes will be repaid in full prior to the redemption of theseries 3 class A issuer notes, the series 4 class A issuer notes and the series5 class A issuer notes and so on for each class of each series of issuer notes.

 

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

 

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

 

Principal repayments on the issuer term AA advances, the issuer term Aadvances and/or the issuer term BBB advances will be deferred in the followingcircumstances:

 

If on a Funding 1 interest payment date:

 

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

 

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

 

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

 

then to the extent that any term AAA advance remains outstanding(whether or not such term AAA advance is then due and payable) after theallocation of principal on that Funding 1 interest payment date to those termadvances, the issuer term AA advances, issuer term A advances and issuer termBBB advances will not be entitled to principal repayments until the relevantcircumstance as described above has been remedied or otherwise ceases to exist.In addition, if any term AA advance remains outstanding (whether or not suchterm AA advance is then due and payable) after the allocation of principal onthat Funding 1 interest payment date to those term advances, the issuer term Aadvances and issuer term BBB advances will not be entitled to principalrepayments until the relevant circumstance as described above has been remediedor otherwise ceases to exist. Also if any term A advance remains outstanding(whether or not such term A advance is then due and payable) after theallocation of principal on that Funding 1 interest payment date to those termadvances, the issuer term BBB advances will not be entitled

 

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to principal repayments until the relevant circumstances as describedabove have been remedied or otherwise cease to exist. This means that paymentsof principal on the class C issuer notes of all series and, as applicable, theclass M issuer notes of all series and the class B issuer notes of all serieswill be 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 issuer notes.

 

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

 

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

 

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

 

•                  there is a cashaccumulation shortfall at that time;

 

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

 

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

 

If the loans comprising the trust property do not perform as expectedat any time after the repayment of previous series of issuer notes, then theunpaid series of issuer notes will be adversely affected.

 

**Noteholders may be subject to exchange rate risks on the issuer notes**

 

Repayments of principal and payments of interest on the series 2 classissuer notes and the series 3 issuer notes will be made in US dollars and onthe series 4 issuer notes and the series 5 class A1 issuer notes will be madein euro, 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 currency exchange rate exposure, including the interestrate exposure connected with that currency exposure the issuer has entered intothe issuer dollar currency swaps for the series 2 and series 3 issuer noteswith the issuer dollar currency swap providers and the issuer euro currencyswaps for the series 4 issuer notes and the series 5 class A1 issuer swap withthe issuer euro currency swap provider and the series 5 class A1 issuerinterest rate swap with the series 5 class A1 issuer interest rate swapprovider.

 

If the issuer fails to make timely payments of amounts due under anissuer swap, then the issuer will have defaulted under that issuer swap. Eachissuer swap provider is obliged only to make payments under an issuer swap ifand for so long as the issuer make payments under the same. If an issuer swapprovider is not obliged to make payments, or if it exercises any right toterminate that it may have under the relevant issuer swap, or if it defaults inits obligations to make payments of amounts in US dollars or euro, asapplicable, equal to the full amount to be paid by it on the payment datesunder the relevant issuer swap (which are the same dates as the interestpayment dates in respect of the issuer notes), the issuer will be exposed tochanges in US

 

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dollar/sterling or euro/sterling currency exchange rates and in theassociated interest rates on these currencies. Unless a replacement issuer swapis entered into, as a result of any adverse movements in the relevant spotexchange rates, the issuer may have insufficient funds to make payments due onthe issuer notes of any class and any series that are then outstanding.

 

Each issuer swap provider will be obliged to gross up payments made byit to the issuer if withholding taxes are imposed on payments under therelevant issuer swap and the AIG issuer swap guarantor will be obliged to grossup payments made by it to the issuer if withholding taxes are imposed onpayments under the AIG issuer swap guarantee. However, if such a gross up isrequired, the relevant issuer swap provider may, subject to obtaining theconsent of the security trustee, terminate the relevant issuer swap. If it doesterminate the relevant issuer swap, the issuer will be exposed to changes incurrency exchange rates and in the associated interest rates on thesecurrencies. Unless a replacement issuer swap is entered into, the issuer mayhave insufficient funds to make payments due on the issuer notes of any classand any series that are then outstanding.

 

**The difference in timing between our obligations and the obligations ofthe series 5 class A1 issuer interest rate swap provider could adversely affectpayments on the issuer notes**

 

To the extent that it has funds available, on each quarterly Funding 1interest payment date, the series 5 class A1 euro currency swap provider willpay to the issuer amounts due under the series 5A1 issuer euro currency swap.On each quarterly interest payment date in relation to its obligations underthe series 5 class A1 issuer interest rate swap, the issuer will pay the amountso received to the series 5 class A1 issuer interest rate swap provider. Theseries 5 class A1 issuer interest rate swap provider will not be obliged tomake any corresponding swap payments to the issuer until the interest paymentdate in respect of the series 5 class A1 issuer notes. This interest paymentdate occurs annually up to and including the earliest to occur of (i) theinterest payment date falling in March 2011 in respect of the series 5class A1 issuer notes, (ii) the occurrence of a trigger event and (iii) enforcementof the issuer security, and quarterly on and following the interest paymentdate occurring immediately thereafter. Therefore, under the series 5 class A1issuer interest rate swap, the date on which the series 5 class A1 issuerinterest rate swap provider pays amounts due to the issuer may be as long asnine months after a date on which the issuer pay amounts due to it.

 

If the series 5 class A1 issuer interest rate swap provider does notmeet its payment obligations to the issuer under the series 5 class A1 issuerinterest rate swap on any semi-annual interest payment date and does not make atermination payment that has become due from it to the issuer, the issuer mayhave a larger shortfall in funds with which to make interest payments on theissuer notes than if its payment obligations were quarterly and thereforecoincidental with the issuers payment obligations under the series 5 class A1issuer interest rate swap. Hence, the difference in timing between the issuersobligations and the obligations of the series 5 class A1 issuer interest rateswap provider under the series 5 class A1 issuer interest rate swap may affectour ability to make payments on the issuer notes of any class and any series.

 

**The mortgages trustee GIC provider or the Funding 1 GIC provider maycease to satisfy certain criteria to provide the mortgages trustee GIC accountor the Funding 1 GIC account**

 

The mortgages trustee GIC provider and the Funding 1 GIC provider arerequired to satisfy certain criteria (including certain criteria and/orpermissions set or required by the

 

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

 

The criteria referred to above include a requirement that theshort-term, unguaranteed and unsecured ratings of the mortgages trustee GICprovider or the Funding 1 GIC provider, as the case may be, are at least A-1+by Standard & Poor’s, F1+ by Fitch and P-1 by Moody’s, unless eachrating agency confirms that its then current rating of the notes would not beadversely affected as a result of such ratings falling below these minimumratings.

 

**Termination payments on the issuer swaps may adversely affect the fundsavailable to make payments on the issuer notes**

 

If any of the issuer swaps terminate, the issuer may as a result beobliged to make a termination payment to the relevant issuer swap provider. Theamount of the termination payment will be based on the cost of entering into areplacement issuer swap. Under the issuer intercompany loan agreement, Funding1 will be required to pay the issuer an amount equal to any termination paymentdue by the issuer to the relevant issuer swap provider. Funding 1 will also beobliged to pay the issuer any extra amounts which it may be required to pay toenter into a replacement swap.

 

The issuer cannot give noteholders any assurance that Funding 1 willhave the funds available to make that payment or that the issuer will havesufficient funds available to make any termination payment under any of itsissuer swaps or to make subsequent payments to noteholders in respect of therelevant series and class of issuer notes. Nor can the issuer give noteholdersany assurance that it will be able to enter into a replacement issuer swap or,if one is entered into, that the credit rating of the replacement issuer swapprovider will be sufficiently high to prevent a downgrading of the then currentratings of the issuer notes by the rating agencies.

 

Except where the relevant issuer swap provider has caused the relevantissuer swap to terminate by its own default, any termination payment due by theissuer will rank equally not only with payments due to the holders of theseries and class of issuer notes which rank equally with the series and classof issuer notes to which the relevant issuer swap relates but also withpayments due to the holders of any other series and class of issuer notes whichrank equally with the series and class of issuer notes to which the relevantissuer swap relates. Any additional amounts required to be paid by the issuerfollowing termination of the relevant issuer swap (including any extra costsincurred (for example, from entering into “spot” currency transactions orinterest rate swaps) if the issuer cannot immediately enter into a replacementswap) will also rank equally not only with payments due to the holders of theseries and class of issuer notes to which the relevant issuer swap relates butalso with payments due to the holder of any other series and class of issuernotes which rank equally with the series and class of issuer notes to which therelevant issuer swap relates. Furthermore, any termination payment oradditional payment or additional amounts required to be paid by the issuerfollowing termination of an issuer swap will rank ahead of payments due to theholders of any series and class of issuer notes which ranks below the seriesand class of issuer notes to which the relevant issuer swap relates. Therefore,if the issuer is obliged to make a termination payment to the relevant issuerswap provider or to pay any other additional amount as a result of thetermination of the relevant issuer swap, this may

 

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affect the funds which the issuer has available to make payments on theissuer notes of any class and any series.

 

**Risks associated with the Funding 1 swap**

 

To provide a hedge against (a) the mortgages trustee variable baserate payable on the variable rate loans, the rates of interest payable on thetracker rate loans and the fixed rates of interest payable on the fixed rateloans; and (b) the rate of interest payable by Funding 1 on theintercompany loans, Funding 1 has entered into 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. The Funding 1 swap provider is obliged onlyto make payments under the Funding 1 swap if and for so long as Funding 1 makespayments under the same. If the Funding 1 swap provider is not obliged to makepayments, or if it exercises any right to terminate that it may have under theFunding 1 swap, or if it defaults in its obligation to make payments under theFunding 1 swap, Funding 1 will be exposed to the variance between the rates ofinterest payable on the loans and the rate of interest payable by it under theintercompany loans unless a replacement Funding 1 swap is entered into. If theFunding 1 swap terminates, Funding 1 may as a result be obliged to make atermination payment to the Funding 1 swap provider. Any variance between therates of interest payable on the loans and the rate of interest payable byFunding 1 under the intercompany loans and any termination payment payable byit to the Funding 1 swap provider may adversely affect the ability of Funding 1to meet its obligations under the issuer intercompany loan agreement.

 

 Funding 1 will receive intereston the variable rate loans, which is based on HVR 1 or HVR 2. The paymentobligations of Funding 1 under the Funding 1 swap will, among other things, bebased on the average of the standard variable mortgage rates or theirequivalent charged to existing borrowers on residential mortgage loans aspublished from time to time, after excluding the highest and the lowest rate,of Abbey National plc, HSBC Bank plc, Cheltenham & Gloucester plc,Nationwide Building Society, Northern Rock plc, National Westminster Bank Plc,and Woolwich plc (and where those banks have more than one standard variablerate, the highest of those rates). While it is anticipated that such averagerate will broadly track both HVR 1 and HVR 2, the variance between such 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 to perform services in relation tothe issuer notes, and the noteholders may be adversely affected if they fail toperform their obligations**

 

The issuer is a party to contracts with a number of other third partiesthat have agreed to perform services in relation to the issuer notes. Forexample, the issuer swap providers have agreed to provide their respectiveissuer swaps, the corporate services provider has agreed to provide corporateservices and the paying agents and the agent bank have agreed to providepayment and calculation services in connection with the issuer notes. In theevent that any of these parties were to fail to perform their obligations underthe respective agreements to which they are a party, the noteholders may beadversely affected.

 

**The issuer may be unable to pay, in full or at all, interest due on theissuer notes if there is an income or principal deficiency**

 

If, on any Funding 1 interest payment date, revenue receipts availableto Funding 1 (including the reserve funds) are insufficient to enable Funding 1to pay interest on the issuer

 

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term advances, and any new term advances and other expenses of Funding1 ranking 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 use principal receipts that would have been applied torepay the term advances with the lowest term advance rating to pay interest onthose other term advances and senior expenses described in the precedingparagraph where there is a shortfall of monies to pay those amounts. At theclosing date, the relevant term advances with the lowest term advance ratinginclude the issuer term BBB advances. If Funding 1 uses principal to repayinterest and senior expenses in this manner, there will be less principalavailable to repay the issuer term BBB advances.

 

Funding 1 will be obliged to keep a ledger that records any principalapplied to pay interest and senior expenses. When the amount recorded on theledger is equal to the principal amount outstanding of the term BBB advances,then Funding 1 will use principal receipts that would have been applied torepay the term advance with the next lowest ranking term advance rating to payinterest on the term advances and senior expenses where there is a shortfall ofmoney to pay those amounts. When the amount recorded on the principaldeficiency ledger exceeds the principal amount outstanding on the term Aadvances, Funding 1 will use principal receipts that would have been applied torepay the term AA advances to pay those amounts. When the amount recorded onthe principal deficiency ledger exceeds the principal amount outstanding on theterm AA advances, Funding 1 will use principal receipts that would have beenapplied to repay the term AAA advances to pay those amounts.

 

During the term of the transaction, however, it is expected that anyprincipal deficiencies of this sort will be recouped from subsequent excessrevenue receipts and amounts standing to the credit of the reserve funds. Therevenue receipts will be applied first to cover any principal deficiency inrespect of the term advances with the highest term advance rating, and then theterm advances with the next highest-ranking term advance rating and so on downto the term advances with the lowest term advance rating.

 

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

 

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

 

•                  there may beinsufficient funds to repay the principal due and payable on any of the issuerterm BBB advances, the issuer term A advances and the issuer term AA advancesprior to their final repayment dates unless the other net income of Funding 1is sufficient, after making other prior ranking payments, to reduce anyprincipal deficiency in respect of the term BBB advances, term A advances andterm AA advances;

 

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

 

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

 

**The seller share of the trust property does not provide creditenhancement for the issuer notes**

 

Any losses from loans included in the trust property will be allocatedto Funding 1 and the seller proportionally on each distribution date inaccordance with the Funding 1 share percentage and the seller share percentageof the trust property. The seller’s share of the trust property therefore doesnot provide credit enhancement for the Funding 1 share of the trust property orthe 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 to the seller if there is a breachof warranty by the seller, but otherwise the seller’s assets will not be availableto the issuer as a source of funds to make payments on the issuer notes**

 

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

 

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

 

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

 

If any of the warranties made by the seller (a) in the case ofeach loan in the portfolio, was materially untrue on the date that new loan wasassigned to the mortgages trustee or (b) in the case of each new loan, ismaterially untrue on the date that new loan is assigned to the mortgagestrustee, then the seller will be required to remedy the breach within 20 Londonbusiness days of the seller becoming aware of the same or of receipt by it of anotice from the mortgages trustee.

 

If the seller fails to remedy the breach within 20 London businessdays, then the seller will be required to repurchase the loan or loans underthe relevant mortgage account and their related security at their outstandingprincipal balance as of the date of repurchase together with any arrears ofinterest and accrued and unpaid interest and expenses. There can be noassurance that the seller will have the financial resources to repurchase theloan or loans under the relevant mortgage account and their related security.However, if the seller does not repurchase those loans and their relatedsecurity when required, then the seller’s share of the trust property will bedeemed to be reduced by an amount equal to the principal amount outstanding ofthose loans together with any arrears of interest and accrued and unpaidinterest and expenses.

 

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

 

**There can be no assurance that a borrower will repay principal at theend of the term on an interest-only loan, which may adversely affect repaymentson the issuer notes**

 

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Each loan in the portfolio is repayable either on a principal repaymentbasis or an interest-only basis. Of the loans in the portfolio as January 1,2005, approximately 33.27 per cent. were interest-only loans. For interest-onlyloans, because the principal is repaid in a lump sum at the maturity of theloan, the borrower is recommended to have some repayment mechanism such as aninvestment plan in place which is intended to provide sufficient funds will beavailable to repay the principal at the end of the term. However, the sellerdoes not ensure that a repayment mechanism is in place in all cases and doesnot take security over these repayment mechanisms. The borrower is alsorecommended to take out a life insurance policy in relation to the loan but, aswith repayment mechanisms, the seller does not take security over these lifeinsurance policies.

 

The ability of a borrower to repay the principal on an interest-onlyloan at maturity depends on the borrower’s responsibility to ensure thatsufficient funds are available from an investment plan or another source, suchas ISAs, pension policies, personal equity plans or endowment policies, as wellas the financial condition of the borrower, tax laws and general economic conditionsat the time.

 

There can be no assurance that the borrower will have the fundsrequired to repay the principal at the end of the term. If a borrower cannotrepay the loan and a loss occurs on the loan, then this may affect repaymentsof principal on the issuer notes if that loss cannot be cured by application ofexcess Funding 1 available revenue receipts.

 

**There may be risks associated with the fact that the mortgages trusteehas no legal title to the loans and their related security, which may adverselyaffect payments on the issuer notes**

 

The sale by the seller to the mortgages trustee of the Englishmortgages will take effect in equity only. The sale by the seller to themortgages trustee of the Scottish mortgages has been given effect by a Scottishdeclaration of trust by the seller (and any sale of Scottish mortgages in thefuture will be given effect by further Scottish declarations of trust) by whichthe beneficial interest in the Scottish mortgages has been or will betransferred to the mortgages trustee. In each case this means that legal titleto the loans in the trust property remains with the seller, but the mortgagestrustee has all the other rights and benefits relating to ownership of eachloan and its related security (which rights and benefits are subject to thetrust in favor of the beneficiaries). The mortgages trustee has the right todemand that the seller give it legal title to the loans and the relatedsecurity in the circumstances and until then the mortgages trustee will not givenotice of the sale of the English mortgages to any borrower or apply to theLand Registry or the Central Land Charges Registry to register or record itsequitable interest in the English mortgages or take any steps to complete orperfect its title to the Scottish mortgages.

 

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

 

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

 

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

 

However, if a borrower exercises any set-off rights, then an amountequal to the amount set off will reduce the total amount of the seller share ofthe trust property only, and the minimum seller share has been sized in anamount expected to cover this risk, although there is no assurance that itwill. If the minimum seller share is exhausted, then the amount of any set-offswould be applied to reduce the Funding 1 share of the trust property.

 

Once notice has been given to borrowers of the transfer of the loansand their related security to the mortgages trustee, independent set-off rightswhich a borrower has against the seller will crystallize (such as, for example,set-off rights associated with borrowers holding deposits with the seller) andfurther rights of independent set-off would cease to accrue from that date andno new rights of independent set-off could be asserted following that notice.Set-off rights arising under transaction set-off (which are set-off claimsarising out of a transaction connected with the loan) will not be affected bythat notice.

 

**Set-off risks in relation to flexible loans and delayed cashbacks mayadversely affect the funds available to the issuer to repay the issuer notes**

 

The seller has made, and in the future may make, an equitableassignment of the relevant loans and their related security, or in the case ofScottish loans a transfer of the beneficial interest in the relevant loans andtheir related security, to the mortgages trustee, with legal title beingretained by the seller. Therefore, the rights of the mortgages trustee may besubject to the direct rights of the borrowers against the seller, including rightsof set-off existing prior to notification to the borrowers of the sale of themortgages. Although the mortgages trust does not currently include flexibleloans or delayed cashbacks, those loans may be added to the mortgages trust inthe future. Set-off rights (including analogous rights in Scotland) may occurif the seller fails to advance to a borrower a drawing or permit the borrowerto make an underpayment or take a payment holiday under a flexible loan whenthe borrower is entitled to draw additional amounts or make an underpayment ortake a payment holiday under a flexible loan or if the seller fails to pay to aborrower any delayed cashback which the seller had agreed to pay to thatborrower after completion of the relevant loan.

 

If the seller fails to advance the drawing or permit the borrower tomake an underpayment or take a payment holiday or pay the delayed cashback,then the relevant borrower may set off any damages claim (or exercise analogousrights in Scotland) arising from the seller’s breach of contract against theseller’s (and, as assignee or holder of the beneficial interest in the loansand their related security, the mortgages trustee’s) claim for payment ofprincipal and/or interest under the loan as and when it becomes due. These set-offclaims will constitute transaction set-off as described in the immediatelypreceding risk factor.

 

The amount of the claim in respect of a drawing will, in many cases, bethe cost to the borrower of finding an alternative source of finance although, inthe case of flexible loans or

 

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

 

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

 

A borrower may also attempt to set-off against his or her mortgagepayments an amount greater than the amount of his or her damages claim (orexercise analogous rights in Scotland). In that case, the servicer will beentitled to take enforcement proceedings against the borrower although theperiod of non-payment by the borrower is likely to continue until a judgment isobtained.

 

The exercise of set-off rights by borrowers would reduce the incomingcashflow to the mortgages trustee during the exercise. However, the amountsset-off will be applied to reduce the seller share of the trust property only.

 

Further there may be circumstances in which certain drawings may rankbehind security created by a borrower after the date upon which the borrowerentered into its mortgage with the seller.

 

The minimum seller share has been sized in an amount expected to coverthis risk, although there is no assurance that it will. If the minimum sellershare is not sufficient in this respect then there is a risk that noteholdersmay not receive all amounts due on the issuer notes or that payments may not bemade when due.

 

**If the servicer is removed, there is no guarantee that a substituteservicer would be found, which could delay collection of payments on the loansand ultimately could adversely affect payments on the issuer notes**

 

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

 

There can be no assurance that a substitute servicer with sufficientexperience of administering mortgages of residential properties would be foundwho would be willing and able to service the loans on the terms of the servicingagreement. In addition, as described below, any substitute servicer may berequired to be authorized under FSMA (as defined below) in order to administerloans that constitute regulated mortgage contracts. The ability of a substituteservicer fully to perform the required services would depend, among otherthings, on the information,

 

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software and records available at the time of the appointment. Anydelay or inability to appoint a substitute servicer may affect payments on theloans and hence our ability to make payments when due on the issuer notes.

 

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

 

**Funding 1 may not receive the benefit of any claims made on thebuildings insurance which could adversely affect payments on the issuer notes**

 

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

 

**Regulatory changes by the Office of Fair Trading, the FinancialServices Authority and other regulatory authorities may have an impact on theseller, the issuer, the servicer, the mortgages trustee, Funding 1, Funding 2and/or the loans and may adversely affect the issuer’s ability to make paymentswhen due on the issuer notes**

 

In the United Kingdom, the Office of Fair Trading (the “OFT”) isresponsible for the issue of licenses under, and the superintendence of theworking and the enforcement of the Consumer Credit Act (the “CCA”), relatedconsumer credit regulations and other consumer protection legislation. The OFTmay review businesses and operations, provide guidelines to follow and takeactions when necessary with regard to the mortgage market in the UnitedKingdom.

 

Currently, a credit agreement is regulated by the CCA where: (a) theborrower is or includes an individual; (b) the amount of “credit” asdefined in the CCA does not exceed the financial limit, which is £25,000 forcredit agreements made on or after May 1, 1998, or lower amounts forcredit agreements made before that date; and (c) the credit agreement isnot an exempt agreement under the CCA, for example, a regulated mortgagecontract under the FSMA (as defined below).

 

Any credit agreement that is wholly or partly regulated by the CCA orto be treated as such has to comply with requirements under the CCA as tolicensing of lenders and brokers, documentation and procedures of creditagreements, and (in so far as will be applicable) pre-contract disclosure. Ifit does not comply with those requirements, then to the extent that the creditagreement is regulated by the CCA or to be treated as such, it is unenforceableagainst the borrower: (a) without an order of the OFT, if the lender orany broker does not hold the required license at the relevant time; (b) totally,if the form to be signed by the borrower is not signed by the borrowerpersonally or omits or mis-states a ‘‘prescribed term’’; or (c) without acourt order in other cases and, in exercising its discretion whether to makethe order, the court would take into account any prejudice suffered by theborrower and any culpability of the lender.

 

Any credit agreement for a loan or further advance might be wholly orpartly regulated by the CCA or treated as such because of technical rules on:(a) determining whether any credit under the CCA arises, or whether thefinancial limit of the CCA is exceeded; (b) determining

 

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whether the credit agreement is an exempt agreement under the CCA; and (c) changesto credit agreements.

 

A court order under section 126 of the CCA is necessary to enforcea land mortgage securing a credit agreement to the extent that the creditagreement is regulated by the CCA or to be treated as such. In dealing withsuch application, the court has the power, if it appears just to do so, toamend the credit agreement or to impose conditions upon its performance or tomake a time order (for example, giving extra time for arrears to be cleared).

 

Under section 75 of the CCA in certain circumstances: (a) thelender is liable to the borrower in relation to misrepresentation and breach ofcontract by a supplier in a transaction financed by the lender, where therelated credit agreement is or is treated as entered into under pre-existingarrangements, or in contemplation of future arrangements, between the lenderand the supplier; and (b) the lender has an indemnity from the supplieragainst such liability, subject to any agreement between the lender and thesupplier.

 

In November 2002, the UK Department of Trade and Industry (the “DTI”)announced its intention that a credit agreement will be regulated by the CCAwhere, for credit agreements made after this change is implemented: (a) theborrower is or includes an individual, save for partnerships of four or morepartners; (b) irrespective of the amount of credit (although in July 2003,the DTI announced its intention that the financial limit will remain forcertain business-to-business lending); and (c) the credit agreement is notan exempt agreement. In December 2003, the DTI published a White paperproposing amendments to the CCA and to secondary legislation made under it.

 

In June 2004, secondary legislation was made on: (a) amendingrequirements as to documentation of credit agreements, coming into force on May 31,2005, or August 31, 2005 for agreements given to the borrower forsignature but not made before May 31, 2005; (b) pre-contractdisclosure, coming into force on May 31, 2005; and (c) replacing theformula for calculating the maximum amount payable on early settlement with aformula more favorable to the borrower, coming into force on May 31, 2005for new agreements or on May 31, 2007 or May 31, 2010 (depending on theterm of the agreement) for agreements existing before May 31, 2005.

 

In December 2004, the UK Parliament published a consumer CreditBill proposing to amend the CCA by, among other things: (a) changing thedefinition of a credit agreement regulated by the CCA to that announced by theDTI as described above; and (b) repealing the rule that, to theextent that a credit agreement is regulated by the CCA or treated as such, itmay be unenforceable totally. If these changes are enacted, then any creditagreement made or changed such that a new contract is entered into after thistime, other than a regulated mortgage contract under the FSMA or other exemptagreement under the CCA, will be regulated by the CCA. Such credit agreementwill have to comply with requirements as described above and, if it does notcomply, it will be unenforceable without an order of the OFT or without a courtorder as described above.

 

This consumer Credit Bill also proposes to amend the CCA by: (a) strengtheningthe licensing regime; (b) reforming the law on extortionate credit, withthe retrospective effect on existing agreements; and (c) extending thejurisdiction of the Ombudsman (as described below) to license holders under theCCA. Further proposals to amend the CCA and secondary legislation made under itare expected at an unspecified time.

 

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The seller has interpreted certain technical rules under the CCAin a way common with many other lenders in the mortgage market. If such aninterpretation were held to be incorrect by a court or the Ombudsman, then acredit agreement, to the extent that it is regulated by the CCA or treated assuch, would be unenforceable as described above. If such interpretation werechallenged by a significant number of borrowers, then this could lead tosignificant disruption and shortfall in income of the mortgages trustee. Courtdecisions have been made on technical rules under the CCA against certainmortgage lenders, but such decisions are very few and are generally countycourt decisions not binding on other courts.

 

The seller has given or, as applicable, will give warranties to themortgages trustee in the mortgage sale agreement that, among other things, eachloan and its related security is enforceable (subject to certain exemptions).If a loan or its related security does not comply with these warranties, and ifthe default cannot be or is not cured within 20 London business days, then theseller will be required to repurchase the loans under the relevant mortgageaccount and their related security from the mortgages trustee.

 

In the United Kingdom, regulation of residential mortgage business bythe FSA under the Financial Services and Markets Act 2000 (the “FSMA”) cameinto force on October 31, 2004, the date known as “N(M)”. Entering into,arranging, advising on and administering regulated mortgage contracts, andagreeing to do any of these things, are (subject to applicable exemptions)regulated activities under the FSMA.

 

A credit agreement is a regulated mortgage contract under the FSMA if,at the time it is entered into on or after N(M): (a) the borrower is anindividual or trustee; (b) the contract provides for the obligation of theborrower to repay to be secured by a first legal mortgage or, in Scotland, afirst ranking standard security on land (other than timeshare accommodation) inthe UK; and (c) at least 40 per cent. of that land is used, or is intendedto be used, as or in connection with a dwelling by the borrower or (in case ofcredit provided to trustees) by an individual who is a beneficiary of thetrust, or by a related person.

 

The main effects are that, unless an exclusion or exemption applies: (a) eachentity carrying on a regulated mortgage activity has to hold authorization and permissionfrom the FSA to carry on that activity; and (b) generally, each financialpromotion in respect of an agreement relating to a qualifying credit has to beissued or approved by a person holding authorization and permission from theFSA. If requirements as to authorization and permission of lenders and brokersor as to issue and approval of financial promotions are not complied with, aregulated mortgage contract will be unenforceable against the borrower exceptwith the approval of a court. An unauthorized person who administers aregulated mortgage contract entered into on or after N(M) may commit a criminaloffence, but this will not render the contract unenforceable against theborrower.

 

Any credit agreement intended to be a regulated mortgage contract underthe FSMA might instead be wholly or partly regulated by the CCA or treated assuch, or unregulated, because of technical rules on: (a) determiningwhether the credit agreement falls within the definition of “regulated mortgagecontract”; and (b) changes to credit agreements.

 

The seller is required to hold authorisization and permission to enterinto and to administer and, where applicable, to advise on regulated mortgagecontracts. Subject to any exemption, brokers will be required to hold authorizationand permission to arrange and, where applicable, to advise on regulatedmortgage contracts.

 

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The issuer and mortgages trustee are not and do not propose to beauthorized persons under the FSMA. The issuer and mortgages trustee will notrequire authorization in order to acquire legal or beneficial title to aregulated mortgage contract. The issuer and mortgages trustee do not carry onthe regulated activity of administering in relation to regulated mortgagecontracts by having them administered pursuant to an administration agreementby an entity having the required FSA authorization and permission. If suchadministration agreement terminates, however, the issuer and mortgages trusteewill have a period of not more than one month in which to arrange for mortgageadministration to be carried out by a replacement administrator having therequired FSA authorization and permission. In addition, from N(M) no variationhas been or will be made to the loans and no further advance has been or willbe made to a loan, where it will result in the issuer, Funding 1, Funding 2 orthe mortgages trustee arranging, advising on, administering or entering into aregulated mortgage contract or agreeing to carry on any of these activities, ifthe issuer Funding 1, Funding 2 or the mortgages trustee would be required tobe authorized under the FSMA to do so.

 

The FSA Mortgages: Conduct of Business Sourcebook (“MCOB”), which setsout its rules for regulated mortgage activities, came into force on October 31,2004. These rules cover, *inter alia*,certain pre-origination matters, such as financial promotion andpre-application illustrations, pre-contract and start of contract andpost-contract disclosure, contract changes, charges, arrears and repossessions.FSA rules for prudential and authorization requirements for mortgage firmsand insurance intermediaries, and for extending the appointed representativesregime came into force on October 31, 2004 for mortgages and on January 14,2005 for general insurance.

 

A borrower who is a private person is entitled to claim damages forloss suffered as a result of any contravention by an authorized person of anFSA rule, and may set-off the amount of the claim against the amount owing bythe borrower under the loan or any other loan that the borrower has taken (orexercise analogous rights in Scotland). Any such set-off may adversely affectthe issuer’s ability to make payments on the issuer notes.

 

So as to avoid dual regulation it is intended that regulated mortgagecontracts will not be regulated by the CCA. This exemption only affects creditagreements made on or after N(M), and credit agreements made before N(M) butsubsequently changed such that a new contract is entered into on or after N(M)and constitutes a regulated mortgage contract. A court order under section 126of the CCA is, however, necessary to enforce a land mortgage securing aregulated mortgage contract that would, apart from this exemption, be regulatedby the CCA or be treated as such.

 

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

 

Prior to M(N), in the United Kingdom, self-regulation of mortgagebusiness existed under the Mortgage Code (the “CML Code”) issued by the Councilof Mortgage Lenders (the “CML”). Halifax subscribed to the CML Code and on andfrom N(M), as an authorized person, has been subject to the FSA requirements inMCOB. Membership of the CML and compliance with the CML Code were voluntary.The CML Code sets out minimum standards of good mortgage business practice,from marketing to lending procedures and dealing with borrowers experiencing

 

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financial difficulties. Since April 30, 1998 lender-subscribers tothe CML Code may not accept mortgage business introduced by intermediaries whowere not registered with (before November 1, 2000) the Mortgage CodeRegister of Intermediaries or (on and after November 1, 2000 until October 31,2004) the Mortgage Code Compliance Board.

 

In September 2002, the European Commission published a proposalfor a directive of the European Parliament and of the Council on theharmonization of the laws, regulations and administrative provisions of themember states concerning credit for consumers and surety agreements entered intoby consumers. In its original form, the proposal does not include a financiallimit for regulated agreements (unlike the existing Directive 87/102/EEC, asamended, which provides that (subject to certain exceptions) loans notexceeding euro 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 theproposal comes into force in its original form, mortgage loans which do notcomply with these requirements may be unenforceable. Significantly, in itsoriginal form, the proposal provides that it does not apply retrospectively(subject to certain exceptions including in respect of new drawings or furtheradvances made in respect of existing agreements) and does not apply toresidential mortgage loans except those which include an equity releasecomponent.

 

There has been significant opposition from the European Parliament tothe original form of the proposed directive. On February 13, 2004, theCommittee of Legal Affairs and the Internal Market published the EuropeanParliament’s amendments to the proposed draft. These amendments provide that(subject to certain exceptions) loans not exceeding euro 100,000 will beregulated, but that the proposed directive will not apply to any loan securedby a land mortgage or, in Scotland, a standard security, and will not apply toany credit agreement or surety agreement made before national implementinglegislation comes into force. In October 2004, the European Commissionpublished an amended form of the proposed directive. In this amended form, theproposed directive provides that (subject to certain exceptions) loans notexceeding euro 100,000 will be regulated, and that it will indeed apply to anyloan secured by a land mortgage or, in Scotland a standard security thatincludes an equity release component, but it is unclear whether it will applyto any credit agreement or surety agreement made before national implementinglegislation comes into force. There are differences in opinion as to the extentto which mortgage loans should be included in the scope of the proposeddirective, which may be substantially further amended before it is ultimatelybrought into effect.

 

The proposal is unlikely to come into force before 2006 as theco-decision procedure of the European Parliament and of the Council, from thepublication of the proposal to the coming into force of the new consumer creditdirective, is likely to take at least two years and member states will thenhave a further two years in which to bring national implementing legislationinto force. The DTI has consulted with consumer and industry organizations inrelation to this proposal and in February 2005 published a consultationpaper on the form of the proposed directive published by the EuropeanCommission in October 2004.

 

Until the final text of the directive is decided and the details of theUnited Kingdom implementing legislation are published, it is not certain whateffect the adoption and implementation of the directive would have on theseller, the issuer, the servicer, the mortgages trustee, Funding1, Funding 2and their respective businesses and operations. This may adversely affect theissuer’s ability to make payments in full on the issuer notes when due.

 

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**Regulations in the United Kingdom could lead to some terms of the loansbeing unenforceable, which may adversely affect payments on the issuer notes**

 

In the United Kingdom, the Unfair Terms in Consumer ContractsRegulations 1999 as amended (the “1999 Regulations”), which, together with (inso far as applicable) the Unfair Terms in Consumer Contracts Regulations 1994(together with the 1999 Regulations, the “UTCCR”), apply to agreements made onor after July 1, 1995 and affect all or almost all of the loans, providethat:

 

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

 

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

 

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

 

For example, if a term permitting the lender to vary the interest rate(as the seller is permitted to do) is found to be unfair, the borrower will notbe liable to pay the increased rate or, to the extent that she or he has paidit, will be able, as against the lender, or any assignee such as the mortgagestrustee, to claim repayment of the extra interest amounts paid or to set-offthe amount of the claim against the amount owing by the borrower under the loanor any other loan that the borrower has taken. Any such non-recovery, claim orset-off may adversely affect the issuer’s ability to make payments on theissuer notes.

 

In February 2000, the OFT issued a guidance note on what the OFTconsiders to be fair terms and unfair terms for interest variation in mortgagecontracts. Where the interest variation term does not provide for precise andimmediate tracking of an external rate outside the lender’s control, and if theborrower is locked in, for example by an early repayment charge that isconsidered to be a penalty, the term is likely to be regarded as unfair underthe UTCCR unless the lender (i) notifies the affected borrower in writingat least 30 days before the rate change and (ii) permits the affectedborrower to repay the whole loan during the next three months after the ratechange, without paying the early repayment charge. The seller has reviewed theguidance note and has concluded that its compliance with it will have nomaterial adverse effect on the loans or its business. The guidance note hasbeen withdrawn from the OFT website and is currently under review by the OFTand FSA. The FSA has agreed with the OFT to take responsibility for theenforcement of the UTCCR in mortgage agreements. It is expected that the FSA willissue guidance on interest variation terms shortly.

 

In August 2002, the Law Commission for England and Wales and theScottish Law Commission issued a joint consultation LCCP No. 166/SLCDP 119on proposals to rationalize the UK’s Unfair Contract Terms Act 1977 and the1999 Regulations into a single piece of legislation and a final report,together with a bill on unfair terms, was published in February 2005. TheLaw Commissions have a duty under section 3 of the UK’s Law CommissionsAct 1965 to keep the law under review for a number of purposes, including itssimplification. The proposals are primarily to simplify the legislation onunfair terms. It is not proposed that there should be any significant increasein the extent of controls over terms in consumer contracts. Some changes areproposed, however, such as that (a) a consumer may also challenge anegotiated term in agreement on the basis that it is “unfair” and “unreasonable”within the

 

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legislation and therefore not binding on the consumer; and (b) inany challenge by a consumer (but not by the OFT or a qualifying body) of astandard term or a negotiated term, the burden of proof lies on the business toshow that the term is fair and reasonable. It is too early to tell how theproposals, if enacted, would affect the loans.

 

No assurance can be given that changes in the UTCCR, if enacted, orchanges to guidance on interest variation terms, if adopted, will not have amaterial adverse effect on the seller, the issuer, the servicer, the mortgagestrustee, Funding 1, Funding 2 and their respective businesses and operations.This may adversely affect the issuer’s ability to make payments in full on theissuer notes when due.

 

**Decisions of the Ombudsman could lead to some terms of the loans beingvaried, which may adversely affect payments on the issuer notes**

 

Under FSMA, the Financial Ombudsman Service is required to makedecisions on, among other things, complaints relating to activities andtransactions under its jurisdiction on the basis of what, in the Ombudsman’sopinion, would be fair and reasonable in all circumstances of the case, takinginto account, among other things, law and guidance. Complaints brought beforethe Financial Ombudsman Service for consideration must be decided on acase-by-case basis, with reference to the particular facts of any individualcase. Each case would first be adjudicated by an adjudicator. Either party tothe case may appeal against the adjudication. In the event of an appeal, thecase proceeds to a final decision by the Ombudsman.

 

In January 2002, the Ombudsman made a determination on the seller’sappeal to an earlier decision by an adjudicator at the Financial OmbudsmanService concerning a case involving HVR 1 and HVR 2. In March 2001, twojoint borrowers with a capped rate loan originated when Halifax offered only asingle standard variable base rate contacted Halifax and requested that theirloan be linked to HVR 2. Halifax informed the borrowers that, because they werestill in their product period, they could either transfer to HVR 2 when theirproduct period expired or transfer to HVR 2 immediately and pay the applicableearly repayment fee. The borrowers complained to the Financial OmbudsmanService and, on January 29, 2002, on appeal by Halifax, the Ombudsmandetermined in the borrowers’ favor and recommended that Halifax recalculate theborrowers’ mortgage by reference to HVR 2 from the date when the seller shouldhave 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 decision only applies to the two borrowers and theirparticular circumstances, though other borrowers may also complain to theOmbudsman. In March 2002, the seller announced that borrowers under loanswho were in similar circumstances and who had asked to be transferred to HVR 2when it was available would be invited to make a product switch to HVR 2 and toobtain a refund for all overpayments of interest since the date they had askedto be transferred. For each of those loans, the borrowers would also receive£150 for any inconvenience caused. The borrowers under loans who requested to betransferred after HVR 2 was withdrawn and before the announcement in March 2002were not offered a switch or a refund, though the seller has given or will giveeach of these customers an ex gratia payment of £100.

 

Since then, further decisions by the Ombudsman in similar cases haveconfirmed that affected borrowers were only entitled to a refund ofoverpayments of interest from the date when they asked to be transferred to HVR2 and not from the date when HVR 2 first became available,

 

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and also that affected borrowers were not entitled to apply to betransferred to HVR 2 after it was withdrawn.

 

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

 

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

 

As the Financial Ombudsman Service is required to make decisions on thebasis of, among other things, the principles of fairness, it is not possible topredict how any future decision of the Financial Ombudsman Service would affectthe ability of the issuer to repay the issuer notes.

 

**Tax payable by Funding 1 or the issuer may adversely affect the issuer’sability to make payments on the issuer notes**

 

Funding 1 and the issuer will generally be subject to UK corporationtax, currently at a rate of 30 per cent., on the profit reflected in theirrespective profit and loss accounts as increased by the amount of anynon-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.

 

The UK corporation tax position of the issuer and Funding 1, however,also depends to a significant extent on the accounting treatment applicable toit. From January 1, 2005, the accounts of the issuer are required tocomply with International Financial Reporting Standards (“IFRS”) or with new UKFinancial Reporting Standards reflecting IFRS (“new UK GAAP”). Funding 1 mayalso choose to comply with IFRS. There is concern that companies such as theissuer and Funding 1 might, under either IFRS or new UK GAAP, suffer timingdifferences that could result in profits or losses for accounting purposes, andaccordingly for tax purposes (unless tax legislation provides otherwise), whichbear little or no relationship to the company’s cash position. However, theFinance Act 2005 requires “securitisation companies” to prepare taxcomputations for accounting periods beginning on or after January 1, 2005and ending before January 1, 2007 on the basis of UK GAAP as applicable upto December 31, 2004, notwithstanding the requirement to prepare statutoryaccounts under IFRS or new UK GAAP. The issuer and Funding 1 will each be a “securitisationcompany” for these purposes.

 

The stated policy of H.M. Revenue & Customs is that the taxneutrality of securitisation special purpose companies in general should not bedisrupted as a result of the transition to IFRS or new UK GAAP and that theyare working with participants in the securitisation industry to identifyappropriate means of preventing any such disruption. The Finance Act 2005enables regulations to be made to establish such a regime. However, if measuresare not introduced by H.M. Revenue & Customs to deal with thecorporation tax position of such companies in respect of accounting periodsending on or after January 1, 2007, then profits or losses could arise inthe

 

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issuer and/or Funding 1 as a result of the application of IFRS or newUK GAAP which could have tax effects not contemplated in the cashflows for thetransaction and as such adversely affect the issuer and/or Funding 1 andtherefore payments on the issuer notes.

 

**Noteholders’ interests may be adversely affected by a change of law inrelation to withholding tax**

 

In the event that amounts due under the issuer notes are subject towithholding tax, the issuer will not be obliged to pay additional amounts inrelation thereto. The issuer may, in certain circumstances, redeem the issuernotes.

 

**Noteholders’ interests may be adversely affected if the United Kingdomjoins the European Monetary Union**

 

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

 

It is possible that prior to the maturity of the issuer notes theUnited Kingdom may become a participating member state in the European economicand monetary union and that the euro may become the lawful currency of theUnited Kingdom. In that event, (a) all amounts payable in respect of anyissuer notes denominated in sterling may become payable in euro; (b) applicableprovisions of law may allow or require the issuer to re-denominate such issuernotes into euro and take additional measures in respect of such issuer notes;and (c) the introduction of the euro as the lawful currency of the UnitedKingdom may result in the disappearance of published or displayed rates fordeposits in pounds sterling used to determine the rates of interest on suchissuer notes or changes in the way those rates are calculated, quoted andpublished or displayed. The introduction of the euro could also be accompaniedby a volatile interest rate environment, which could adversely affect aborrower’s ability to repay its loan as well as adversely affect investors. Itcannot be said with certainty what effect, if any, adoption of the euro by theUnited Kingdom will have on investors in the issuer notes.

 

**Changes of law may adversely affect noteholders’ interests**

 

The structure of the issue of the issuer notes and the ratings whichare assigned to them are based on English law and (in relation to the Scottishloans) Scots law in effect as at the date of this prospectus. The issuer cannotprovide assurance as to the impact of any possible change to English or Scotslaw or administrative practice in the United Kingdom after the date of this Form 20-F.

 

*Insolvency Act 2000*.Significant changes to the UK insolvency regime have been enacted in pastyears, including the Insolvency Act 2000. The Insolvency Act 2000 allowscertain “small” companies to seek protection from their creditors for a periodof 28 days, for the purposes of putting together a company voluntaryarrangement, with the option for creditors to extend the moratorium for afurther two months. A “small” company is defined as one which satisfies, in anyfinancial year, two or more of the following criteria: (i) its turnover isnot more than £5.6 million, (ii) its balance sheet total is not more than£2.8 million and (iii) the number of employees is not more than 50.Whether or not a company is a “small” company may change from period to periodand consequently no assurance can be given that the issuer, the mortgagestrustee or Funding 1 will not, at any given time, be determined to be a “small”company. The Secretary of State for Trade and Industry may by regulation modifythe eligibility requirements for “small” companies

 

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and can make different provisions for different cases. No assurance canbe given that any such modification or different provisions will not bedetrimental to the interests of the noteholders.

 

Secondary legislation has now been enacted which excludes certainspecial purpose companies in relation to capital markets transactions from theoptional moratorium provisions. Such exceptions include (amongst other matters)(i) a company which is a party to an agreement which is or forms part of acapital market arrangement (as defined in the secondary legislation) underwhich (a) a party has incurred or when the agreement was entered into wasexpected to incur a debt of at least £10 million under the arrangement and (b) thearrangement involves the issue of a capital markets investment (also defined,but generally a rated, listed or traded bond) and (ii) a company which atthe date of filing for a moratorium has incurred a liability (including apresent, future or contingent liability) of at least £10 million. While theissuer, the mortgages trustee and Funding 1 should fall within the exceptions,there is no guidance as to how the legislation will be interpreted and theSecretary of State for Trade and Industry may by regulation modify theexception. No assurance may be given that any modification of the eligibilityrequirements for “small” companies and/or the exceptions will not bedetrimental to the interests of the noteholders.

 

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

 

*Enterprise Act 2002*.On September 15, 2003, the corporate insolvency provisions of theEnterprise Act 2002 came into force, amending certain provisions of the InsolvencyAct 1986 (as amended, the “Insolvency Act”). These provisions introducedsignificant reforms to corporate insolvency law. In particular the reformsrestrict the 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).

 

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

 

The Insolvency Act contains provisions that continue to allow for theappointment of an administrative receiver in relation to certain transactionsin the capital markets. The relevant exception provides that the right toappoint an administrative receiver is retained for certain types of security(such as the issuer security) that form part of a capital markets arrangement(as defined in the Insolvency Act) that involves indebtedness of at least £50million (or, when the relevant security document was entered into (being inrespect of the transactions described in the prospectus, relating to the issuernotes and the issued deed of charge), a party to the relevant transaction (suchas the issuer) was expected to incur a debt of at least £50 million) and theissue of a capital markets investment (also defined, but generally a rated,listed or traded bond). The Secretary of State for Trade and Industry may, bysecondary legislation, modify the capital market exception and/or provide thatthe exception shall cease to have effect. No assurance can be given that anysuch modification or provision in respect of the capital market exception, orits ceasing to be applicable to the transactions described in this documentwill not adversely affect payments on the issuer notes. In addition, as theprovisions of the Enterprise Act have never been

 

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considered judicially, no assurance can be given as to whether theEnterprise Act could have a detrimental effect on the interests of thenoteholders.

 

The Insolvency Act also contains a new out-of-court route intoadministration for a qualifying floating charge holder, the directors or thecompany itself. The relevant provisions provide for a notice period duringwhich the 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 qualifying floating charge holder does not respond tothe directors’ notice of intention to appoint, the directors’, or as the casemay be, the company’s appointee will automatically take office after the noticeperiod has elapsed. Where the holder of a qualifying floating charge within thecontext of a capital market transaction retains the power to appoint anadministrative receiver, such holder may prevent the appointment of anadministrator (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 administration provisions of the Insolvency Act give primaryemphasis to the rescue of the company as a going concern. The purpose ofrealizing property to make a distribution to one or more secured creditors issubordinated to the primary purposes of rescuing the company as a going concernor achieving a better result for the creditors as a whole than would be likelyif the company were wound up. No assurances can be given that the primarypurposes of the new provisions will not conflict with the interests ofnoteholders were the issuer ever subject to administration.

 

In addition to the introduction of a prohibition on the appointment ofan administrative receiver as set out above, section 176A of theInsolvency Act provides that in relation to floating charges created after September 15,2003 any receiver (including an administrative receiver), liquidator oradministrator of a company is required to make a “prescribed part” of thecompany’s “net property” available for the satisfaction of unsecured debts inpriority to the claims of the floating charge holder. The company’s “netproperty” is defined as the amount of the chargor’s property which would beavailable for satisfaction of debts due to the holder(s) of any debenturessecured by a floating charge and so refers to any floating charge realizationsless any amounts payable to the preferential creditors or in respect of theexpenses of the liquidation or administration. The “prescribed part” is definedin The Insolvency Act 1986 (Prescribed Part) Order 2003 (SI 2003/2097) to be anamount equal to 50 per cent. of the first £10,000 of floating chargerealizations plus 20 per cent. of the floating charge realizations thereafter,provided that such amount may not exceed £600,000.

 

This obligation does not apply if the net property is less than aprescribed minimum and the relevant officeholder is of the view that the costof making a distribution to unsecured creditors would be disproportionate tothe benefits. The relevant 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 charge realizations upon the enforcement of the issuersecurity and the security created by the second supplemental Funding 1 deed ofcharge may be reduced by the operation of these “ring fencing” provisions.

 

**The noteholders will not receive issuer notes in physical form, whichmay cause delays in distributions and hamper the noteholders’ ability to pledgeor resell the issuer notes**

 

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Unless the global issuer notes are exchanged for definitive issuernotes, which will only occur under a limited set of circumstances, thenoteholders’ beneficial ownership of the issuer notes will only be recorded inbook-entry form with DTC, Euroclear or Clearstream, Luxembourg. The lack ofissuer notes in physical form could, among other things:

 

•                  result inpayment 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;

 

•                  make itdifficult for the noteholders to pledge the issuer notes if issuer notes inphysical form are required by the party demanding the pledge; and

 

•                  hinder thenoteholders’ ability to resell the issuer notes because some investors may beunwilling to buy issuer notes that are not in physical form.

 

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

 

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

 

**Implementation of the Basel II risk-weighted asset framework may resultin changes to the risk-weighting of the issuer notes**

 

The Basel Committee on Banking Supervision published the text of thenew framework on June 26, 2004 under the title “Basel II: InternationalConvergence of Capital Measurement and Capital Standards: a Revised Framework”.This new framework (the “Framework”), which places enhanced emphasis on marketdiscipline and sensitivity to risk, will serve as the basis for nationalrule-making and approval processes to continue and for banking organizations tocomplete their preparations for implementation of the Framework. The Committeeconfirmed that it is currently intended that the various approaches under theFramework will be implemented in stages, some from year-end 2006, the mostadvanced at year-end 2007. As and when implemented (including through the EUCapital Requirements Directive), the Framework could affect the risk–weightingof the issuer notes in respect of certain investors if those investors aresubject to the Framework following its implementation. Consequently, investorsshould consult their own advisers as to the consequences to and effect on themof the proposed implementation of the Framework. No predictions can be made asto the precise effects of potential changes which might result upon theimplementation of the Framework.

 

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

 

**Item 4.  Information on theCompany**

 

A.*            History andDevelopment of the Company*

 

Not applicable.

 

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B.*            Business Overview*

 

Not applicable.

 

C.*            OrganizationalStructure*

 

Not applicable.

 

D.*            Property, Plants andEquipment*

 

The issuer

 

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

 

Funding 1

 

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

 

The mortgages trustee

 

The trust property includes the portfolio of loans and their relatedsecurity assigned to the mortgages trustee by the seller on June 14, 2002,and on several subsequent dates, any new loans and their new related securityassigned to the mortgages trustee by the seller after the closing date, anyincrease in the outstanding principal balance of a loan due to the borrowertaking payment holidays or making underpayments under a loan or a borrowermaking a drawing under any flexible loan, any interest, principal and otheramounts (excluding third party amounts) paid by borrowers on their loans andtheir related security, the rights under the insurance policies that areassigned to the mortgages trustee or of which the mortgages trustee has thebenefit, and amounts on deposit and interest earned on the mortgages trusteeguaranteed investment contract. Any actual losses in relation to the loans, anyactual 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, asborrowers take payment holidays or make underpayments under a loan and as theloans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

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

 

A.*            Operating Results*

 

Not applicable.

 

B.*            Liquidity and CapitalResources*

 

Not applicable.

 

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

 

Not applicable.

 

D*.**            TrendInformation*

 

Not applicable.

 

E.*             Off-balance Sheet Arrangements*

 

Not applicable.

 

F.*             Tabular Disclosure ofContractual Obligations*

 

Not applicable.

 

G*.**            SafeHarbor*

 

Notapplicable.

 

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

 

A.*            Directors and SeniorManagement*

 

The following sets out the names, business addresses and businessoccupations of the directors of the issuer, Funding 1 and the mortgagestrustee. Because each of the issuer, Funding 1 and the mortgages trustee isorganized as a special purpose company and will be largely passive, it is expectedthat the directors of each entity in that capacity will manage its operationsto the extent necessary.

 

The issuer

 
| **Name**                           | ** ** | **Business Address**                                             | ** ** | **Business Occupation**                             | ** ** |
|------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| SFM Directors Limited              |       | 35 Great St. Helen’s  LondonEC3A 6AP                        |       | Provision of directors to special purpose companies |       |
|                               |       |                                                             |       |                                                |       |
| SFM Directors (No. 2) Limited |       | 35 Great St. Helen’s  LondonEC3A 6AP                        |       | Provision of directors to special purpose companies |       |
|                               |       |                                                             |       |                                                |       |
| David Balai                        |       | HBOS Treasury Services plc  33 Old Broad Street  London EC2N 1HZ |       | Head of Mortgage Securitisation and Covered Bonds   |       |
|                               |       |                                                             |       |                                                |       |
| SFM Directors Limited              |       | 35 Great St. Helen’s  LondonEC3A 6AP                        |       | Provision of directors to special purpose companies |       |

 

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Funding 1

 
| **Name**                           | ** ** | **Business Address**                                             | ** ** | **Business Occupation**                             | ** ** |
|------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| SFM Directors (No. 2) Limited |       | 35 Great St. Helen’s  LondonEC3A 6AP                        |       | Provision of directors to special purpose companies |       |
|                               |       |                                                             |       |                                                |       |
| David Balai                        |       | HBOS Treasury Services plc  33 Old Broad Street  London EC2N 1HZ |       | Head of Mortgage Securitisation and Covered Bonds   |       |

 

The mortgages trustee

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

 

David Balai is an employee of a company in the same group of companiesas the seller.

 

B.*            Compensation*

 

The issuer

 

In accordance with the issuer corporate services agreement entered intobetween the issuer, the seller, the security trustee, the note trustee,Holdings and Structured Finance Management Limited (“SFM”), the seller and SFMwill each provide directors and other corporate services for the issuer inconsideration for a payment of a separate fee payable by the issuer to SFM. Noother remuneration is paid to any director or officer in connection with suchdirector’s or officer’s activities on behalf of the issuer.

 

Funding 1

 

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

 

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The mortgages trustee

 

In accordance with the mortgages trustee corporate services agreemententered into between the mortgages trustee, the security trustee, the notetrustee and SFM Offshore Limited (“SFM Offshore”), the seller and SFM Offshorewill each provide directors and SFM Offshore will provide other corporateservices for the mortgages trustee in consideration for a payment of a separatefee payable by the mortgages trustee to SFM Offshore. No other remuneration ispaid to 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 anyemployees.

 

E.             *ShareOwnership*

 

Not applicable.

 

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

 

A.            *MajorShareholders*

 

The issuer and Funding 1 are wholly owned byPermanent Holdings Limited, a company incorporated under the laws of Englandand Wales. SFM Corporate holds all of the beneficial interest in the issuedshares of Holdings on a discretionary trust for the benefit of The NationalSociety for the Prevention of Cruelty to Children in the United Kingdom and forother charitable purposes.

 

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

 

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

 

B.            *RelatedParty Transactions*

 

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

 

C.            *Interests ofExperts and Counsel*

 

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

 

**Item 8.  Financial Information**

 

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

 

The issuer, Funding 1 and the mortgages trustee know of no materiallegal or arbitration proceedings involving their respective companies that mayhave significant effects on the

 

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registrants’ financial position or profitability, includinggovernmental proceedings pending or known to be contemplated and any materialproceeding in which any director or affiliate is either a party adverse to aregistrant or has a material interest adverse to a registrant.

 

**Item 9.  The Offer and Listing**

 

A.*            Offer and ListingDetails*

 

Not applicable.

 

B.*            Plan of Distribution*

 

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

 

C.*            Markets*

 

The principal trading market for each class of the issuer notes is theLondon Stock Exchange. The issuer notes have been listed on the London StockExchange since March 12, 2004.

 

D.*            Selling Shareholders*

 

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

 

E.*             Dilution*

 

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

 

F.*             Expenses of the Issue*

 

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

 

**Item 10.  Additional Information**

 

A.*            Share Capital*

 

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

 

B.*            Memorandum andArticles of Association*

 

The memorandum and articles of association for each of the issuer,Funding 1 and the mortgages trustee are incorporated by reference from theRegistration Statement. Please also see the description of the issuer, Funding1 and the mortgages trustee set forth in the Registration Statement.

 

C.            *MaterialContracts*

 

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

 

D.*            Exchange Controls*

 

None.

 

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E.*             Taxation*

 

**United Kingdom Taxation**

 

The following section summarizes the material UK tax consequencesof the purchase, ownership and disposition of the issuer notes based on currentlaw and practice in the UK. The summary assumes that the profit in Funding 1’sprofit and loss account will not exceed 0.01 per cent. of the Funding 1available revenue receipts and that the profit in the issuer’s profit and lossaccount will not exceed 0.01 per cent. of the interest on the issuer termadvances under the issuer intercompany loan and any interest earned by theissuer on its share capital proceeds are correct. It further assumes that allpayments made pursuant to the final documentation are calculated on arm’slength terms. The summary does not purport to be a complete analysis of all taxconsiderations of the purchase, ownership and disposition of the issuer notes.It relates to the position of persons who are the absolute beneficial owners ofissuer notes and may not apply to certain classes of persons such as dealers orpersons 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 more detail below, no UK withholding tax will berequired in relation to interest payments on the issuer notes provided that theissuer notes are listed on a recognised stock exchange, which includes theLondon Stock Exchange. If the issuer notes cease to be listed on a “recognisedstock exchange”, an amount must be withheld on account of UK income tax at thelower rate (currently 20 per cent.), subject to any direction to the contraryfrom H.M. Revenue & Customs in respect of such relief as may beavailable pursuant to the provisions of an applicable double taxation treaty.

 

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

 

Subject to the opinions set out in the preceding paragraphs, asdiscussed in more detail under “-Directassessment of non-UK resident holders of the issuer notes to UK tax on interest”below, a noteholder who is resident in the US for US tax purposes and who is notresident in the UK for UK tax purposes will not be subject to UK tax in respectof any payments on the issuer notes unless they are held by or for a trade,profession or vocation carried on by him through a branch or agency (or, in thecase of a noteholder that is a company, through a permanent establishment) inthe UK.

 

US resident noteholders will not be liable toUK tax in respect of a disposal of the issuer notes provided they are notwithin the charge to UK corporation tax and (i) are not resident orordinarily resident in the UK, and (ii) do not carry on a trade,profession or vocation carried on by him through a branch or agency inconnection with which interest is received or to which the issuer notes areattributable.

 

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Funding 1 and the issuer will generally besubject to UK corporation tax, currently at a rate of 30 per cent, on theprofit reflected in their respective profit and loss accounts as increased bythe amounts of any non-deductible expenses or losses.

 

The mortgages trustee will have no liabilityto UK tax in relation to amounts which it receives on behalf of Funding 1 orthe seller under the mortgages trust.

 

**Withholding tax**

 

There will be no UK withholding tax in relation to interest payments onthe issuer notes provided that, so far as concerns deduction by the issuer orits paying agents, the issuer notes are listed on a “recognised stock exchange”,as defined in Section 841 of the Income and Corporation Taxes Act 1988 (“ICTA”).The London Stock Exchange is currently a recognised stock exchange for thispurpose. If the issuer notes cease to be listed on a “recognised 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 H.M. Revenue & Customs in respect of such relief asmay be available pursuant to the provisions of an applicable double taxationtreaty or to the interest being paid to persons (including companies within thecharge to UK corporation tax) and in circumstances specified in Section 349Ato 349D of the ICTA.

 

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

 

**Direct assessment of non-UK resident holdersof the issuer notes to UK tax on interest**

 

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

 

In general, noteholders who are within the charge to UK corporation tax(other than authorized unit trusts) will normally be subject to tax on allprofits and gains, including interest and profit and gains attributable tocurrency regulations, arising on or in connection with the issuer notes underthe loan relationship rules. Any such profits and gains will generally fall tobe calculated in accordance with the statutory accounting treatment of theissuer 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

 

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that accounting treatment. Relief may be available in respect of lossesor for related expenses on a similar basis.

 

**Taxation of returns: other noteholders**

 

Noteholders who are not within the charge to UK corporation tax and whoare resident or ordinarily resident in the UK for tax purposes or who carry ona trade, profession or vocation in the UK through a branch or agency inconnection with which interest on the issuer notes is received or to which theissuer notes are attributable will generally be liable to UK tax on the amountof any interest received in respect of the issuer notes. As the series 2 issuernotes are denominated in US dollars and the series 4 issuer notes and series 5class A1 issuer notes are denominated in euro, they will not constitute “qualifyingcorporate bonds” within the meaning of Section 117 of the Taxation ofChargeable Gains Act 1992. Accordingly, a disposal of any of these issuer notesmay give rise to a chargeable gain or an allowable loss for the purpose of theUK taxation of chargeable gains.

 

It is expected that the series 5 class A2 issuer notes, the series 5class B issuer notes, the series 5 class M issuer notes and the series 5 classC issuer notes will be regarded by H.M. Revenue & Customs asconstituting “qualifying corporate bonds” within the meaning of Section 117of the Taxation of Chargeable Gains Act 1992. Accordingly, a disposal of any ofthese issuer notes is not expected to give rise to a chargeable gain or anallowable loss for the purpose of the UK taxation of chargeable gains.

 

A disposal of the issuer notes by such noteholders as described abovemay also give rise to a charge to tax on income in respect of an amount representinginterest accrued on the issuer notes since the preceding payment date. For theissuer notes which constitute variable rate securities, taxation in respect ofsuch a disposal will be computed on the basis that such amount as H.M. Revenue &Customs considers to be just and reasonable will be treated as accrued income.However, the transferee of a variable rate security will not be entitled to anyrelief on such amount. All of the issuer notes will constitute variable rateissuer notes for this purpose.

 

**Stamp duty and stamp duty reserve tax**

 

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

 

**UK taxation of Funding 1 and the issuer**

 

Funding 1 and the issuer will generally be subject to UK corporationtax, currently at a rate of 30 per cent. on the profit reflected in theirrespective profit and loss accounts as increased by the amounts of anynon-deductible expenses or losses. 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 the issuerterm advances under the issuer intercompany loan and any interest earned by theissuer on its Share Capital proceeds.

 

**UK taxation of the mortgages trustee**

 

The mortgages trustee will have no liability to UK tax in respect ofany income, profit or gain arising under these arrangements. Accordingly, themortgages trustee will have no liability

 

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to UK tax in relation to amounts that it receives on behalf of Funding1 or the seller under the mortgages trust.

 

**EU Savings Directive**

 

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

 

Jersey is not a member of the EU and therefore is not required toimplement the EU Savings Tax Directive. However, the Policy &Resources Committee of the States of Jersey has announced that, in keeping withJersey’s policy of constructive international engagement, Jersey, in line withsteps proposed by other relevant third countries, proposes to introduce aretention tax system in respect of payments of interest, or other similarincome, made to an individual beneficial owner resident in an EU Member Stateby a paying agent situated in Jersey (the terms “beneficial owner” and “payingagent” for this purpose are as defined in the EU savings tax directive). Theretention tax system would apply for a transitional period prior to theimplementation of a system of automatic communication to EU Member States ofinformation regarding such payments. During this transitional period, such anindividual beneficial owner resident in an EU Member State would be entitled torequest a paying agent not to retain tax from such payments but instead toapply a system by which the details of such payments are communicated to thetax authorities of the EU Member State in which the beneficial owner isresident.

 

**United States Federal Income Taxation**

 

The following section summarizes the material US federal incometax consequences of the purchase, ownership and disposition of the series 2issuer notes and series 3 issuer notes (the “US notes”). In general, thesummary assumes that a holder acquires the US notes at original issuanceand 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 discussspecial tax considerations that may apply to certain types of taxpayers,including, without limitation, the following: (i) financial institutions; (ii) insurancecompanies; (iii) dealers or traders in stocks, securities, notionalprincipal contracts or currencies; (iv) tax-exempt entities; (v) regulatedinvestment companies; (vi) persons that will hold the US notes as part ofa “hedging” or “conversion” transaction or as a position in a “straddle” for USfederal income tax purposes; (vii) persons that own (or are deemed to own)10 per cent. or more of the voting shares of theissuer; (viii) persons who hold US notes through partnerships or otherpass-through entities; and (ix) persons that have a “functional currency”other than the US dollar. In addition, this summary does not addressalternative minimum tax consequences, nor does it describe any tax consequencesarising under the laws of any taxing jurisdiction other than the USfederal government.

 

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

 

**Investors should consult their own taxadvisors 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 this section, the term “United States holder” means abeneficial owner of US notes that is for US federal income tax purposes: (i) acitizen or resident of the United States; (ii) a corporation (orother entity treated as a corporation) or partnership, created or organized inor under the laws of the United States or any state thereof (including theDistrict of Columbia); (iii) any estate the income of which is subject toUS federal income tax regardless of the source of its income; or (iv) anytrust if a court within the United States is able to exercise primarysupervision over the administration of the trust and one or more United Statespersons have the authority to control all substantial decisions of the trust.If a 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 States holder” is a beneficial owner of US notesthat is not a United States holder.

 

**Tax status of the issuer, Funding 1, themortgages trustee and the mortgages trust**

 

Each of the issuer, Funding 1 and the mortgages trustee acting it itscapacity as trustee of the mortgages trust covenants not to engage in anyactivities in the United States (directly or through agents), not to derive anyincome from sources within the United States as determined under US federalincome tax principles, and not to hold any property if doing so would cause itto be engaged or deemed to be engaged in a trade or business within the UnitedStates as determined under US federal income tax principles. 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. No election will be made to treat the issuer,Funding 1 or the mortgages trustee or any of their assets as a REMIC (a type ofsecuritization vehicle having a special tax status under the Code).

 

**Characterization of the US notes**

 

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

 

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

 

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**Taxation of United States holders of the USnotes**

 

*QualifiedStated Interest and Original Issue Discount.***The issuer intends to treat interest on the US notes as “qualifiedstated interest” under US Treasury regulations relating to original issuediscount (hereafter the “OID regulations”). As a consequence, discount on theUS notes arising from an issuance at less than par will only be required to beaccrued under the OID regulations if such discount exceeds a statutorilydefined *de minimis* amount. Qualified statedinterest, which generally must be unconditionally payable at least annually, istaxed under a holder’s normal method of accounting as ordinary interest income.*De minimis* original issuediscount (“OID”) is included in income on a *pro rata* basisas principal payments are made on the US notes.

 

It is possible that interest on the US notes that are class B, class Mor class C issuer notes could be treated as OID because such interest issubject to deferral in certain limited circumstances. A United States holder ofa US note issued with OID must include OID in income over the term of such USnote under a constant yield method that takes into account the compounding ofinterest. Under the Code, OID is calculated and accrued using prepaymentassumptions where payments on a debt instrument may be accelerated by reason ofprepayments of other obligations securing such debt instrument. Moreover, thelegislative history to the provisions provide that the same prepaymentassumptions used to price a debt instrument be used to calculate OID, as wellas to accrue market discount and amortize premium. Here, prepayment of themortgage loans is not expected to alter the scheduled principal payments on theUS notes that are class B, class M and class C issuer notes and, accordingly,the issuer intends to assume that such US notes will have their principalrepaid according to the schedule for purposes 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 the above treatments, United States holders mayelect to include in gross income all interest with respect to the US notes,including stated interest, 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 US notes will be treated as foreign sourceincome for US federal income tax purposes, which may be relevant in calculatinga United States holder’s foreign tax credit limitation for US federal incometax purposes. The limitation on foreign taxes eligible for the US foreign taxcredit is calculated separately with respect to specific classes of income. Theforeign tax credit rules are complex, and United States holders shouldconsult their own tax advisers regarding the availability of a foreign taxcredit and the application of the limitation in their particular circumstances.

 

*Sales andRetirement.* In general, a United States holderof a US note will have a tax basis in such US note equal to the cost of the USnote to such holder, and reduced by any payments thereon other than payments ofstated interest. Upon a sale or exchange of the US note, a United States holderwill generally recognize gain or loss equal to the difference between the amount realized (less any accrued interest, which would betaxable as such) and the holder’s tax basis in the US note. Such gain or losswill be long-term capital gain or loss if the United States holder has held theUS note for more than one year at the time of disposition. **Investorsshould consult their own tax advisors with respect to the treatment of capitalgains (which may be taxed at lower rates than ordinary income for taxpayers whoare individuals, trusts or estates that hold the US notes for more than oneyear) and capital losses (the deductibility of which is subject tolimitations).**

 

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**Taxation of Non-United States holders of theUS Notes**

 

Subject to the backup withholding rules discussed below, aNon-United States holder generally should not be subject to US federal incomeor withholding tax on any payments on a US note and gain from the sale,redemption or other disposition of a US note unless: (i) that paymentand/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 ofany gain realized on the sale or exchange of a US note by an individualNon-United States holder, that holder is present in the United States for 183days or more in the taxable year of the sale, exchange or retirement andcertain other conditions are met; or (iii) the Non-United States holder issubject to tax pursuant to provisions of the Code applicable to certainexpatriates. **Non-United States holders should consulttheir own tax advisors regarding the US federal income and other taxconsequences of owning US notes.**

 

**Alternative characterization of the US notes**

 

The proper characterization of the arrangement involving the issuer andthe holders of the US notes is not clear because there is no authority ontransactions comparable to that contemplated herein. The issuer intends totreat 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 alternative characterization is that the US Internal RevenueService (“IRS”) could assert that the class C or any other class of US notesshould be treated as equity in the issuer for US federal income tax purposes.If the class C or any other class of US notes were treated as equity, UnitedStates holders of such notes would be treated as owning equity in a passiveforeign investment company (“PFIC”) which, depending on the level of ownershipof such United States holder and certain other factors, might also constitutean interest in a controlled foreign corporation for such United States holder.This would have certain timing and character consequences for United Statesholders and could require certain elections and disclosures that would need tobe made shortly after acquisition to avoid potentially adverse US taxconsequences.

 

If a United States holder weretreated as owning an equity interest in a PFIC, unless a United States holdermakes a “QEF election” or “mark to market election”, a United States holderwill be subject to a special tax regime (i) in respect of gains realizedon the sale or other disposition of the relevant notes, and (ii) inrespect of distributions on the relevant notes held for more than one taxableyear to the extent those distributions constitute “excess distributions”.Although not free from doubt, the PFIC rules should not apply to gainrealized in respect of any notes disposed of during the same taxable year inwhich such notes are acquired. An excess distribution generally includesdividends or other distributions received from a PFIC in anytaxable year to the extent the amount of such distributions exceeds 125per cent. of the average distributions for the threepreceding years (or, if shorter, the investor’s holding period). Because the USnotes pay interest at a floating rate, it is possible that a US holder willreceive “excess distributions” as a result of fluctuations in the rate ofUSD-LIBOR over the term of the US notes. In general, under the PFIC rules, aUnited States holder will be required to allocate such excess distributions andany gain realized on a sale of its notes to each day during the United Statesholder’s holding period for the notes, and will be taxable at the highest rateof taxation applicable to the notes for the year to which the excessdistribution or gain is allocable (without regard to the United States holder’sother items of income and loss for such taxable year) (the “deferred tax”). Thedeferred tax (other than the tax on amounts allocable to the year ofdisposition or receipt of

 

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the distribution) will then be increased by an interest chargecomputed by reference to the rate generally applicable to underpayments of tax(which interest charge generally will be non-deductible interest expense for individualtaxpayers).

 

**Backup withholding and information reporting**

 

Backup withholding and information reportingrequirements may apply to certain payments on the US notes and proceeds of thesale or redemption of the US notes to United States holders. 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 thatsuch United States holder is not subject to backup withholding, or to otherwisecomply with the applicable requirements of the backup withholding rules. Certain United States holders (including,among others, corporations) are not subject to the backup withholding andinformation reporting requirements. Non-United States holders may be requiredto comply with applicable certification procedures (usually on IRS Form W-8BEN)to establish that they are not United States holders in order to avoid theapplication of such information reporting requirements and backup withholding.

 

Payments of principal or interest made to or through a foreign officeof a custodian, nominee or other agent acting on behalf of a beneficial ownerof a US note generally will not be subject to backup withholding. However, ifsuch custodian, nominee or other agent is (i) a United States person (asdefined in section 7701(a)(30) of the Code), (ii) a controlledforeign corporation (as defined in section 957(a) of the Code), (iii) aforeign person 50 per cent. or more of whose gross income is effectivelyconnected with a US trade or business for a specified three-year period, or (iv) aforeign partnership if (A) at any time during its tax year, one or more ofits partners are United States persons (as defined in applicable Treasuryregulations) who in the aggregate hold more than 50 per cent. of the income orcapital interest in the partnership or (B) at any time during its taxableyear, it is engaged in a US trade or business (each of (i) through (iv), a“US Connected Holder”), such custodian, nominee or other agent may be subjectto certain information reporting requirements with respect to such paymentunless it has in its records documentary evidence that the beneficial owner isnot a United States holder and certain conditions are met or the beneficialowner otherwise establishes an exemption. Principal and interest paid by the USoffice of a custodian, nominee or agent will be subject to both backupwithholding and information reporting unless the beneficial owner certifies itsnon-US status under penalties of perjury or otherwise establishes an exemption.Payments of proceeds on the sale of a US note made to or through a foreignoffice of a broker will not be subject to backup withholding. However, if suchbroker is a US Connected Holder, information reporting will be required unlessthe broker has in its records documentary evidence that the beneficial owner isnot a United States holder and certain conditions are met or the beneficialowner otherwise establishes an exemption. Payments of proceeds on the sale of aUS note made to or through the US office of a broker will be subject to backupwithholding and information reporting unless the beneficial owner certifies,under penalties of perjury, that it is not a US holder or otherwise establishesan exemption.

 

Backup withholding is not an additional tax. Any amounts withheld underthe 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. **Holders ofUS notes should consult their tax advisors as to their qualification forexemption from backup withholding and the procedure for obtaining an exemption.**

 

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**Material Jersey (Channel Islands) TaxConsiderations**

 

The mortgages trustee is resident in Jersey for taxation purposes andwill be liable to income tax in Jersey at a rate of 20 per cent. in respect of the profits it makes from acting as trustee ofthe mortgages trust. The mortgages trustee will not be liable for any incometax in Jersey in respect of any income it receives in its capacity as mortgagestrustee on behalf of the beneficiaries of the mortgages trust.

 

F.             *Dividendsand Paying Agents*

 

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

 

G.            *Statement byExperts*

 

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

 

H.            *Documents onDisplay*

 

The issuer, Funding 1 and the mortgages trustee are subject to theinformation requirements of the U.S. Securities Exchange Act of 1934, asamended, and are therefore required to file reports, including annual reportson Form 20-F, and other information with the SEC. These materials,including this annual report and the exhibits thereto, may be inspected andcopied at the SEC’s public reference rooms in Washington, DC, New York, NY andChicago, IL. Please call the SEC at +1-800-732-0330 for further information onthe public reference rooms. Any filings made by the issuer, Funding 1 or themortgages trustee will be made available to the public over the Internet at theSEC’s web site at http://www.sec.gov.

 

I.              *SubsidiaryInformation*

 

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

 

**Item 11.****  Quantitative and QualitativeDisclosures About Market Risk**

 

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

 

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

 

•      issuerdollar currency swaps: to protect the issuer against changes in the sterling toUS dollar exchange rate following the closing date and the possible variancebetween a LIBOR based rate for three-month sterling deposits and a LIBOR basedrate for three-month dollar deposits, applicable to the series 2 issuer notes,and the series 3 issuer notes; and

 

•      issuer euro currency swaps: to protect the issuer againstchanges in the sterling to euro exchange rate following the closing date andthe possible variance between a

 

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LIBOR based rate for three-month sterling deposits and either (i) afixed rate of interest applicable to the series 5 class A1 issuer notes up toand including the interest payment date in March 2011 payable, during thisperiod, annually on the interest payment dates falling in March of eachyear until the occurrence of a trigger event or the enforcement of the issuersecurity or (ii) a EURIBOR-based rate for three-month euro depositsapplicable to the series 4 issuer notes at any time, and the series 5 class A1issuer notes from and including the interest payment date falling in March 2011.

 

**The Funding 1 swap**

 

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

 

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

 

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

 

Funding 1, the Funding 1 swap provider and the security trustee haveentered into the Funding 1 swap as amended and restated on June 22, 2005.The Funding 1 swap:

 

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

 

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

 

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

 

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

 

•      the amount produced by applying a rate equal to the weightedaverage of:

 

(i)            the average of the standard variable mortgage rates or theirequivalent charged to existing borrowers on residential mortgage loans aspublished from time to time, after excluding the highest and the lowest rate,of Abbey National plc, HSBC Bank plc, Cheltenham & Gloucester plc,National Westminster Bank Plc, Nationwide Building Society, Northern

 

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Rock plc and Woolwich plc (and where those banks have more than onestandard variable rate, the highest of those rates);

 

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

 

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

 

for the relevant calculation period to thenotional amount of the Funding 1 swap (known as the “calculation period Funding1 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 defined as a day (other than a Saturday orSunday) on which banks are generally open for business in London.

 

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

 

•      the sum of each of the calculation period swap provideramounts calculated during the preceding interest period; and

 

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

 

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

 

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

 

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

 

•      if the two amounts are equal, neither party will make apayment to the other.

 

If a payment is to be made by the Funding 1 swap provider, that paymentwill be included in the Funding 1 available revenue receipts and will beapplied on the relevant Funding 1 interest payment date according to therelevant order of priority of payments of Funding 1. If a payment is to be madeby Funding 1, it will be made according to the relevant order of priority ofpayments of Funding 1.

 

The notional amount of the Funding 1 swap in respect of a calculationperiod will be an amount in sterling equal to:

 

•      the aggregate principal amount outstanding of allintercompany loans on the first day of the relevant calculation period, less

 

•      the balance of the principal deficiency ledger attributableto all intercompany loans 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.

 

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In the event that the Funding 1 swap is terminated prior to the serviceof any issuer intercompany loan acceleration notice or final repayment of anyintercompany loan, Funding 1 shall enter into a replacement Funding 1 swap onterms acceptable to the rating agencies, with the security trustee and with aswap provider whom the rating agencies have previously confirmed in writing to Funding1, the issuer and the security trustee will not cause the then current ratingsof the issuer notes to be downgraded, withdrawn or qualified. If Funding 1 isunable to enter into a new Funding 1 swap on terms acceptable to the ratingagencies, this may affect amounts available to pay interest on the intercompanyloans.

 

**The issuer currency swaps**

 

The issuer intercompany loan is denominated in sterling, and interestpayable by Funding 1 to the issuer under the issuer term advances is calculatedas a margin over LIBOR for three-month sterling deposits. However, some of theissuer notes are denominated in US dollars and accrue interest at either aLIBOR based rate for one-month US dollar deposits or a LIBOR based rate forthree-month US dollar deposits. In addition, the series 4 issuer notes, and theseries 5 class A1 issuer notes are denominated in euro and accrue interest at aEURIBOR based rate for three-month euro deposits (although the series 5 classA1 issuer notes will accrue interest at a fixed rate until the interest paymentdate in March 2011). To deal with the potential interest rate and currencymismatch between (i) its receipts and liabilities in respect of the issuerintercompany loan and (ii) its receipts and liabilities under the issuernotes, the issuer has, pursuant to the terms of the issuer currency swaps,swapped its receipts and liabilities in respect of all euro denominated issuernotes and all US dollar denominated issuer notes into sterling on terms thatmatch the issuer’s obligations under the US dollar denominated issuer notes,the series 4 issuer notes or the series 5 class A1 issuer interest rate swap,as applicable.

 

The currency amount of each issuer currency swap is the principalamount outstanding under the issuer notes to which the relevant issuer currencyswap relates. Subject, in the case of the class B and C issuer swaps, tocertain deferral of interest provisions that will apply when payment ofinterest under the corresponding offered issuer notes is deferred in accordancewith the terms and conditions of such offered issuer notes, the issuer swapproviders will pay to the issuer amounts in US dollars or euro, as applicablethat are equal to the amounts of interest to be paid on each of the classes ofthe offered issuer notes and the issuer will pay to the issuer swap providersthe sterling interest amounts received on the issuer term advancescorresponding to the classes of the offered issuer notes. In order to allow forthe effective currency amount of each issuer currency swap to amortize at thesame rate as the relevant series and class of issuer notes, each issuercurrency swap agreement provides that as and when the issuer notes amortize, acorresponding portion of the relevant issuer currency swap so terminated will beswapped from sterling into US dollars at the relevant US dollar currencyexchange rate or into euro at the euro currency exchange rate, as applicable.

 

The payment obligations of the series 3 issuer swap provider under therelevant issuer currency swaps are guaranteed by the AIG issuer swap guarantorpursuant to a guarantee (the “AIG issuer swap guarantee”).

 

The payment obligations of the series 5 class A1 issuer euro currencyswap provider under the relevant issuer currency swaps are guaranteed by theSwiss Re issuer swap guarantor pursuant to a guarantee (the “Swiss Re issuerswap guarantee”).

 

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In the event that any issuer currency swap is terminated prior to theservice of an issuer note acceleration notice or the final redemption of therelevant US dollar denominated or euro denominated issuer notes, as applicable,the issuer shall enter into a replacement issuer currency swap in respect ofthat class and series of issuer notes. Any replacement issuer currency swapmust be entered into on terms acceptable to the rating agencies, the issuer andthe security trustee and with a replacement issuer currency swap provider whomthe rating agencies have previously confirmed in writing to the issuer and thesecurity trustee will not cause the then current ratings of the issuer notes tobe downgraded, withdrawn or qualified. If the issuer is unable to enter intoany replacement issuer currency swaps on terms acceptable to the ratingagencies, this may affect amounts available to pay amounts due under the issuernotes.

 

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

 

**The issuer interest rate swap**

 

Under the series 5 class A1 issuer euro currency swap, the issuer willreceive interest amounts at a EURIBOR-based rate for three-month euro deposits.The series 5 class A1 issuer notes, until the interest payment date falling in March 2011accrues interest at a fixed rate in euro. To deal with the potential interestrate mismatch between (i) its receipts in respect of the series 5 class A1issuer euro currency swap and (ii) its receipts and liabilities in respectof interest payable on the series 5 class A1 issuer notes, the issuer has,pursuant to the terms of the series 5 class A1 issuer interest rate swap,swapped its receipts in respect of the series 5 class A1 issuer euro currencyswap on terms that match the issuer’s obligation to pay interest under theseries 5 class A1 issuer notes.

 

In the event that the issuer interest rate swap is terminated prior tothe service of an issuer note acceleration notice or the interest payment datefalling in March 2011, the issuer shall enter into a replacement issuerinterest rate swap. Any replacement issuer interest rate swap must be enteredinto on terms acceptable to the rating agencies, the issuer and the securitytrustee and with a replacement issuer interest rate swap provider whom therating agencies have previously confirmed in writing to the issuer and thesecurity trustee will not cause the current ratings of the issuer notes to bedowngraded, withdrawn or qualified. If the issuer is unable to enter into areplacement issuer interest rate swap on terms acceptable to the ratingagencies, this may affect amounts available to pay amounts due under the issuernotes.

 

If an issuer interest rate swap agreement is terminated and the issueris unable to enter into a replacement swap as described above, then anyinterest payments received by the issuer in respect of the series 5 class A1issuer euro currency swap on each Funding 1 interest payment date shall bedeposited in the issuer bank account (or such account opened for this purpose)applied by the issuer to pay interest to the holders of the series 5 class A1issuer notes on each interest payment date.

 

**Ratings downgrade of swap providers**

 

Under each of the swap agreements, in the event that the relevantrating(s) of a swap provider, or its respective guarantor, as applicable, is orare, as applicable, downgraded by a

 

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rating agency below the rating(s) specified in the relevant swapagreement (in accordance with the requirements of the rating agencies) for suchswap provider, and, as a result of the downgrade, the then current ratings ofthe current notes, in respect of the Funding 1 swap, or the issuer notescorresponding to the relevant issuer swap in respect of the relevant issuerswap, would or may, as applicable, be adversely affected, the relevant swapprovider will, in accordance with the Funding 1 swap or the relevant issuerswap, as applicable, be required to take certain remedial measures, which mayinclude providing collateral for its obligations under the relevant swap,arranging for its obligations under the relevant swap to be transferred to anentity with rating(s) required by the relevant rating agency as specified inthe relevant swap agreement (in accordance with the requirements of the ratingagency), procuring another entity with rating(s) required by the relevantrating agency as specified in the relevant swap agreement (in accordance withthe requirements of the rating agency), to become co-obligor or guarantor asapplicable, in respect of its obligations under the relevant swap, or takingsuch other action as it may agree with the relevant rating agency.

 

**Termination of the swaps**

 

The Funding 1 swap will terminate on the dateon which the aggregate principal amount outstanding under all intercompanyloans is reduced to zero.

 

Each issuer swap other than the series 2class A issuer swap and the series 3 class A issuer swap, will terminate on theearlier of the interest payment date falling in June 2042 and the date onwhich all of the relevant class and series of issuer notes are redeemed infull. The series 2 class A issuer swap will terminateon the earlier of the interest payment date falling in March 2009 and thedate on which the series 2 class A issuer notes are redeemed in full. Theseries 3 class A issuer swap will terminate on theearlier of the interest payment date falling in March 2024 and the date onwhich the series 3 class A issuer notes are redeemed in full.

 

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

 

•      if there is a failure by a party to pay any amounts dueunder that swap and any applicable grace period has expired;

 

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

 

•      in respect of the Funding 1 swap, if an event of defaultunder any intercompany loan occurs and the security trustee serves anintercompany loan acceleration notice;

 

•      inrespect of the issuer swaps, if a redemption or purchase of the relevant classof issuer notes occurs pursuant to number 5(F) Redemption or purchasefollowing a regulatory event;

 

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

 

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

 

•      inrespect of the issuer swaps, at the option of the issuer, and in respect of theFunding 1 swap, at the option of Funding 1, upon the occurrence of aninsolvency of the relevant swap provider, or its guarantor, as applicable, orthe merger of the relevant swap provider without an assumption of itsobligations under the relevant swap agreement, or if a materialmisrepresentation is made by the swap provider under the relevant swapagreement, or if the relevant swap provider defaults under an over-the-counterderivatives transaction under another agreement between the issuer and suchswap provider; or if a breach of a provision of the relevant swap agreement bythe swap provider is not remedied within the applicable grace period, or, ifapplicable, if the guarantor of the relevant swap provider fails to comply withits obligations under the guarantee;

 

•      if a change in law results in the obligations of one of theparties becoming illegal;

 

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

 

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

 

If any issuer swap is terminated early and a termination payment is dueby the issuer to an issuer swap provider, then, pursuant to its obligationsunder the issuer intercompany loan, Funding 1 shall pay to the issuer an amountequal to the termination payment due to the relevant issuer swap provider lessany amount received by the issuer under any replacement issuer swap agreement.These payments will be made by Funding 1 only after paying interest amounts dueon the issuer term advances and after providing for any debit balance on theprincipal deficiency ledger. The issuer shall apply amounts received fromFunding 1 under the issuer intercompany loan in accordance with the issuerpre-enforcement revenue priority of payments or, as the case may be, the issuerpost-enforcement priority of payments. The application by the issuer of

 

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termination payments due to an issuer swapprovider may affect the funds available to pay amounts due to noteholders.

 

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

 

If the issuer receives a termination payment from the issuer interestrate swap provider, then the issuer shall deposit those funds in the issuerbank account (or such other account opened for such purpose) and apply thefunds to pay interest on the series 5 class A1 issuer notes until a replacementissuer interest rate swap is entered into and/or acquire a replacement issuerinterest rate swap.

 

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

 

**Transfer of the swaps**

 

Each issuer swap provider may, subject to certain conditions specifiedin the relevant issuer swap agreement, including (without limitation) the satisfactionof certain requirements of the rating agencies, transfer its obligations underany of the issuer swaps to another entity.

 

**Taxation**

 

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

 

Each swap provider will be obliged to gross up payments made by it toFunding 1 or the issuer, as appropriate, if withholding taxes are imposed onpayments made under the Funding 1 swap or the issuer swaps.

 

The AIG issuer swap guarantor will be obliged to gross up payments madeby it to the issuer if withholding taxes are imposed on payments under the AIGissuer swap guarantee. However, if the AIG issuer swap guarantor is required togross up a payment under the AIG issuer swap guarantee in respect of a relevantcurrency swap, it may, subject to the consent of the security trustee,terminate the relevant issuer currency swap.

 

**Item 12.****  Description of Securities Otherthan Equity Securities**

 

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

 

**PART II**

 

**Item 13.****  Defaults, Dividend Arrearagesand Delinquencies**

 

None.

 

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**Item 14.****  Material Modifications to theRights of Security Holders and Use of Proceeds**

 

None.

 

**Item 15.****  Controls and Procedures**

 

Not applicable.

 

**Item 16A.****  Audit Committee FinancialExpert**

 

Not applicable.

 

**Item 16B.****  Code of Ethics**

 

Not applicable.

 

**Item 16C.  Principal AccountantFees and Services**

 

Not applicable.

 

**Item 16D.  Exemptions from theListing Standards for Audit Committees**

 

Not applicable.

 

**Item 16E.****  Purchases of Equity Securitiesby the Issuer and Affiliated Purchasers**

 

Not applicable.

 

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**PART III**

 

**Item 17.****  Financial Statements**

 

Not applicable.

 

**Item 18.****  Financial Statements**

 

Not applicable.

 

**Item 19.****  Exhibits**

 

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

 

Exhibit 1: a copy of the Memorandum and Articles of Association ofeach of the issuer, Funding 1 and the mortgages trustee is incorporated byreference from the Registration Statement.

 

Exhibit 2: instruments defining the rights of the security holdersas described in the Registration Statement are incorporated by reference fromthe Registration Statement.

 

Exhibit 12: Section 302 certification.

 

Exhibit 15.1: Investor’s Report for themonth of March 2004 (incorporated by reference from the Form 6-Kpreviously filed on May 13, 2004 and revised July 13, 2004).

 

Exhibit 15.2: Investor’s Report for themonth of April 2004 (incorporated by reference from the Form 6-Kpreviously filed on May 13, 2004 and revised July 13, 2004).

 

Exhibit 15.3: Investor’s Report for the month of May 2004(incorporated by reference from the Form 6-K previously filed on June 14,2004 and revised July 13, 2004).

 

Exhibit 15.4: Investor’s Report for the month of June 2004(incorporated by reference from the Form 6-K previously filed on July 13,2004).

 

Exhibit 15.5: Investor’s Report for themonth of July 2004 (incorporated by reference from the Form 6-Kpreviously filed on August 12, 2004).

 

Exhibit 15.6: Investor’s Report for themonth of August 2004 (incorporated by reference from the Form 6-Kpreviously filed on September 9, 2004).

 

Exhibit 15.7: Investor’s Report for themonth of September 2004 (incorporated by reference from the Form 6-Kpreviously filed on October 13, 2004).

 

Exhibit 15.8: Investor’s Report for themonth of October 2004 (incorporated by reference from the Form 6-Kpreviously filed on November 17, 2004).

 

Exhibit 15.9: Investor’s Report for themonth of November 2004 (incorporated by reference from the Form 6-Kpreviously filed on December 8, 2004).

 

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Exhibit 15.10: Investor’s Report for themonth of December 2004 (incorporated by reference from the Form 6-Kpreviously filed on January 14, 2004 and revised January 18, 2004).

 

Exhibit 15.11: Servicercompliance statement.

 

Exhibit 15.12: Attestation report of independent accountants.

 

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**SIGNATURES**

 

Each registrant hereby certifies that it meets all of the requirementsfor filing on Form 20-F and that it has duly caused and authorized theundersigned to sign this annual report on its behalf.

 
|                     | PERMANENT FINANCING (NO. 4) PLC     |
|--------------------------|-------------------------------------|
|                     |                                |
|                     | By:                                 | /s/ David Balai |   |
|                     | Name:                               | David Balai |
|                     | Title:                              | Director |
|                     |                                |   |
|                     | PERMANENT FUNDING (NO. 1) LIMITED   |
|                     |                                |   |
|                     | By:                                 | /s/ David Balai |   |
|                     | Name:                               | David Balai |
|                     | Title:                              | Director |
|                     |                                |   |
|                     | PERMANENT MORTGAGES TRUSTEE LIMITED |
|                     |                                |   |
|                     | By:                                 | /s/ David Balai |   |
| Date: June 30, 2005 | Name:                               | David Balai |
|                     | Title:                              | Director |
|                          |                                     |  |  |  |  |  |

 

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