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

** **

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 20-F**

 

**(Mark One)**

 
| **o** | ** ** | **Registration statement pursuant to Section 12(b) or  12(g) of the Securities Exchange Act of 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------------------|

 

**or**

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

 

**For the fiscal year ended December 31, 2004**

 

**or**

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

 

**For thetransition periodfrom                         to                         **

 

**Commission file number:  333-88874**

 

**PERMANENT FINANCING (NO. 1) PLC**

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

 

**United Kingdom**

(Jurisdiction of Incorporation or Organization)

 

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

(Address of Principal Executive Offices)

 

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

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

 

**United Kingdom**

(Jurisdiction of Incorporation or Organization)

 

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

(Address of Principal Executive Offices)

 

**PERMANENT MORTGAGES TRUSTEELIMITED**

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

 

**Jersey, Channel Islands**

(Jurisdiction of Incorporation or Organization)

 

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

(Address of Principal Executive Offices)

 

Securities registered or to be registered pursuant to Section 12(b) ofthe Act:                          **None**.

 

Securities registered or to be registered pursuant to Section 12(g) ofthe Act:                          **None**.

 

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

 
| **Title of each class**                                       | ** ** |
|---------------------------------------------------------------|------------|
|                                                          |
| $26,000,000  series 2 class B notes due June 2042        |
|                                                          |
| $26,000,000  series 2 class C notes due June 2042        |
|                                                          |
| $1,100,000,000  series 3 class A notes due December 2007 |
|                                                          |
| $38,500,000  series 3 class B notes due June 2042        |
|                                                          |
| $38,500,000  series 3 class C notes due June 2042        |
|                                                          |
| Series 2  term AA advance(1)                             |
|                                                          |
| Series 2 term  BBB advance(1)                            |
|                                                          |
| Series 3  term AAA advance(1)                            |
|                                                          |
| Series 3  term AA advance(1)                             |
|                                                          |
| Series 3  term BBB advance(1)                            |
|                                                          |
| Funding 1  interest in the mortgages trust(1)                 |

 

Indicatethe number of outstanding shares of each of the issuer’s classes of capital orcommon stock as of the close of the period covered by the annual report.

 

**Notapplicable.**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes ý  No o

 

Indicateby check mark which financial statement item the registrant has elected tofollow.

 

**Notapplicable.**

 

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

 

 

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**PRESENTATION OF INFORMATION**

 

Thisannual report on Form 20-F relates to Permanent Financing (No. 1) PLC(the “issuer”) and the following securities (the “issuer notes”), which wereissued pursuant to a trust deed dated June 14, 2002 (the “issuer trust deed”),between the issuer and State Street Bank and Trust Company (since, succeeded byThe Bank of New York), as note trustee (the “note trustee”):

 

•                  $26,000,000 series 2 class B notesdue June 2042

•                  $26,000,000 series 2 class C notesdue June 2042

•                  $1,100,000,000 series 3 class A notesdue December 2007

•                  $38,500,000 series 3 class B notesdue June 2042

•                  $38,500,000 series 3 class C notesdue June 2042

 

Thisannual report on Form 20-F also relates to the following advances madepursuant to the intercompany loan agreement dated June 14, 2002, (the “issuerintercompany loan agreement”), between the issuer, Permanent Funding (No. 1)Limited (“Funding 1”), State Street Bank and Trust Company (since, succeeded byThe Bank of New York), as security trustee (the “security trustee”) andCitibank, N.A., as agent bank:

 

•                  £17,666,644 series 2 term AA advance

•                  £17,666,644 series 2 term BBB advance

•                  £748,299,320 series 3 term AAAadvance

•                  £26,190,476 series 3 term AA advance

•                  £26,190,476 series 3 term BBB advance

 

Thisannual report on Form 20-F further relates to Funding 1’s interest in themortgages trust, comprising, among other things, the portfolio of loans andtheir related security assigned to Permanent Mortgages Trustee Limited (the “mortgagestrustee”) by Halifax plc (the “seller”) on June 14, 2002 (the “closingdate”) and on several subsequent dates, any new loans and their new relatedsecurity assigned to the mortgages trustee by the seller after the closingdate, any increase in the outstanding principal balance of a loan due to theborrower taking payment holidays or making underpayments under a loan or aborrower making a drawing under any flexible loan, any interest, principal andother amounts (excluding third party amounts) paid by borrowers on their loansand their related security, the rights under the insurance policies that areassigned to the mortgages trustee or of which the mortgages trustee has thebenefit, and amounts on deposit and interest earned on the mortgages trusteeguaranteed investment contract. The mortgages trustee guaranteed investmentcontract, or GIC, account is the bank account in which the mortgages trusteeholds any cash that is part of the trust property until it is distributed tothe beneficiaries. Any actual losses in relation to the loans, any actualreductions occurring in respect of the loans and distributions of principalmade from time to time to the beneficiaries or the mortgages trust will bededucted from the trust property. The composition of the trust property willfluctuate as drawings under flexible loans and new loans are added and as theloans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

Certainterms used herein and not defined have the same meaning ascribed to such termsin the Registration Statement filed on Form S-11 (the “RegistrationStatement”) relating to the securities (file number 333-88874).

 

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

 

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Certainitems in Form 20-F are not applicable to the issuer, Funding 1 or themortgages trustee. Therefore, as used in this filing, “Not applicable” meansthe response to the reference item is omitted in reliance on the proceduresoutlined in numerous no-action letters issued by the staff of the SEC withrespect to issuers of substantially similar asset-backed securities that fileannual reports on Form 10-K, or that the referenced item is otherwise notapplicable.

 

**FORWARD-LOOKING STATEMENTS**

 

Thisannual report includes forward-looking statements including, but not limitedto, statements made under the “Risk Factors” section. These forward-lookingstatements can be identified by the use of forward-looking terminology, such asthe words “believes”, “expects”, “may”, “intends”, “should” or “anticipates”,or the negative or other variations of those terms. These statements involveknown and unknown risks, uncertainties and other important factors that couldcause the actual results and performance of the issuer notes, the seller or theUK residential mortgage industry to differ materially from any future resultsor performance expressed or implied in the forward-looking statements. Theserisks, uncertainties and other factors include, among others: general economicand business conditions in the UK; currency exchange and interest fluctuations;government, statutory, regulatory or administrative initiatives affecting theseller, changes in business strategy, lending practices or customerrelationships and other factors that may be referred to in this annual report.

 

Someof the most significant of these risks, uncertainties and other factors arediscussed in the section of this annual report entitled “Risk Factors”.Investors are encouraged to carefully consider those factors prior to making aninvestment decision regarding the issuer notes.

 

**INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE**

 

Eachof the issuer, Funding 1 and the mortgages trustee incorporates by referenceits periodic filings on Form 6-K, which contain all financial informationrelating to the securities relevant to the holders of the issuer notes.

 

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**PART I**

 

**Item1.  Identity of Directors, SeniorManagement and Advisers**

 

Notapplicable to annual reports filed on Form 20-F.

 

**Item2.  Offer Statistics and Expected Timetable**

 

Notapplicable to annual reports filed on Form 20-F.

 

**Item3.  Key Information**

 

A.*                                   SelectedFinancial Data*

 

Eachof the issuer, Funding 1 and the mortgages trustee incorporates by referenceand 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’s Report for the month of January 2004

•                  Investor’s Report for the month of February 2004

•                  Investor’s Report for the month of March 2004

•                  Investor’s Report for the month of April 2004

•                  Investor’s Report for the month of May 2004

•                  Investor’s Report for the month of June 2004

•                  Investor’s Report for the month of July 2004

•                  Investor’s Report for the month of August 2004

•                  Investor’s Report for the month of September 2004

•                  Investor’s Report for the month of October 2004

•                  Investor’s Report for the month of November 2004

•                  Investor’s Report for the month of December 2004

 

B.*                                     Capitalizationand Indebtedness*

 

Notapplicable to annual reports filed on Form 20-F.

 

C.*                                     Reasonsfor the Offer and Use of Proceeds*

 

Notapplicable to annual reports filed on Form 20-F.

 

D*.**                                    RiskFactors*

 

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

 

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

 

Theissuer notes do not represent an obligation and are not the responsibility ofany of Halifax plc or any of its affiliates, underwriters, managers, themortgages trustee, the note trustee or any other party to the transaction otherthan the issuer.

 

4

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

 

Theissuer’s ability to make payments of principal and interest on the issuer notesand to pay its operating and administrative expenses will depend primarily onthe funds being received under the issuer intercompany loan. In addition, theissuer will rely on the issuer dollar currency swaps and the issuer eurocurrency swaps to provide payments on the issuer notes denominated in USdollars and euro, respectively.

 

Noteholdersshould note that there is no liquidity facility directly available to theissuer, although Funding 1 has the benefit of a liquidity facility to payinterest on the issuer term advances corresponding to the issuer notes and topay principal on the class A issuer notes other than the series 4 class A2issuer notes. In the event that the seller suffers certain ratings downgrades, Funding1 will be required to fund the liquidity reserve fund, though there can be noassurance that Funding 1 will have sufficient resources to do so at such time,and Funding 1 may draw money from the liquidity reserve fund, to the extent ithas been funded, to pay amounts due to the issuer. The ability of Funding 1 todraw on the Funding 1 liquidity facility is subject to satisfying certainconditions precedent.

 

Inaddition, as new issuers are established, each new issuer will have an indirectinterest in the Funding 1 liquidity facility (which will be available to meetinterest and principal obligations of Funding 1 to new issuers, subject tocertain conditions precedent). If a drawing is made under the Funding 1liquidity facility to enable Funding 1 to meet its obligations to new issuers,then that may affect the amount of funds available to Funding 1 to meet itsobligations to the issuer.

 

Theissuer will not have any other significant sources of funds available to meetits obligations under the issuer notes and/or any other payments ranking inpriority to the issuer notes.

 

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

 

Funding1’s ability to pay amounts due on the issuer term advances will depend upon:

 

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

 

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

 

•                  the amount of funds credited to thegeneral reserve fund;

 

•                  the amount of funds credited to theliquidity reserve fund;

 

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

 

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

 

Accordingto the terms of the mortgages trust deed, the mortgages trustee is obliged topay to Funding 1 the Funding 1 share percentage of revenue receipts on theloans by crediting those amounts to the Funding 1 GIC account on eachdistribution date. The mortgages trustee is obliged to pay Funding 1 principalreceipts on the loans by crediting those amounts to the Funding 1 GIC accountas and when required pursuant to the terms of the mortgages trust deed.

 

Funding1 will be obliged to pay revenue receipts due to the issuer under the issuerintercompany loan only to the extent that it has revenue receipts left overafter making payments

 

5

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ranking in priority tothe issuer, such as payments of certain fees and expenses of Funding 1 andpayments on certain higher ranking new term advances under new intercompanyloans.

 

Funding1 will be obliged to pay principal receipts due to the issuer under the issuerintercompany loan only to the extent that it has principal receipts availablefor that purpose after repaying amounts ranking in priority to the issuer(including repaying any higher ranking new term advances).

 

Ifthere is a shortfall between the amounts payable by Funding 1 to the issuerunder the issuer intercompany loan agreement and the amounts payable by theissuer 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.

 

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

 

IfFunding 1 does not make payments due and payable on the issuer intercompanyloan, then the issuer may not have enough money to make payments on the issuernotes, and in addition the issuer will have only limited recourse to the assetsof Funding 1. If Funding 1 does not pay amounts under the issuer intercompanyloan because it does not have enough money available, those amounts will bedeemed not to be due and payable, so there will not be an event of defaultunder the issuer intercompany loan, and the issuer will not have recourse tothe assets of Funding 1 in that instance.

 

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

 

Thetransaction has been structured in the expectation that on the final repaymentdate of the issuer intercompany loan in June 2042, the interest andprincipal due and payable on the issuer term AA advances and the issuer termBBB advances will be in an amount equal to the sum available to pay alloutstanding interest and/or principal (including interest and/or principaldeferred and unpaid) on the issuer term AA advances and the issuer term BBBadvances (after paying amounts of a higher order of priority as required by theFunding 1 priority of payments).

 

Ifthere is a shortfall between the amount available to pay the interest and/orprincipal and the amount required to pay all outstanding interest and/orprincipal on the issuer term AA advances and the issuer term BBB advances, thenthe shortfall will be deemed to be not due and payable under the issuerintercompany loan agreement and the issuer will not have any claim againstFunding 1 for the shortfall.

 

Ifthere is a shortfall in interest and/or principal payments under the issuerintercompany loan agreement, the noteholders may not receive the full amount ofinterest and/or principal which would otherwise be due and payable on the classB issuer notes or the class C issuer notes outstanding.

 

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

 

Theonly remedy for recovering amounts on the issuer notes is through theenforcement of the issuer security. The issuer has no recourse to the assets ofFunding 1 unless Funding 1 has also defaulted on its obligations under theissuer intercompany loan and the Funding 1 security has been enforced.

 

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If thesecurity created as required by the issuer deed of charge is enforced, theproceeds of enforcement may be insufficient to pay all principal and interestdue on the issuer notes.

 

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

 

Thetransaction has been structured in the expectation that:

 

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

 

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

 

•                  the series 4 class A1 issuer noteswill be redeemed in full prior to the redemption of the series 4 class A2issuer notes.

 

Thismeans, among other things, that the series 2 class B issuer notes and theseries 2 class C issuer notes are expected to be redeemed before the series 3class A issuer notes and the series 4 class A issuer notes, even though theseries 3 class A issuer notes and the series 4 class A issuer notes have ahigher rating that the series 2 class B issuer notes and the series 2 class Cissuer notes. Similarly, the series 3 class B issuer notes and the series 3class C issuer notes are expected to be redeemed before the series 4 class Aissuer notes.

 

However,there is no assurance that the series 2 issuer notes will be redeemed in fullbefore the series 3 issuer notes and the series 4 issuer notes or that theseries 3 issuer notes will be redeemed in full before the series 4 issuer notesor that the series 4 class A1 issuer notes will be redeemed in full before theseries 4 class A2 issuer notes. In each case, redemption of the issuer notes isultimately dependent on, among other things, repayment and redemptions on theloans and on the term advance rating of the issuer term advances.

 

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

 

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

 

Theissuer deed of charge requires the security trustee to consider the interestsof each of the issuer secured creditors in the exercise of all of its powers,trusts, authorities, duties and discretions, but requires the security trustee,in the event of a conflict between the noteholders’ interests and the interestsof any of the other issuer secured creditors, to consider only the noteholders’interests. In certain circumstances, the security trustee can make amendmentsto the documents without the noteholders’ prior consent.

 

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

 

7

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Pursuantto the terms of the Funding 1 deed of charge and the issuer deed of charge, thesecurity trustee may, without the consent or sanction of Funding 1’s securedcreditors or the issuer’s secured creditors, concur with any person in makingor sanctioning any modifications to the transaction documents:

 

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

 

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

 

Thesecurity trustee will be entitled to assume that the exercise of its discretionwill not be materially prejudicial to the noteholders’ interests if each of therating agencies has confirmed that the then current rating by it of the noteswould not be adversely affected by such exercise.

 

Inaddition, the security trustee will give its consent to any modifications tothe mortgage sale agreement, the servicing agreement, the cash managementagreement, the Funding 1 deed of charge, the Funding 1 liquidity facilityagreement, the Funding 1 swap agreement, the intercompany loan terms andconditions, the bank account agreement and the master definitions andconstruction schedule, that are requested by Funding 1 or the cash manager,provided that Funding 1 or the cash manager certifies to the security trusteein writing that the modifications are required in order to accommodate:

 

i)                 theentry by Funding 1 into new intercompany loan agreements and/or the issue ofnew types of notes by new issuers and/or the addition of other relevantcreditors to the transaction;

 

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

 

iii)           theissue of new notes by Funding 2;

 

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

 

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

 

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

 

vii)       theinclusion of an additional Funding 1 liquidity facility;

 

and provided furtherthat:

 

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

 

•                  in respect of the matters listed inparagraphs (i) to (vii), the security trustee has received writtenconfirmation from each of the rating agencies that the relevant modificationswill not adversely affect the then current ratings of the notes.

 

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Themodifications required to give effect to the matters listed in paragraphs (i) to(vii) above may include, *inter alia*,amendments to the provisions of the Funding 1 deed of charge relating to theapplication of monies. Accordingly, there can be no assurance that the effectof the modifications to the transaction documents will not ultimately adverselyaffect noteholders’ interests. Any modifications to the documents describedabove will require the actual consent of the Funding 1 liquidity facilityprovider, the Funding 1 swap provider and each of the issuer swap providers (inrespect of each document to which they are a party), as applicable, suchconsent not to be unreasonably withheld and to be deemed given if no response(affirmative or negative) is given within ten business days after the requestfor consent is sent to each such party.

 

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

 

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

 

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

 

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

 

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

 

Theremay also be circumstances where the interests of the class A noteholders of oneseries of the issuer notes conflict with the interests of the class Anoteholders of another series of the issuer notes. Similarly, there may becircumstances where the interests of the class B noteholders of one series ofthe issuer notes conflict with the interests of the class B noteholders ofanother series of the issuer notes or the interests of the class C noteholdersof one series of the issuer notes conflict with the interests of the class Cnoteholders of another series of the issuer notes.

 

Theissuer trust deed and the terms of the issuer notes will provide that where, inthe sole opinion of the note trustee, there is a conflict, then a resolutiondirecting the note trustee to take any action must be passed at separatemeetings of the holders of each series of the class A issuer notes, or, asapplicable, each series of the class B issuer notes or each series of the classC issuer notes. A resolution may only be passed at a single meeting ofnoteholders of each series of the relevant class if the note trustee is, in itsabsolute discretion, satisfied that there is no conflict between them.

 

Similarprovisions will apply in relation to requests in writing from holders of aspecified percentage of the principal amount outstanding of the issuer notes ofeach class within each series (the principal amount outstanding being convertedinto sterling for the purposes of making the calculation). Noteholders shouldnote that, as a result of repayments of principal first to the series 2 issuernotes and to the series 3 issuer notes and then to the series 4 issuer notes,the principal amount outstanding of each series of the issuer notes will changeafter the closing date.

 

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

 

Holdingshas established a separate entity, Funding 2, which may issue new notes fromtime to time and use the proceeds to pay for a direct interest in the trustproperty rather than lending the proceeds to Funding 1. Simultaneously with theacquisition by Funding 2 of an interest in the trust property, the seller andFunding 1, as existing beneficiaries of the mortgages trust, would be requiredto agree to a decrease in their beneficial interests in the trust property(which would require a partial release of security by Funding 1 over its sharein the trust property).

 

Theseller, Funding 1 and Funding 2 would each have a joint and undivided interestin the trust property but their entitlement to the proceeds from the trustproperty would be in proportion to their respective shares of the trustproperty. On each distribution date the mortgages trustee would distributeinterest and principal receipts to one, two or all three beneficiaries,depending on the terms of the mortgages trust.

 

It isanticipated that Funding 2 will issue notes directly or indirectly to investorsfrom time to time backed by its share of the trust property. Noteholders wouldnot have a direct or indirect interest in Funding 2’s share of the trustproperty.

 

Amendmentswould be made to a number of the issuer transaction documents as a result ofthe inclusion of Funding 2 as a beneficiary of the mortgages trust. Inparticular (but without limitation), amendments would be made to:

 

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

 

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

 

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

 

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

 

•                  the master definitions andconstruction agreement.

 

Inaddition, Funding 1, Funding 2 and the seller may enter into new agreements toregulate the making of decisions between them.

 

Theremay be conflicts of interest between Funding 1 and Funding 2, in which case itis expected that the mortgages trustee will follow the directions given by therelevant beneficiary (excluding the seller) that has the largest share of thetrust property at that time. The interests of Funding 1 may not prevail, whichmay adversely affect the noteholders’ interests.

 

Noteholders’prior consent to the inclusion of Funding 2 as a beneficiary of the mortgagestrust and the subsequent amendments to the documents and/or release of securityby Funding 1 will not be obtained. Before becoming a beneficiary of themortgages trust, however, Funding 2 will be required to satisfy a number ofconditions, including:

 

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

 

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

 

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

 

Therecan be no assurance that the inclusion of Funding 2 as a beneficiary of themortgages trust would not affect cashflows available to pay amounts due on thenoteholders’ issuer notes and therefore adversely affect the noteholders’interests.

 

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

 

Sincethe closing date, Holdings has established new issuers to issue new notes toinvestors, and it is likely that Holdings will establish additional new issuersin the future. The proceeds of each new issue will be used by the new issuer tomake a new intercompany loan to Funding 1. Funding 1 will use the proceeds ofthe new intercompany loan either to:

 

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

 

•                  pay the seller for a portion of theseller share of the trust property, which will result in an increase in Funding1’s share of the trust property;

 

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

 

•                  deposit some of those proceeds in thegeneral reserve fund.

 

Thepayment and security priorities of the issuer notes relative to each other asset out in the issuer deed of charge and the issuer cash management agreementwill not be affected as a result of an issue of new notes by a new issuer,because that new issue will be separately documented. However, Funding 1 may berequired to repay to a new issuer amounts owing under a new term advance aheadof or in the same order of priority as amounts owing to the issuer on theissuer term advances, depending on the term advance rating, the scheduledrepayment date of that new term advance and certain other rules regardingthe repayment of principal by Funding 1. If this is the case, then the relevantnew noteholders will be paid before the noteholders.

 

IfHoldings establishes new issuers to make new intercompany loans to Funding 1,the noteholders will not have any right of prior review or consent with respectto those new intercompany loans or the corresponding issuance by new issuers ofnew notes. Similarly, the terms of the Funding 1 transaction documents(including the mortgage sale agreement, the mortgages trust deed, the Funding 1deed of charge, the definitions of the trigger events, the criteria for thesale of new loans to the mortgages trustee and the amount available to be drawnunder the Funding 1 liquidity facility) may be amended to reflect the newissue. Noteholders’ consent to these changes will not be required.

 

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There can be no assurancethat these changes will not affect the cashflows available to pay amounts dueon the issuer notes.

 

However,before issuing new notes, a new issuer will be required to satisfy a number ofconditions, including:

 

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

 

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

 

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

 

**Funding 1has entered into other intercompany loan agreements with other issuers, andsome of the term advances in the other intercompany loans rank ahead of some ofthe issuer term advances in the issuer intercompany loan as to payment, andaccordingly some of the notes issued by the other issuers rank ahead of some ofthe issuer notes as to payment**

 

The other issuers issued notes toinvestors, the equivalent net issue proceeds of which were used by the otherissuers to make intercompany loans to Funding 1. Funding 1 used most of theproceeds of these intercompany loans to pay the seller for the initial loans(together with their related security) that it assigned to the mortgagestrustee on the initial closing date, which comprised Funding 1’s original shareof the trust property. Funding 1 used most of the proceeds of each otherissuers’ intercompany loan to pay the seller for loans (together with theirrelated security) sold to the mortgages trustee or to pay consideration to theseller for an increase in Funding 1’s share in the mortgages trust.

 

The payment and security prioritiesof the issuer notes relative to each other as set out in the issuer deed ofcharge and the issuer cash management agreement are not affected as a result ofthe issue of notes by the other issuers, because the other issues wereseparately documented. However, Funding 1 may be required to pay to the otherissuers amounts that are owing under one or more term advances ahead of or inthe same order of priority as amounts owing to the issuer on the issuer termadvances, depending on the term advance rating, the scheduled repayment date ofthat term advance and other rules regarding the payment of interest andthe repayment of principal by Funding 1. If this is the case then the other noteholderswill be paid before the holders of the issuer notes.

 

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

 

IfFunding 1 enters into a new intercompany loan agreement, then if required itwill also enter into a new start-up loan agreement with new start-up loanproviders and the security trustee.

 

Ifrequired by the rating agencies, Funding 1 will use part of the proceeds of thenew start-up loan to fund further the existing general reserve fund. Similarly,if necessary, Funding 1 will also enter into a new Funding 1 swap with eitherthe Funding 1 swap provider or a new Funding 1 swap provider and the securitytrustee.

 

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Thenew issuer, any new start-up loan provider and any new Funding 1 swap providerwill become party to the Funding 1 deed of charge and will be entitled to sharein the security granted by Funding 1 for its benefit (and the benefit of the otherFunding 1 secured creditors) under the Funding 1 deed of charge. In addition,the liabilities owed to the Funding 1 liquidity facility provider and theFunding 1 swap provider which are secured by the Funding 1 deed of charge mayincrease each time that Funding 1 enters into a new intercompany loanagreement. Those factors could ultimately cause a reduction in the paymentsnoteholders receive on the issuer notes. Noteholders’ consent to the requisitechanges to the transition documents will not be required.

 

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

 

Thesecurity trustee will exercise its rights under the Funding 1 deed of chargeonly in accordance with directions given by the issuers (which could be theissuer and, if Funding 1 enters into new intercompany loans, any new issuer)that have the highest-ranking outstanding term advances, provided that thesecurity trustee is indemnified and/or secured to its satisfaction.

 

If thesecurity trustee receives conflicting directions, it will follow the directionsgiven by the relevant issuers representing the largest principal amountoutstanding 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 newloans are sold to the mortgages trustee, the characteristics of the trustproperty may change from those existing at the closing date, and those changesmay adversely affect payments on the issuer notes**

 

Thereis no guarantee that any new loans sold to the mortgages trustee will have thesame characteristics as the loans in the initial portfolio as of the closingdate. In particular, new loans may have different payment characteristics thanthe loans in the initial portfolio as of the closing date. The ultimate effectof this could be to delay or reduce the payments the noteholders receive on theissuer notes.

 

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

 

Theyield to maturity of the issuer notes of each class will depend mostly on (a) theamount and timing of payment of principal on the loans and (b) the pricepaid by noteholders of each class of issuer notes. The yield to maturity of theissuer notes of each class may be adversely affected by a higher or lower thananticipated rate of prepayments on the loans.

 

Noassurance can be given that Funding 1 will accumulate sufficient funds duringthe cash accumulation period relating to the issuer series 2 term AAA advance,the issuer series 3 term AAA advance or the issuer series 4A1 term AAA advance toenable it to repay these issuer bullet term advances to the issuer so that thecorresponding classes of issuer notes will be redeemed in their entirety ontheir scheduled redemption dates.

 

Duringthe cash accumulation period for the issuer bullet term advances, repayments ofprincipal will only be made on the issuer series 4A2 term AAA advance, theissuer term AA advances or the issuer term BBB advances that are due andpayable if the quarterly CPR of the loans in the trust property is greater than15 per cent. and certain other conditions are met. This means that there may beno corresponding repayments of principal on the class B issuer notes or theclass C issuer notes.

 

Theextent to which sufficient funds are saved by Funding 1 during a cash accumulationperiod or received by it from its share in the mortgages trust on a scheduledrepayment date will depend on whether the actual principal prepayment rate ofthe loans is the same as the assumed

 

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principal prepaymentrate. If Funding 1 is not able to save enough money during a cash accumulationperiod or does not receive enough money from its share in the mortgages truston a scheduled repayment date to repay the relevant issuer bullet term advance(and if it is unable to make a drawing on the Funding 1 liquidity facility orthe reserve 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 onthose scheduled 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.

 

**Theissuer’s ability to redeem the series 3 class A issuer notes and/or the series4 class A1 issuer notes on their scheduled redemption dates is affected by therate of prepayment on the loans**

 

Therate of prepayment of loans is influenced by a wide variety of economic, socialand other factors, including prevailing mortgage market interest rates, theavailability of alternative financing programs, local and regional economicconditions and homeowner mobility. For instance, prepayments on the loans maybe due to borrowers refinancing their loans and sales of propertiesby borrowers (either voluntarily or as a result of enforcement actiontaken). In addition, if the seller is required to repurchase a loanor loans under a mortgage account and their related security because, forexample, one of the loans does not comply with the loan 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 themortgage account. Because these factors are not within its control or thecontrol of Funding 1 or the mortgages trustee, the issuer cannot give anyassurances as to the level of prepayments that the portfolio may experience.

 

Variationin the rate of prepayments of principal on the loans may affect each class ofthe issuer notes differently depending upon amounts already repaid by Funding 1to the issuer under the issuer intercompany loan and whether a trigger eventhas occurred, or a loan is subject to a product switch or a further advance orthe security granted by the issuer under the issuer deed of charge has beenenforced. If prepayments on the loans occur less frequently than anticipated,then there may not be sufficient funds available to redeem the series 3 class Aissuer notes and/or the series 4 class A1 issuer notes in full on theirrespective scheduled redemption dates.

 

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

 

Eachof the loans was originated in accordance with the seller’s lending criteria atthe time of origination. These lending criteria consider a variety of factorssuch as a potential borrower’s credit history, employment history and statusand repayment ability, as well as the value of the property to be mortgaged. Inthe event of the sale of any new loans and new related security to themortgages trustee, the seller will warrant that those new loans and new relatedsecurity were originated in accordance with the seller’s lending criteria atthe time of their origination. However, the seller retains the right to reviseits lending criteria as determined from time to time, and so the lendingcriteria applicable to any loan at the time of its origination may not be orhave been the same as those when other loans were originated. If new loans thathave been originated under revised lending criteria are sold to the mortgagestrustee, the characteristics of the trust property could change. This couldlead to a delay or a reduction in the payments received on the issuer notes.

 

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

 

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Theseller does not require a solicitor, licensed conveyancer or (in Scotland)qualified conveyancer to conduct a full investigation of the title to aproperty 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 the matters been revealed, though to mitigateagainst this risk search indemnity insurance is obtained in respect of theproperties. The introduction of loans secured by the 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.

 

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

 

Theloans are affected by credit, liquidity and interest rate risks. Variousfactors influence mortgage delinquency rates, prepayment rates, repossessionfrequency and the ultimate payment of interest and principal, such as changesin the national or international economic climate, regional economic or housingconditions, changes in tax laws, interest rates, inflation, the availability offinancing, yields on alternative investments, political developments andgovernment policies. Other factors in borrowers’ individual, personal orfinancial circumstances may affect the ability of borrowers to repay loans.Loss of earnings, illness, divorce and other similar factors may lead to anincrease in delinquencies by and bankruptcies of borrowers, and could ultimatelyhave an adverse impact on the ability of borrowers to repay loans.

 

Inaddition, the ability of a borrower to sell a property given as security for aloan at a price sufficient to repay the amounts outstanding under the loan willdepend upon a number of factors, including the availability of buyers for thatproperty, the value of that property and property values in general at thetime.

 

Further,the mortgage loan industry in the United Kingdom is highly competitive. Thiscompetitive environment may affect the rate at which the seller originates newloans and may also affect the level of attrition of the seller’s existingborrowers.

 

Theprincipal source of income for repayment of the issuer notes by the issuer isthe issuer intercompany loan. The principal source of income for repayment byFunding 1 of the issuer intercompany loan is its interest in the loans held ontrust by the mortgages trustee for Funding 1 and the seller. If the timing andpayment of the loans is adversely affected by any of the risks described inthis section, the payments on the issuer notes could be reduced or delayed.

 

**Theoccurrence of trigger events and enforcement of the issuer security mayadversely affect the scheduled redemption dates of the series 3 class A issuernotes and/or series 4 class A1 issuer notes**

 

If notrigger event has occurred and the issuer security has not been enforced inaccordance with the terms of the issuer deed of charge, then payments ofprincipal will not occur on the series 3 class A issuer notes and/or series 4class A1 issuer notes before their respective scheduled redemption dates.

 

If atrigger event occurs or the issuer security is enforced in accordance with theissuer deed of charge prior to the scheduled redemption dates for the series 3class A issuer notes and/or series 4 class A1 issuer notes, then the relevantclasses of issuer notes outstanding will not be repaid on their scheduledredemption dates but will be repaid on each interest payment date from moniesreceived from Funding 1 on the issuer term AAA advances of the correspondingseries as described in the following three risk factors.

 

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**If anasset trigger event occurs, any series 3 class A issuer notes, and/or series 4class A1 issuer notes then outstanding will not be repaid on their scheduledredemption dates**

 

Whenan asset trigger event has occurred, the mortgages trustee will distributeprincipal receipts on the loans to Funding 1 and the seller proportionally andequally based on their percentage shares of the trust property (that is, theFunding 1 share percentage and the seller share percentage). When an assettrigger event has occurred, Funding 1 will repay (after making requisitepayments to the Funding 1 liquidity facility provider and to replenish thereserve fund):

 

*first*,the issuer term AAA advances in respect of the issuer intercompany loan and anynew intercompany loans, until all of those term AAA term advances are fullyrepaid;

 

*then*,the issuer term AA advances in respect of the issuer intercompany loan and anynew intercompany loans, until all of those term AA term advances are fullyrepaid;

 

*then*,the issuer term A advances in respect of any new intercompany loans, until allof those term A term advances are fully repaid; and

 

*finally*,the issuer term BBB advances in respect of the issuer intercompany loan and anynew intercompany loans, until all of those term BBB term advances are fullyrepaid, until all of those term BBB term advances are fully repaid.

 

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

 

**If anon-asset trigger event occurs, any series 3 class A issuer notes and/or series4 class A1 issuer notes then outstanding will not be repaid on their scheduledredemption dates**

 

If anon-asset trigger event has occurred, but an asset trigger event has notoccurred, the mortgages trustee will distribute all principal receipts toFunding 1 until the Funding 1 share percentage of the trust property is zero.When a non-asset trigger event has occurred, Funding 1 will repay (after makingrequisite payments to the Funding 1 liquidity facility provider and toreplenish the reserve funds):

 

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

 

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

 

*then*,the term A advances in respect of any new issuer intercompany loans, until eachof those term AA advances is fully repaid; and

 

*finally*,the term BBB advances in respect of the issuer intercompany loan and any newissuer intercompany loans, until each of those term BBB advances is fullyrepaid.

 

If anon-asset trigger event occurs, any series 3 class A issuer notes and/or series4 class A1 issuer notes then outstanding will not be repaid on their scheduledredemption dates.

 

**If theissuer security is enforced, any series 3 class A issuer notes and/or series 4class A1 issuer notes then outstanding will not be repaid on their scheduledredemption dates**

 

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If theissuer security is enforced, then the mortgages trustee will distribute fundsas required under the terms of the transaction agreements. In thesecircumstances, any series 3 class A issuer notes and/or series 4 class A1issuer notes then outstanding will not be repaid on their scheduled redemptiondates and there is also a risk that those class A issuer notes may not berepaid by their final maturity dates.

 

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

 

If theservicer at its discretion decides to grant a borrower a further advance undera loan which has been assigned to the mortgages trustee, then the seller willbe required to repurchase that loan under the relevant mortgage account and itsrelated security from the mortgages trustee save for any loan in arrears at aprice equal to the outstanding principal balance of those loans together withany accrued and unpaid interest and expenses to the date of purchase. The yieldto maturity of the issuer notes may be affected by the repurchase of loanssubject to further advances.

 

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

 

Loanssubject to product switches will not be repurchased unless on any distributiondate, the seller is in breach of the conditions precedent to the sale of newloans to the mortgages trustee. From and including that date to but excludingthe date when those conditions precedent have been satisfied, the seller willbe required to repurchase any loans and their related security that are subjectto product switches. The seller will be required to repurchase the relevantloan or loans under the relevant mortgage account and their related securityfrom the mortgages trustee at a price equal to the outstanding principalbalance of those loans together with any accrued and unpaid interest andexpenses to the date of purchase.

 

A loanwill be subject to a product switch if the borrower and the seller agree on orthe servicer offers a variation in the financial terms and conditionsapplicable to the relevant borrower’s loan, other than:

 

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

 

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

 

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

 

•                  any variation imposed by statute;

 

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

 

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

 

Theyield to maturity of the issuer notes may be affected by the repurchase ofloans subject to product switches.

 

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

 

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

 

Achange to the ratings assigned to each class of the issuer notes will notaffect the term advance ratings assigned to each issuer term advance in theintercompany loans.

 

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

 

Theclass B issuer notes and class C issuer notes are subordinated in right ofpayment of interest to the class A issuer notes. The class C issuer notes aresubordinated in right of payment of interest to the class B issuer notes.However, the transaction has been structured in the expectation that the series2 issuer notes will be repaid in full prior to the redemption of the series 3class A issuer notes and the series 4 class A issuer notes.

 

Accordingly,there is no assurance that these subordination rules will protect theholders of class A issuer notes or the holders of class B issuer notes from allrisk of loss.

 

**Principal payments on the class B issuer notes, the class Cissuer notes and the series 4 class A2 issuer notes will be deferred in somecircumstances**

 

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

 

•                  if a principal loss has been recordedon the principal deficiency ledger in respect of any term AA advances or anyterm BBB advances (whether in respect of the issuer intercompany loan or anynew intercompany loan); or

 

•                  if monies standing to the credit ofthe reserve fund have been used, on or prior to the relevant Funding 1 interestpayment date, for the purposes of curing a principal deficiency in respect ofany term AA advances and/or any term BBB advances (whether in respect of theissuer intercompany loan or any new intercompany loan) and the reserve fund hasnot been replenished by a corresponding amount on the relevant Funding 1interest payment date; or

 

•                  if, as at the relevant Funding 1interest payment date, the total outstanding principal balance of loans in themortgages trust, in respect of which the aggregate amount in arrears is morethan three times the monthly payment then due, is more than five per cent. ofthe total outstanding principal balance of loans in the mortgages trust; or

 

•                  if Funding 1 is accumulatingprincipal during a cash accumulation period to repay the term AAA advances(other than the issuer series 4A2 term AAA advance) and the quarterly CPR ofthe loans in the trust property is less than or equal to 15 per cent.

 

Inthese circumstances, the issuer term BBB advances and, as applicable, theissuer term AA advances will not be entitled to principal repayments until therelevant circumstance as described in this risk factor has been remedied (ifever).

 

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Inaddition, if the circumstance described in the last bullet point above occurs,then payment on the issuer series 4A2 advance will also be deferred.

 

Thismeans that payments of principal on the class C issuer notes of all series and,as applicable, the class B issuer notes of all series and the series 4 class A2issuer notes will be deferred until the earlier of the time when the relevantcircumstance described in this risk factor has been remedied (if ever) and thematurity date of the relevant issuer notes.

 

**Series 2 issuer notes, series 3 issuer notes and series4 issuer notes may be subject to risk if the trust property deteriorates afterrepayment of previous series of the issuer notes**

 

If theloans comprising the trust property do not perform as expected at any timeafter the repayment in full of the series 2 issuer notes, then the series 3issuer notes and/or the series 4 issuer notes may not be repaid in full.

 

**Noteholdersmay be subject to exchange rate risks on the series 2 issuer notes, the series3 issuer notes and the series 4 class A1 issuer notes**

 

Repaymentsof principal and payments of interest on the series 2 issuer notes and theseries 3 issuer notes will be made in US dollars and on the series 4 class A1issuer notes will be made in euro, but the issuer term advances made by theissuer to Funding 1 were in sterling, and repayments of principal and paymentsof interest by Funding 1 to the issuer under the issuer intercompany loan willbe in sterling.

 

Tohedge its currency exchange rate exposure, including the interest rate exposureconnected with that currency exposure, the issuer has entered into the issuerdollar currency swaps for the series 2 issuer notes and the series 3 issuernotes with the issuer dollar currency swap provider and the issuer eurocurrency swap for the series 4 class A1 issuer notes with the issuer eurocurrency swap provider.

 

If theissuer fails to make timely payments of amounts due under an issuer swap, thenthe issuer will have defaulted under that issuer swap. Each issuer swapprovider is obliged only to make payments under an issuer swap as long as theissuer make payments under the same. If an issuer swap provider is not obligedto make payments, or if it exercises any right to terminate that it may haveunder the relevant issuer swap, or if it defaults in its obligations to makepayments of amounts in US dollars or euro, as applicable, equal to the fullamount to be paid by it on the payment dates under the relevant issuer swap(which are the same dates as the interest payment dates in respect of theissuer notes), the issuer will be exposed to changes in US dollar / sterling oreuro / sterling currency exchange rates and in the associated interest rates onthese currencies. Unless a replacement issuer swap is entered into, the issuermay have insufficient funds to make payments due on the issuer notes of any classand any series that are then outstanding.

 

Eachissuer swap provider will be obliged to gross up payments made by it to theissuer if withholding taxes are imposed on payments under the relevant issuerswap and the AIG issuer swap guarantor will be obliged to gross up paymentsmade by it to the issuer if withholding taxes are imposed on payments under theAIG issuer swap guarantee. However, if such a gross up is required the relevantswap provider may subject to obtaining the consent of the security trustee,terminate the relevant issuer currency swap. If it does terminate the relevantissuer currency swap, the issuer will be exposed to changes in currencyexchange rates and in the associated interest rates on these currencies. Unlessa replacement issuer currency swap is entered into, the issuer may haveinsufficient funds to make payments due on the issuer notes of any class andany series that are then outstanding.

 

**Thedifference in timing between the issuer’s obligations and the obligations ofthe series 4 class A1 issuer euro currency swap provider could adversely affectpayments on the issuer notes**

 

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To theextent that it has funds available, on each Funding 1 interest payment dateFunding 1 will pay to the issuer interest and, as applicable, principal due onthe issuer series 4A1 term AAA advance. On each interest payment date inrelation to its obligations under the series 4 class A1 issuer swap, the issuerwill pay the interest received from Funding 1 to, as applicable, the series 4issuer swap provider. The series 4 issuer swap provider will not be obliged tomake any corresponding swap payments to the issuer for up to nine months untilamounts are due from the relevant issuer swap provider on the interest paymentdate in respect of the series 4 class A1 issuer notes, as applicable. Theseinterest payment dates occur semi-annually or annually up to and including theearliest of (i) the interest payment date falling in June 2007 inrespect of the series 4 class A1 issuer notes, (ii) the occurrence of atrigger event or (iii) enforcement of the issuer security, and quarterlyon and following the interest payment date occurring immediately thereafter.

 

If theseries 4 issuer swap provider does not meet its payment obligations to theissuer under the relevant issuer swap on any semi-annual or annual interestpayment date and the relevant issuer swap provider does not make a terminationpayment that has become due from it to the issuer, the issuer may have a largershortfall in funds with which to make interest payments on the issuer notesthan if their payment obligations were quarterly and therefore coincidentalwith the issuer’s payment obligations under those issuer swaps. Hence, thedifference in timing between the issuer’s obligations and the obligations ofthe relevant issuer swap providers under the series 4 class A1 issuer swap mayaffect the issuer’s ability to make payments on the issuer notes of any classand any series.

 

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

 

Themortgages trustee GIC provider and the Funding 1 GIC provider are required tosatisfy certain criteria (including certain criteria and/or permissions set orrequired by the Financial Services Authority (the “FSA”) from time to time) inorder to continue to receive deposits in the mortgages trustee GIC account andthe Funding 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.

 

Thecriteria referred to above include a requirement that the short-term,unguaranteed and unsecured ratings of the mortgages trustee GIC provider or theFunding 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 each rating agency confirmsthat its then current rating of the notes would not be adversely affected as aresult of such ratings falling below these minimum ratings.

 

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

 

If anyof the issuer swaps terminates the issuer may as a result be obliged to make atermination payment to the relevant issuer swap provider. The amount of thetermination payment will be based on the cost of entering into a replacementissuer swap. Under the issuer intercompany loan agreement, Funding 1 will berequired to pay the issuer an amount equal to any termination payment due bythe issuer to the relevant issuer swap provider. Funding 1 will also be obligedto pay the issuer any extra amounts that the issuer may be required to pay toenter into a replacement swap.

 

Theissuer cannot give noteholders any assurance that Funding 1 will have the fundsavailable to make that payment or that the issuer will have sufficient funds availableto make any termination payment under any of its issuer swaps or tomake subsequent payments to noteholders in respect of the relevant seriesand class of the issuer notes. Nor can the issuer give noteholders anyassurance that

 

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it will be able to enter into a replacement issuer swap,or, if one is entered into, that the credit rating of thereplacement issuer swap provider will be sufficiently high to prevent adowngrading of the then current ratings of the issuer notes by the ratingagencies.

 

Exceptwhere the relevant issuer swap provider has caused the relevant issuer swap toterminate by its own default, any termination payment due by the issuer willrank equally not only with payments due to the holders of the series and classof the issuer notes which rank equally with the series and class of issuernotes to which the relevant swap relates but also with payments due to theholders of any other series and class of issuer notes to which the relevantswap relates. Any additional amounts required to be paid by the issuerfollowing termination of the relevant issuer swap (including any extra costsincurred (for example, from entering into “spot” currency or interest rateswaps) if the issuer cannot immediately enter into a replacement swap) willalso rank equally not only with payments due to the holders of the series andclass of the issuer notes to which the relevant issuer swap relates but alsowith payments due to the holder of any other series and class of the issuernotes which rank equally with the series and class of the issuer notes to whichthe relevant issuer swap relates. Furthermore, any termination payment oradditional payment or additional amounts required to be paid by the issuerfollowing termination of an issuer swap will rank ahead of payments due to theholders of any series and class of the issuer notes which ranks below theseries and class of the issuer notes to which the relevant issuer swap relates.Therefore, if the issuer is obliged to make a termination payment to therelevant issuer swap provider or to pay any other additional amount as a resultof the termination of the relevant issuer swap, this may affect the funds whichthe issuer has available to make payments on the issuer notes of any class andany series.

 

**Risksassociated with the Funding 1 swap**

 

Toprovide a hedge against (a) the mortgages trustee variable base ratepayable on the variable rate loans, the rates of interest payable on thetracker rate loans and the fixed rates of interest payable on the fixed rateloans; and (b) the rate of interest payable by Funding 1 on 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.

 

Funding1 will receive interest on the variable rate loans, which is based onHVR 1 or HVR 2. The payment obligations of Funding 1 under theFunding 1 swap will, among other things, be based on the average of thestandard variable mortgage rates or their equivalent charged to existingborrowers on residential mortgage loans as published from time to time, afterexcluding the highest and the lowest rate, of Abbey National plc, HSBC Bankplc, Cheltenham & Gloucester plc, National Westminster Bank Plc,Nationwide Building Society, Northern Rock plc and Woolwich plc (and wherethose banks have more than one standard variable rate, the highest of thoserates). While it is anticipated that the average rate will broadly track bothHVR 1 and HVR 2, the variance between the average rate and HVR 1 and HVR 2,respectively, may affect the ability of Funding 1 to meet its paymentobligations under the Funding 1 swap agreement.

 

**The issuerrelies on third parties to perform services in relation to the issuer notes,and the noteholders may be adversely affected if they fail to perform theirobligations**

 

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Theissuer is a party to contracts with a number of other third parties that haveagreed to perform services in relation to the issuer notes. For example, theissuer swap providers have agreed to provide their respective issuer swaps, thecorporate services provider has agreed to provide corporate services and thepaying agents and the agent bank have agreed to provide payment and calculationservices in connection with the issuer notes. In the event that any of theseparties were to fail to perform their obligations under the respective agreementsto which they are a party, the noteholders may be adversely affected.

 

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

 

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

 

Funding1 will use principal receipts that would have been applied to repay the termadvances with the lowest term advance rating to pay interest on those otherterm advances and senior expenses described in the preceding paragraph wherethere is a shortfall of monies to pay those amounts. At the closing date, therelevant term advances with the lowest term advance rating include the issuerterm BBB advances. If Funding 1 uses principal to repay interest and seniorexpenses in this manner, there will be less principal available to repay theissuer term BBB advances.

 

Funding1 will be obliged to keep a ledger that records any principal applied to payinterest and senior expenses (as well as any losses on the loans causing aprincipal deficiency). When the amount recorded on the ledger is equal to theprincipal amount outstanding of the term BBB advances, then Funding 1 will useprincipal receipts that would have been applied to repay the term advance withthe next lowest ranking term advance rating to pay interest on the termadvances and senior expenses where there is a shortfall of money to pay thoseamounts. When the amount recorded on the principal deficiency ledger exceedsthe principal amount outstanding on the term A advances, Funding 1 will useprincipal that would have been applied to repay the term AA advances to paythose amounts. When the amount recorded on the principal deficiency ledgerexceeds the principal amount outstanding on the term AA advances, Funding 1will use principal receipts that would have been applied to repay the term AAAadvances to pay those amounts.

 

Duringthe term of the transaction, however, it is expected that any principaldeficiencies will be recouped from subsequent excess revenue receipts andamounts standing to the credit of the reserve fund. The revenue receipts andthe reserve fund monies will be applied first to cover any principal deficiencyin respect of the term advances with the highest term advance rating, and thenthe term advances with the next highest ranking term advance rating, and so ondown to the term advances with the lowest term advance rating.

 

Ifthere are insufficient funds available because of income or principaldeficiencies, then one or more of the following consequences may occur:

 

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

 

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

 

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principaldeficiency in respect of the term BBB advances, term A advances and term AAadvances;

 

**•**                  if the amount of principaldeficiencies exceeds the principal amount outstanding of any of the termadvances (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, the noteholders may notreceive the full face value of the class C issuer notes, the class B issuernotes and the class A issuer notes, as the case may be; and/or

 

**•**                  the issuer may be unable to pay, in fullor at all, interest due on the issuer notes.

 

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

 

Anylosses from loans included in the trust property will be allocated to Funding 1and the seller proportionally on each distribution date in accordance with theFunding 1 share percentage and the seller share percentage of the trustproperty. The seller’s share of the trust property therefore does not providecredit enhancement for the Funding 1 share of the trust property or the issuernotes. Losses on the loans in the trust property are allocated proportionatelybetween the seller and Funding 1 depending on their respective shares in thetrust property.

 

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

 

Afteran issuer intercompany loan acceleration notice under the issuer intercompany loanis given, the security trustee may, but shall not be obliged to, sell theFunding 1 share of the trust property. There is no assurance that a buyer wouldbe found or that a sale would realize enough money to repay amounts due andpayable under the issuer intercompany loan agreement.

 

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

 

Theissuer, Funding 1, the mortgages trustee and the security trustee will notundertake any investigations, searches or other actions on any loan or itsrelated security and each of them will rely instead on the warranties given inthe mortgage sale agreement by the seller.

 

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

 

If theseller fails to remedy the breach within 20 London business days, then theseller will be required to repurchase the loan or loans under the relevantmortgage account and their related security at their outstanding principalbalance as of the date of repurchase together with any arrears of interest andaccrued and unpaid interest and expenses. There can be no assurance that theseller will have the financial resources to repurchase the loan or loans underthe relevant mortgage account and their related security. However, if theseller does not repurchase those loans and their related security whenrequired, then the seller’s share of the trust property will be deemed to bereduced by an amount equal to the principal amount outstanding of those loanstogether with any arrears of interest and accrued and unpaid interest andexpenses.

 

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Otherthan as described here, neither the noteholders nor the issuer will have anyrecourse to the assets of the seller.

 

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

 

Eachloan in the portfolio is repayable either on a principal repayment basis or aninterest-only basis. Of the loans in the portfolio as at January 1, 2005,approximately 33.27 per cent. were interest-only loans. For interest-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 to repaythe principal at the end of the term. However, the seller does not ensure thata repayment mechanism is in place in all cases and does not take security overthese repayment mechanisms. The borrower is also recommended to take out a lifeinsurance policy in relation to the loan but, as with repayment mechanisms, theseller does not take security over these life insurance policies.

 

Theability of a borrower to repay the principal on an interest-only loan atmaturity depends on the borrower’s responsibility to ensure that sufficientfunds are available from an investment plan or another source, such as ISAs,pension policies, personal equity plans or endowment policies, as well as thefinancial condition of the borrower, tax laws and general economic conditionsat the time.

 

Therecan be no assurance that the borrower will have the funds required to repay theprincipal at the end of the term. If a borrower cannot repay the loan and aloss occurs on the loan, then this may affect repayments of principal on theissuer notes if that loss cannot be cured by amounts standing to the credit ofthe reserve fund or the application of excess Funding 1 available revenuereceipts.

 

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

 

Thesale by the seller to the mortgages trustee of the English mortgages will takeeffect in equity only. The sale by the seller to the mortgages trustee of theScottish mortgages has been given effect by a Scottish declaration of trust bythe seller (and any sale of Scottish mortgages in the future will be giveneffect by further Scottish declarations of trust) by which the beneficialinterest in the Scottish mortgages has been or will be transferred to themortgages trustee. In each case this means that legal title to the loans in thetrust property remains with the seller, but the mortgages trustee has all theother rights and benefits relating to ownership of each loan and itsrelated security (which rights and benefits are subject to the trust in favorof the beneficiaries). The mortgages trustee has the right to demand that theseller give it legal title to the loans and the related security in certaincircumstances and until then the mortgages trustee will not give notice of thesale of the English mortgages to any borrower or apply to the Land Registry orthe Central Land Charges Registry to register or record its equitable interestin the English mortgages or take any steps to complete or perfect its title tothe Scottish mortgages.

 

Becausethe mortgages trustee has not obtained legal title to the loans or theirrelated security, there are risks, as follows:

 

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

 

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

 

However,if a borrower exercises any set-off rights, then an amount equal to the amountset off will reduce the total amount of the seller share of the trust propertyonly, and the minimum seller share has been sized in an amount expected tocover this risk, although there is no assurance that it will. If the minimumseller share is exhausted, then the amount of any set-offs would be applied toreduce the Funding 1 share of the trust property.

 

Oncenotice has been given to borrowers of the transfer of the loans and theirrelated security to the mortgages trustee, independent set-off rights which aborrower has against the seller will crystallize (such as, for example, set-offrights associated with borrowers holding deposits with the seller) and furtherrights of independent set-off would cease to accrue from that date and no newrights of independent set-off could be asserted following that notice. Set-offrights arising under transaction set-off (which are set-off claims arising outof a transaction connected with the loan) will not be affected by that notice.

 

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

 

Theseller has made, and in the future may make, an equitable assignment of therelevant loans and their related security, or in the case of Scottish loans atransfer of the beneficial interest in the relevant loans and their relatedsecurity, with legal title being retained by the seller. Therefore, the rightsof the mortgages trustee may be subject to the direct rights of the borrowersagainst the seller, including rights of set-off existing prior to notificationto the borrowers of the sale of the mortgages. Although the mortgages trusteedoes not currently include flexible loans or delayed cashbacks, those loans maybe added to the mortgages trust. Set-off rights (including analogous rights inScotland) may occur if the seller fails to advance to a borrower a drawing orpermit the borrower to make an underpayment or to take a payment holiday undera flexible loan or if the seller fails to pay to a borrower any delayedcashback which the seller had agreed to pay to that borrower after completionof the relevant loan.

 

If theseller fails to advance the drawing or permit the borrower to make anunderpayment or take a payment holiday or pay the delayed cashback, then therelevant borrower may set off any damages claim (or exercise analogous rightsin Scotland) arising from the seller’s breach of contract against the seller’s(and, as assignee or holder of the beneficial interest in the loans and theirrelated security, the mortgages trustee’s) claim for payment of principaland/or interest under the loan as and when it becomes due. These set-off claimswill constitute transaction set-off as described in the immediately precedingrisk factor.

 

Theamount of the claim in respect of a drawing will, in many cases, be the cost tothe borrower of finding an alternative source of finance although, in thecase of flexible loans or delayed cashbacks which are Scottish, it is possiblethat the borrower’s right of set-off could extend to the full amount of therelevant drawing: the borrower may obtain a loan elsewhere in which case thedamages would be equal to any difference in the borrowing costs together withany consequential losses, namely the associated costs of obtainingalternative funds (for example, legal fees and survey fees). If the borrower isunable to obtain an alternative loan, he or she may have a claim in respect ofother losses arising from the seller’s breach of contract where there arespecial circumstances communicated by the borrower to the seller at the timethe mortgage was taken out or which

 

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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.

 

Inrespect of a delayed cashback, underpayment or payment holiday, the claim islikely to be in an amount equal to the amount due under the delayed cashbacktogether with interest and expenses and consequential losses (if any).

 

Aborrower may also attempt to set off against his or her mortgage payments anamount greater than the amount of his or her damages claim (or exerciseanalogous rights in Scotland). In that case, the servicer will be entitled totake enforcement proceedings against the borrower although the period ofnon-payment by the borrower is likely to continue until a judgment is obtained.

 

Theexercise of set-off rights by borrowers would reduce the incoming cashflow tothe mortgages trustee during the exercise. However, the amounts set off will beapplied to reduce the seller share of the trust property only.

 

Furtherthere may be circumstances in which certain drawings may rank behind securitycreated by a borrower after the date upon which the borrower entered into itsmortgage with the seller.

 

Theminimum seller share has been sized in an amount expected to cover this risk,although there is no assurance that it will. If the minimum seller share is notsufficient in this respect then there is a risk that noteholders may notreceive all amounts due on the issuer notes or that payments may not be madewhen due.

 

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

 

Theseller has been appointed by the mortgages trustee and the beneficiaries asservicer to service the loans. If the servicer breaches the terms of theservicing agreement, then the mortgages trustee, Funding 1 and/or the securitytrustee will be entitled to terminate the appointment of the servicer andappoint a new servicer in its place.

 

Therecan be no assurance that a substitute servicer with sufficient experience ofadministering mortgages of residential properties would be found who would bewilling and able to service the loans on the terms of the servicing agreement.In addition, as described below, any substitute servicer may be required to beauthorized under FSMA (as defined below in order to administer loans thatconstitute regulated mortgage contracts). The ability of a substitute servicerfully to perform the required services would depend, among other things, on theinformation, software and records available at the time of the appointment. Anydelay or inability to appoint a substitute servicer may affect payments on theloans and hence the issuer’s ability to make payments when due on the issuernotes.

 

Thenoteholders should note that the servicer has no obligation itself to advancepayments that borrowers fail to make in a timely fashion.

 

**Funding 1may not receive the benefit of any claims made on the buildings insurance whichcould adversely affect payments on the issuer notes**

 

Noassurance can be given that Funding 1 will always receive the benefit of anyclaims made under any applicable insurance contracts. This could reduce theprincipal receipts received by

 

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Funding 1 according to the Funding 1 share percentage and couldadversely affect the issuer’s ability to redeem the issuer notes. Thenoteholders should note that buildings insurance is renewed annually.

 

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

 

In theUnited Kingdom, the Office of Fair Trading (the “OFT”) is responsible for theissue of licenses under, and the superintendence of the working and theenforcement of the Consumer Credit Act (the “CCA”), related consumer creditregulations and other consumer protection legislation. The OFT may reviewbusinesses and operations, provide guidelines to follow and take actions whennecessary with regard to the mortgage market in the United Kingdom.

 

Currently,a credit agreement is regulated by the CCA where: (a) the borrower is orincludes an individual; (b) the amount of “credit” as defined in the CCAdoes not exceed the financial limit, which is £25,000 for credit agreementsmade on or after May 1, 1998, or lower amounts for credit agreements madebefore that date; and (c) the credit agreement is not an exempt agreementunder the CCA, for example, a regulated mortgage contract under the FSMA (asdefined below).

 

Anycredit agreement that is wholly or partly regulated by the CCA or to be treatedas such has to comply with requirements under the CCA as to licensing oflenders and brokers, documentation and procedures of credit agreements, and (inso far as will be applicable) pre-contract disclosure. If it does not complywith those requirements, then to the extent that the credit agreement isregulated by the CCA or to be treated as such, it is unenforceable against theborrower: (a) without an order of the OFT, if the lender or any brokerdoes not hold the required license at the relevant time; (b) totally, ifthe form to be signed by the borrower is not signed by the borrower personallyor omits or mis-states a ‘‘prescribed term’’; or (c) without a court orderin other cases and, in exercising its discretion whether to make the order, thecourt would take into account any prejudice suffered by the borrower and anyculpability of the lender.

 

Anycredit agreement for a loan or further advance might be wholly or partlyregulated by the CCA or treated as such because of technical rules on: (a) determiningwhether any credit under the CCA arises, or whether the financial limit of theCCA is exceeded; (b) determining whether the credit agreement is an exemptagreement under the CCA; and (c) changes to credit agreements.

 

Acourt order under section 126 of the CCA is necessary to enforce a landmortgage securing a credit agreement to the extent that the credit agreement isregulated by the CCA or to be treated as such. In dealing with suchapplication, the court has the power, if it appears just to do so, to amend thecredit agreement or to impose conditions upon its performance or to make a timeorder (for example, giving extra time for arrears to be cleared).

 

Under section 75of the CCA in certain circumstances: (a) the lender is liable to theborrower in relation to misrepresentation and breach of contract by a supplierin a transaction financed by the lender, where the related credit agreement isor is treated as entered into under pre-existing arrangements, or incontemplation of future arrangements, between the lender and the supplier; and (b) thelender has an indemnity from the supplier against such liability, subject toany agreement between the lender and the supplier.

 

In November 2002,the UK Department of Trade and Industry (the “DTI”) announced its intentionthat a credit agreement will be regulated by the CCA where, for creditagreements made after this change is implemented: (a) the borrower is orincludes an individual, save for partnerships of four or more partners; (b) irrespectiveof the amount of credit (although in July 2003, the DTI announced itsintention that the financial limit will remain for certain business-to-businesslending);

 

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and (c) the credit agreement is not an exempt agreement. In December 2003,the DTI published a White paper proposing amendments to the CCA and tosecondary legislation made under it.

 

In June 2004,secondary legislation was made on: (a) amending requirements as todocumentation of credit agreements, coming into force on May 31, 2005, or August 31,2005 for agreements given to the borrower for signature but not made before May 31,2005; (b) pre-contract disclosure, coming into force on May 31, 2005;and (c) replacing the formula for calculating the maximum amount payableon early settlement with a formula more favorable to the borrower, coming intoforce on May 31, 2005 for new agreements or on May 31, 2007 or May 31,2010 (depending on the term of the agreement) for agreements existing before May 31,2005.

 

In December 2004,the UK Parliament published a consumer Credit Bill proposing to amend the CCAby, among other things: (a) changing the definition of a credit agreementregulated by the CCA to that announced by the DTI as described above; and (b) repealingthe rule that, to the extent that a credit agreement is regulated by theCCA or treated as such, it may be unenforceable totally. If these changes areenacted, then any credit agreement made or changed such that a new contract isentered into after this time, other than a regulated mortgage contract underthe FSMA or other exempt agreement under the CCA, will be regulated by the CCA.Such credit agreement will have to comply with requirements as described aboveand, if it does not comply, it will be unenforceable without an order of theOFT or without a court order as described above.

 

Thisconsumer Credit Bill also proposes to amend CCA by: (a) strengthening thelicensing regime; (b) reforming the law on extortionate credit, with theretrospective 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.

 

Theseller has interpreted certain technical rules under the CCA in a waycommon 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 sellerhas given or, as applicable, will give warranties to the mortgages trustee inthe mortgage sale agreement that, among other things, each loan and its relatedsecurity is enforceable (subject to certain exemptions). If a loan or itsrelated security does not comply with these warranties, and if the defaultcannot be or is not cured within 20 London business days, then the seller willbe required to repurchase the loans under the relevant mortgage account andtheir related security from the mortgages trustee.

 

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

 

Acredit agreement is a regulated mortgage contract under the FSMA if, at thetime 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

 

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borrower or (in case of credit provided to trustees) by an individualwho is a beneficiary of the trust, or by a related person.

 

Themain effects are that, unless an exclusion or exemption applies: (a) eachentity carrying on a regulated mortgage activity has to hold authorization andpermission from the FSA to carry on that activity; and (b) generally, eachfinancial promotion in respect of an agreement relating to a qualifying credithas to be issued or approved by a person holding authorization and permissionfrom the FSA. If requirements as to authorization and permission of lenders andbrokers or as to issue and approval of financial promotions are not compliedwith, a regulated mortgage contract will be unenforceable against the borrowerexcept with 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.

 

Anycredit agreement intended to be a regulated mortgage contract under the FSMAmight instead be wholly or partly regulated by the CCA or treated as such, orunregulated, because of technical rules on: (a) determining whetherthe credit agreement falls within the definition of “regulated mortgagecontract”; and (b) changes to credit agreements.

 

Theseller is required to hold authorisization and permission to enter into and toadminister and, where applicable, to advise on regulated mortgage contracts.Subject to any exemption, brokers will be required to hold authorization andpermission to arrange and, where applicable, to advise on regulated mortgagecontracts.

 

Theissuer and mortgages trustee are not and do not propose to be authorizedpersons under the FSMA. The issuer and mortgages trustee will not requireauthorization in order to acquire legal or beneficial title to a regulatedmortgage contract. The issuer and mortgages trustee do not carry on theregulated activity of administering in relation to regulated mortgage contractsby having them administered pursuant to an administration agreement by anentity 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.

 

TheFSA Mortgages: Conduct of Business Sourcebook (“MCOB”), which sets out its rules forregulated mortgage activities, came into force on October 31, 2004. These rules cover,*inter**alia*, certain pre-origination matters, such as financialpromotion and pre-application illustrations, pre-contract and start of contractand post-contract disclosure, contract changes, charges, arrears andrepossessions. FSA rules for prudential and authorization requirements formortgage firms and insurance intermediaries, and for extending the appointedrepresentatives regime came into force on October 31, 2004 for mortgagesand on January 14, 2005 for general insurance.

 

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

 

So asto avoid dual regulation it is intended that regulated mortgage contracts willnot be regulated by the CCA. This exemption only affects credit agreements madeon or after N(M), and credit agreements made before N(M) but subsequentlychanged such that a new contract is entered into on or after N(M) andconstitutes a regulated mortgage contract. A court order under section 126

 

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of 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.

 

Noassurance can be given that additional regulations from the OFT, the FSA or anyother regulatory authority will not arise with regard to the mortgage market inthe United Kingdom generally, the seller’s particular sector in that market orspecifically in relation to the seller. Any such action or developments orcompliance costs may have a material adverse effect on the seller, the issuerand/or the servicer and their respective businesses and operations. This mayadversely affect our ability to make payments in full on the issuer notes whendue.

 

Priorto M(N), in the United Kingdom, self-regulation of mortgage business existedunder the Mortgage Code (the “CML Code”) issued by the Council of MortgageLenders (the “CML”). Halifax subscribed to the CML Code and on and from N(M),as an authorized person, has been subject to the FSA requirements in MCOB.Membership of the CML and compliance with the CML Code were voluntary. The CMLCode sets out minimum standards of good mortgage business practice, from marketingto lending procedures and dealing with borrowers experiencing financialdifficulties. Since April 30, 1998 lender-subscribers to the CML Code maynot accept mortgage business introduced by intermediaries who were notregistered with (before November 1, 2000) the Mortgage Code Register ofIntermediaries or (on and after November 1, 2000 until October 31,2004) the Mortgage Code Compliance Board.

 

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

 

Therehas been significant opposition from the European Parliament to the originalform of the proposed directive. On February 13, 2004, the Committee ofLegal Affairs and the Internal Market published the European Parliament’samendments to the proposed draft. These amendments provide that (subject tocertain exceptions) loans not exceeding euro 100,000 will be regulated, butthat the proposed directive will not apply to any loan secured by a landmortgage or, in Scotland, a standard security, and will not apply to any creditagreement or surety agreement made before national implementing legislationcomes into force. In October 2004, the European Commission published anamended form of the proposed directive. In this amended form, the proposeddirective provides that (subject to certain exceptions) loans not exceedingeuro 100,000 will be regulated, and that it will indeed apply to any loansecured by a land mortgage or, in Scotland a standard security that includes anequity release component, but it is unclear whether it will apply to any creditagreement or surety agreement made before national implementing legislationcomes into force.  There are differencesin opinion as to the extent to which mortgage loans should be included in thescope of the proposed directive, which may be substantially further amendedbefore it is ultimately brought into effect.

 

Theproposal is unlikely to come into force before 2006 as the co-decisionprocedure of the European Parliament and of the Council, from the publicationof the proposal to the coming into force of the new consumer credit directive,is likely to take at least two years and member states will then have a furthertwo years in which to bring national implementing legislation into force. TheDTI has

 

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consulted with consumer and industry organizations in relation to thisproposal and in February 2005 published a consultation paper on the formof the proposed directive published by the European Commission in October 2004.

 

Untilthe final text of the directive is decided and the details of the United Kingdomimplementing legislation are published, it is not certain what effect theadoption and implementation of the directive would have on the seller, theissuer, the servicer, the mortgages trustee, Funding1, Funding 2 and theirrespective businesses and operations. This may adversely affect the issuer’sability to make payments in full on the issuer notes when due.

 

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

 

In theUnited Kingdom, the Unfair Terms in Consumer Contracts Regulations 1999 asamended (the “1999 Regulations”), which, together with (in so far asapplicable) the Unfair Terms in Consumer Contracts Regulations 1994 (togetherwith the 1999 Regulations, the “UTCCR”), apply to agreements made on or after July 1,1995 and affect all or almost all of the loans, provide that:

 

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

 

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

 

TheUTCCR will not generally affect “core terms” which define the main subjectmatter 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.

 

Forexample, if a term permitting the lender to vary the interest rate (as theseller is permitted to do) is found to be unfair, the borrower will not beliable to pay the increased rate or, to the extent that she or he has paid it,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 OFT considers to be fair terms andunfair terms for interest variation in mortgage contracts. Where the interestvariation term does not provide for precise and immediate tracking of anexternal rate outside the lender’s control, and if the borrower is locked in,for example by an early repayment charge that is considered to be a penalty,the term is likely to be regarded as unfair under the UTCCR unless the lender (i) notifiesthe affected borrower in writing at least 30 days before the rate change and (ii) permitsthe affected borrower to repay the whole loan during the next three monthsafter the rate change, without paying the early repayment charge. The sellerhas reviewed the guidance note and has concluded that its compliance with itwill have no material adverse effect on the loans or its business. The guidancenote has been withdrawn from the OFT website and is currently under review bythe OFT and FSA. The FSA has agreed with the OFT to take responsibility for theenforcement of the UTCCR in mortgage agreements. It is expected that the FSAwill issue guidance on interest variation terms shortly.

 

In August 2002,the Law Commission for England and Wales and the Scottish Law Commission issueda joint consultation LCCP No. 166/SLCDP 119 on proposals to rationalizethe UK’s Unfair Contract Terms Act 1977 and the 1999 Regulations into a singlepiece of legislation and a final report, together with a bill on unfair terms,was published in February 2005. The Law Commissions have a duty under section 3of the UK’s Law Commissions Act 1965 to keep the law

 

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under review for a number of purposes, including its simplification.The proposals are primarily to simplify the legislation on unfair terms. It isnot proposed that there should be any significant increase in the extent ofcontrols over terms in consumer contracts. Some changes are proposed, however,such as that (a) a consumer may also challenge a negotiated term inagreement on the basis that it is “unfair” and “unreasonable” within thelegislation and therefore not binding on the consumer; and (b) in anychallenge by a consumer (but not by the OFT or a qualifying body) of a standardterm or a negotiated term, the burden of proof lies on the business to showthat the term is fair and reasonable. It is too early to tell how theproposals, if enacted, would affect the loans.

 

Noassurance can be given that changes in the UTCCR, if enacted, or changes toguidance on interest variation terms, if adopted, will not have a materialadverse effect on the seller, the issuer, the servicer, the mortgages trustee,Funding 1, Funding 2 and their respective businesses and operations. This mayadversely affect the issuer’s ability to make payments in full on the issuernotes when due.

 

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

 

UnderFSMA, the Financial Ombudsman Service is required to make decisions on, amongother things, complaints relating to activities and transactions under itsjurisdiction on the basis of what, in the Ombudsman’s opinion, would be fairand reasonable in all circumstances of the case, taking into account, amongother things, law and guidance. Complaints brought before the FinancialOmbudsman Service for consideration must be decided on a case-by-case basis,with reference to the particular facts of any individual case. Each case wouldfirst be adjudicated by an adjudicator. Either party to the case may appealagainst the adjudication. In the event of an appeal, the case proceeds to afinal decision by the Ombudsman.

 

In January 2002,the Ombudsman made a determination on the seller’s appeal to an earlierdecision by an adjudicator at the Financial Ombudsman Service concerning a caseinvolving HVR 1 and HVR 2. In March 2001, two joint borrowers with acapped rate loan originated when Halifax offered only a single standardvariable base rate contacted Halifax and requested that their loan be linked toHVR 2. Halifax informed the borrowers that, because they were still in theirproduct period, they could either transfer to HVR 2 when their product periodexpired or transfer to HVR 2 immediately and pay the applicable early repaymentfee. The borrowers complained to the Financial Ombudsman Service and, on January 29,2002, on appeal by Halifax, the Ombudsman determined in the borrowers’ favorand recommended that Halifax recalculate the borrowers’ mortgage by referenceto HVR 2 from the date when the seller should have granted their request in March 2001,refund any overpayments and pay £150 for any inconvenience caused. HVR 2 waswithdrawn and ceased to be available to new borrowers with effect from February 1,2002.

 

TheOmbudsman’s decision only applies to the two borrowers and their particularcircumstances, though other borrowers may also complain to the Ombudsman. In March 2002,the seller announced that borrowers under loans who were in similarcircumstances and who had asked to be transferred to HVR 2 when it wasavailable would be invited to make a product switch to HVR 2 and to obtain arefund for all overpayments of interest since the date they had asked to betransferred. For each of those loans, the borrowers would also receive £150 forany 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.

 

Sincethen, further decisions by the Ombudsman in similar cases have confirmed thataffected borrowers were only entitled to a refund of overpayments of interestfrom the date when they asked to be transferred to HVR 2 and not from the datewhen HVR 2 first became available, and also that affected borrowers were notentitled to apply to be transferred to HVR 2 after it was withdrawn.

 

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Theseller does not believe that any Ombudsman’s decision to date or any otherdecision by any competent authority in the future (in respect of the seller’stwo variable base rates, HVR 1 and HVR 2) would affect the yield on the loansin such a way as to have a material adverse effect on our ability to meet ourobligations on the issuer notes.

 

Asregards other borrowers, in the event that a decision (in respect of the seller’svariable base rate) by the Ombudsman or any other competent authority findsthat a borrower’s loan should be linked to HVR 2, then that borrower mayset-off the overpaid sum against the amount owing under his or her loan if theseller does not reimburse that borrower. Any such non-recovery, claim orset-off ultimately may adversely affect the issuer’s ability to make paymentson the issuer notes.

 

As theFinancial Ombudsman Service is required to make decisions on the basis of,among other things, the principles of fairness, it is not possible to predicthow any future decision of the Financial Ombudsman Service would affect theability of the issuer to repay the issuer notes.

 

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

 

Funding1 and the issuer will generally be subject to UK corporation tax, currently ata rate of 30 per cent., on the profit reflected in their respective profit andloss accounts as increased by the amount of any non-deductible expenses orlosses. If the tax payable by Funding 1 or the issuer is greater than expectedbecause, for example, non-deductible expenses or losses are greater thanexpected, the funds available to make payments on the noteholders’ issuer noteswill be reduced and this may adversely affect the issuer’s ability to makepayments on the issuer notes.

 

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

 

Thestated policy of H.M. Revenue & Customs is that the tax neutrality ofsecuritisation special purpose companies in general should not be disrupted asa result of the transition to IFRS or new UK GAAP and that they are workingwith participants in the securitisation industry to identify appropriate meansof preventing any such disruption. The Finance Act 2005 enables regulations tobe made to establish such a regime. However, if measures are not introduced byH.M. Revenue & Customs to deal with the corporation tax position ofsuch companies in respect of accounting periods ending on or after January 1,2007, then profits or losses could arise in the issuer and/or Funding 1 as aresult of the application of IFRS or new UK GAAP which could have tax effectsnot contemplated in the cashflows for the transaction and as such adverselyaffect the issuer and/or Funding 1 and therefore payments on the issuer notes.

 

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

 

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In theevent that amounts due under the issuer notes are subject to withholding tax,the issuer will not be obliged to pay additional amounts in relation thereto.The issuer may, in certain circumstances, redeem the issuer notes.

 

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

 

If theUnited Kingdom joins the European Monetary Union prior to the maturity of theissuer notes, investors cannot be assured that this would not adversely affectpayments on their issuer notes.

 

It ispossible that prior to the maturity of the issuer notes the United Kingdom maybecome a participating member state in the European economic and monetary unionand that the euro may become the lawful currency of the United Kingdom. In thatevent, (a) all amounts payable in respect of any issuer notes denominatedin sterling may become payable in euro; (b) applicable provisions of lawmay allow or require the issuer to re-denominate such issuer notes into euroand take additional measures in respect of such issuer notes; and (c) theintroduction of the euro as the lawful currency of the United Kingdom mayresult in the disappearance of published or displayed rates for deposits in poundssterling used to determine the rates of interest on such issuer notes orchanges in the way those rates are calculated, quoted and published ordisplayed. The introduction of the euro could also be accompanied by a volatileinterest rate environment, which could adversely affect a borrower’s ability torepay its loan as well as adversely affect investors. It cannot be said withcertainty what effect, if any, adoption of the euro by the United Kingdom willhave on investors in the issuer notes.

 

**Changes oflaw may adversely affect noteholders’ interests**

 

Thestructure of the issue of the issuer notes and the ratings which are assignedto them are based on English law and (in relation to the Scottish loans) Scotslaw in effect as at the date of this prospectus. The issuer cannot provideassurance as to the impact of any possible change to English or Scots law oradministrative practice in the United Kingdom after the date of this Form 20-F.

 

*Insolvency Act 2000*. Significant changesto the UK insolvency regime have been enacted in past years, including theInsolvency Act 2000. The Insolvency Act 2000 allows certain “small” companiesto seek protection from their creditors for a period of 28 days, for thepurposes of putting together a company voluntary arrangement, with the optionfor creditors to extend the moratorium for a further two months. A “small”company is defined as one which satisfies, in any financial year, two or moreof the following criteria: (i) its turnover is not more than £5.6 million,(ii) its balance sheet total is not more than £2.8 million and (iii) thenumber of employees is not more than 50. Whether or not a company is a “small”company may change from period to period and consequently no assurance can begiven that the issuer, the mortgages trustee or Funding 1 will not, at anygiven time, be determined to be a “small” company. The Secretary of State forTrade and Industry may by regulation modify the eligibility requirements for “small”companies and can make different provisions for different cases. No assurancecan be given that any such modification or different provisions will not bedetrimental to the interests of the noteholders.

 

Secondarylegislation has now been enacted which excludes certain special purposecompanies in relation to capital markets transactions from the optionalmoratorium provisions. Such exceptions include (amongst other matters) (i) acompany which is a party to an agreement which is or forms part of a capitalmarket arrangement (as defined in the secondary legislation) under which (a) aparty has incurred or when the agreement was entered into was expected to incura 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 the

 

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

 

*Enterprise Act 2002.*On September 15,2003, the corporate insolvency provisions of the Enterprise Act 2002 came intoforce, amending certain provisions of the Insolvency Act 1986 (as amended, the “InsolvencyAct”). These provisions introduced significant reforms to corporate insolvencylaw. In particular the reforms restrict the right of the holder of a floatingcharge created after September 15, 2003 to appoint an administrativereceiver (unless an exception applies) and instead gives primacy to collectiveinsolvency procedures (in particular, administration).

 

Theholder of a floating charge created before September 15, 2003 over thewhole or substantially the whole of the assets of a company (such as thesecurity 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.

 

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

 

TheInsolvency Act also contains a new out-of-court route into administration for aqualifying floating charge holder, the directors or the company itself. Therelevant provisions provide for a notice period during which the holder of thefloating charge can either agree to the administrator proposed by the directorsof the company or appoint an alternative administrator, although the moratoriumwill take effect immediately after notice is given. If the qualifying floatingcharge holder does not respond to the directors’ notice of intention toappoint, the directors’, or as the case may be, the company’s appointee willautomatically take office after the notice period has elapsed. Where the holderof a qualifying floating charge within the context of a capital markettransaction retains the power to appoint an administrative receiver, suchholder may prevent the appointment of an administrator (either by the newout-of-court route or by the court based procedure), by appointing anadministrative receiver prior to the appointment of the administrator beingcompleted.

 

Thenew administration provisions of the Insolvency Act give primary emphasis tothe rescue of the company as a going concern. The purpose of realizing propertyto make a distribution to one or more secured creditors is subordinated to theprimary purposes of rescuing the company as a going concern or achieving abetter result for the creditors as a whole than would be likely if the companywere wound up. No assurances can be given that the primary purposes of the newprovisions will not conflict with the interests of noteholders were the issuerever subject to administration.

 

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Inaddition to the introduction of a prohibition on the appointment of anadministrative receiver as set out above, section 176A of the InsolvencyAct 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.

 

Thisobligation does not apply if the net property is less than a prescribed minimumand the relevant officeholder is of the view that the cost of making adistribution to unsecured creditors would be disproportionate to the benefits.The relevant officeholder may also apply to court for an order that theprovisions of section 176A of the Insolvency Act should not apply on thebasis that the cost of making a distribution would be disproportionate to thebenefits.

 

Floatingcharge realizations upon the enforcement of the issuer security and thesecurity created by the second supplemental Funding 1 deed of charge may bereduced by the operation of these “ring fencing” provisions.

 

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

 

Unlessthe global issuer notes are exchanged for definitive issuer notes, which willonly occur under a limited set of circumstances, the noteholders’ beneficialownership of the issuer notes will only be recorded in book-entry form withDTC, Euroclear or Clearstream, Luxembourg. The lack of issuer notes in physicalform could, among other things:

 

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

 

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

 

**•**                  hinder the noteholders’ ability toresell the issuer notes because some investors may be unwilling to buy issuernotes that are not in physical form.

 

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

 

Theissuer has agreed to submit to the non-exclusive jurisdiction of the courts ofEngland, and it may be necessary for noteholders to bring a suit in England toenforce their rights against the issuer.

 

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

 

TheBasel Committee on Banking Supervision published the text of the new frameworkon June 26, 2004 under the title “Basel II: International Convergence ofCapital Measurement and

 

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

 

Theissuer may, under certain circumstances relating to implementation of the NewBasel Capital Accord in the United Kingdom, require investors to sell theirissuer notes or redeem their issuer notes.

 

**Item4.  Information on the Company**

 

A.*            History andDevelopment of the Company*

 

Not applicable.

 

B.*            Business Overview*

 

Notapplicable.

 

C.*            OrganizationalStructure*

 

Notapplicable.

 

D.*            Property, Plants andEquipment*

 

Theissuer

 

The property of the issuer consists primarily of its right toreceive payments of interest and principal from Funding 1 on the various termadvances made under the issuer intercompany loan agreement.

 

Funding1

 

Theproperty of Funding 1 consists primarily of its interest in the trust propertyheld by the mortgages trustee (which entitles Funding 1 to receive certainpayments of principal and interest from the trust property according to theterms of the mortgages trust deed) and amounts available under a reserve fund.

 

Themortgages trustee

 

Thetrust property includes the portfolio of loans and their related securityassigned to the mortgages trustee by the seller on June 14, 2002, any newloans and their new related security assigned to the mortgages trustee by theseller after the closing date, any increase in the outstanding principalbalance of a loan due to the borrower taking payment holidays or makingunderpayments under a loan or a borrower making a drawing under any flexibleloan, any interest, principal and other amounts (excluding third party amounts)paid by borrowers on their loans and their related security, the rights underthe insurance policies that are assigned to the mortgages trustee or of whichthe

 

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mortgages trustee has the benefit, and amounts on deposit and interestearned on the mortgages trustee guaranteed investment contract. Any actuallosses in relation to the loans, any actual reductions occurring in respect ofthe loans and distributions of principal made from time to time to thebeneficiaries or the mortgages trust will be deducted from the trust property.The composition of the trust property will fluctuate as drawings under flexibleloans and new loans are added, as borrowers take payment holidays or makeunderpayments under a loan and as the loans that were previously part of thetrust property are repaid, mature, default or are repurchased by the seller.

 

**Item5.  Operating and Financial Review andProspects**

 

A.*            Operating Results*

 

Notapplicable.

 

B.*            Liquidity and CapitalResources*

 

Notapplicable.

 

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

 

Notapplicable.

 

D*.            Trend Information*

 

Notapplicable.

 

E.*             Off-balance SheetArrangements*

 

Notapplicable.

 

F.*             Tabular Disclosure ofContractual Obligations*

 

Notapplicable.

 

G*.            Safe Harbor*

 

Notapplicable.

 

**Item6.  Directors, Senior Management andEmployees**

 

A.*            Directors and SeniorManagement*

 

Thefollowing sets out the names, business addresses and business occupations ofthe directors of the issuer, Funding 1 and the mortgages trustee. Because eachof the issuer, Funding 1 and the mortgages trustee is organized as a specialpurpose company and will be largely passive, it is expected that the directorsof each entity in that capacity will manage its operations to the extentnecessary.

 

Theissuer

 
| **Name**               | ** ** | **Business Address**                         | ** ** | **Business Occupation**                              |
|------------------------|------------|----------------------------------------------|------------|------------------------------------------------------|
| SFM Directors  Limited |       | 35 Great St.  Helen’s  London  EC3A 6AP |       | Provision of  directors to special purpose companies |

 

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

 

Funding 1

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

 

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 |

 

DavidBalai is an employee of a company in the same group of companies as the seller.

 

B.*            Compensation*

 

Theissuer

 

Inaccordance with the issuer corporate services agreement entered into betweenthe issuer, the seller, the security trustee, the note trustee, Holdings andStructured Finance Management Limited (“SFM”), the seller and SFM will eachprovide directors and other corporate services for the issuer in considerationfor a payment of a separate fee payable by the issuer to SFM. No otherremuneration is paid to any director or officer in connection with suchdirector’s or officer’s activities on behalf of the issuer.

 

Funding1

 

Inaccordance with the Funding 1 corporate services agreement entered into betweenFunding 1, the seller, the security trustee, the note trustee, Holdings, PermanentPECOH Limited, SFM, and

 

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** **

SFM Corporate ServicesLimited (“SFM Corporate”), the seller and SFM will each provide directors andSFM will provide other corporate services for Funding 1 in consideration for apayment of a separate fee payable by Funding 1 to SFM. No other remuneration ispaid to any director or officer in connection with such director’s or officer’sactivities on behalf of Funding 1.

 

Themortgages trustee

 

Inaccordance with the mortgages trustee corporate services agreement entered intobetween the mortgages trustee, the security trustee, the note trustee and SFMOffshore Limited (“SFM Offshore”), the seller and SFM Offshore will eachprovide directors and SFM Offshore will provide other corporate services forthe mortgages trustee in consideration for a payment of a separate fee payableby the mortgages trustee to SFM Offshore. No other remuneration is paid to anydirector or officer in connection with such director’s or officer’s activitieson behalf of the mortgages trustee.

 

C.                                     *Board Practices*

 

Notapplicable.

 

D.                                    *Employees*

 

Noneof the issuer, Funding 1 or the mortgages trustee has any employees.

 

E.                                      *Share Ownership*

 

Notapplicable.

 

**Item7.  Major Shareholders and Related PartyTransactions**

 

A.                                   *Major Shareholders*

 

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

 

SFMOffshore holds all of the issued shares of the mortgages trustee in trust forcharitable purposes.

 

NeitherSFM Corporate nor SFM Offshore is affiliated with Halifax plc.

 

B.                                     *Related Party Transactions*

 

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

 

C.                                     *Interests of Experts and Counsel*

 

Notapplicable to annual reports filed on Form 20-F.

 

**Item8.  Financial Information**

 

For adiscussion of the available financial information, see “Item 3.A — SelectedFinancial Information”.

 

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Theissuer, Funding 1 and the mortgages trustee know of no material legal orarbitration proceedings involving their respective companies that may havesignificant effects on the registrants’ financial position or profitability,including governmental proceedings pending or known to be contemplated and anymaterial proceeding in which any director or affiliate is either a partyadverse to a registrant or has a material interest adverse to a registrant.

 

**Item9.  The Offer and Listing**

 

A.*                                   Offerand Listing Details*

 

Notapplicable.

 

B.*                                     Planof Distribution*

 

Notapplicable to annual reports filed on Form 20-F.

 

C.*                                     Markets*

 

Theprincipal trading market for each class of the issuer notes is the London StockExchange.  The issuer notes have beenlisted on the London Stock Exchange since June 14, 2002.

 

D.*                                    SellingShareholders*

 

Notapplicable to annual reports filed on Form 20-F.

 

E.*                                      Dilution*

 

Notapplicable to annual reports filed on Form 20-F.

 

F.*                                      Expensesof the Issue*

 

Notapplicable to annual reports filed on Form 20-F.

 

**Item10.  Additional Information**

 

A.*                                   ShareCapital*

 

Notapplicable to annual reports filed on Form 20-F.

 

B.*                                     Memorandumand Articles of Association*

 

Thememorandum and articles of association for each of the issuer, Funding 1 andthe mortgages trustee are incorporated by reference from the RegistrationStatement.  Please also see thedescription of the issuer, Funding 1 and the mortgages trustee set forth in theRegistration Statement.

 

C.                                     *Material Contracts*

 

Notapplicable other than with respect to contracts relating to the issuer notes,which were described in the Registration Statement.

 

D.*                                    ExchangeControls*

 

None.

 

E.*                                      Taxation*

 

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**United Kingdom Taxation**

 

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

 

**Taxationof US residents**

 

Asdiscussed in more detail below, no UK withholding tax will be required inrelation to interest payments on the issuer notes provided that the issuernotes are listed on a “recognised stock exchange”, which includes the London Stock Exchange.If the issuer notes cease to be listed on a “recognised stock exchange”, anamount must be withheld on account of UK income tax at the lower rate (currently20 per cent.), subject to any direction to the contrary from H.M. Revenue &Customs in respect of such relief as may be available pursuant to theprovisions of an applicable double taxation treaty.

 

Residentsof the US are generally not subject to tax in the UK on payments on the issuernotes under the terms of the double taxation treaty between the US and the UK(the “Treaty”), subject to completion of administrative formalities, exceptwhere the issuer notes are effectively connected with a permanent establishmentor a fixed base of the noteholder situated in the UK or where the amounts paidon the issuer notes not exceed the return on comparable debt instruments, inwhich event the UK may tax the excess in accordance with UK domestic law.

 

Subjectto the opinions set out in the preceding paragraphs, as discussed in moredetail under “- Direct assessment of non-UK resident holders of the issuernotes to UK tax on interest” below, anoteholder 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 to UK taxin respect of a disposal of the issuer notes provided they are not within thecharge to UK corporation tax and (i) are not resident or ordinarilyresident in the UK, and (ii) do not carry on a trade, profession orvocation carried on by him through a branch or agency in connection with whichinterest is received or to which the issuer notes are attributable.

 

Funding 1 and the issuer will generally be subjectto UK corporation tax, currently at a rate of 30 per cent., on the profitreflected in their respective profit and loss accounts as increased by theamounts of any non-deductible expenses or losses.

 

The mortgages trustee will have no liability to UKtax in relation to amounts which it receives on behalf of Funding 1 or theseller under the mortgages trust.

 

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**Withholdingtax**

 

Therewill be no UK withholding tax in relation to interest payments on the issuernotes provided that, so far as concerns deduction by the issuer or its payingagents, the issuer notes are listed on a “recognised stock exchange”, asdefined 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 as maybe available pursuant to the provisions of an applicable double taxation treatyor to the interest being paid to persons (including companies within the chargeto UK corporation tax) and in circumstances specified in Section 349A to349D of the ICTA.

 

Noteholderswho are individuals may wish to note that H.M. Revenue & Customs haspower to obtain information (including the name and address of the beneficialowner of the interest) from any person in the UK who either pays interest to,or receives interest for the benefit of, an individual. Information so obtainedmay, in certain circumstances, be exchanged by H.M. Revenue & Customs with thetax authorities of other jurisdictions.

 

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

 

Intereston the issuer notes has a UK source. Accordingly, payments of interest on theissuer notes will in principle be within the charge to UK tax even if paidwithout withholding or deduction. However, other than where the provisions ofthe Treaty apply to allow certain interest paid to residents of the US to betaxed in the UK, such payments will not be chargeable to UK tax in the hands ofa noteholder who is not resident for tax purposes in the UK unless suchnoteholder carries on a trade, profession or vocation through a branch oragency (or, in the case of a noteholder which is a company, which carries on atrade through a permanent establishment) in the UK in connection with which thepayments are received or to which the issuer notes are attributable, in whichcase (subject to exemptions for interest received by certain categories ofagent such as some brokers and investment managers) tax may be levied on the UKbranch or agency or permanent establishment.

 

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

 

Ingeneral, noteholders who are within the charge to UK corporation tax (otherthan authorized unit trusts) will normally be subject to tax on all profits andgains, including interest and profit and gains attributable to currencyregulations, arising on or in connection with the issuer notes under the loanrelationship rules. Any such profits and gains will generally fall to becalculated in accordance with the statutory accounting treatment of the issuernotes in the hands of the relevant noteholder, and will generally be charged totax as income in respect of each accounting period to which they are allocated,in accordance with that accounting treatment. Relief may be available inrespect of losses or for related expenses on a similar basis.

 

**Taxationof returns: other noteholders**

 

Noteholderswho are not within the charge to UK corporation tax and who are resident orordinarily resident in the UK for tax purposes or who carry on a trade,profession or vocation in the UK through a branch or agency in connection withwhich interest on the issuer notes is received or to which the issuer notes areattributable will generally be liable to UK tax on the amount of any interestreceived in respect of the issuer notes. As the series 2 issuer notes andseries 3 issuer notes are denominated in US dollars and the series 4 class A1issuer notes are denominated in euro, they will not be regarded by H.M. Revenue &Customs as constituting “qualifying corporate bonds” within the meaning of Section 117of the Taxation of Chargeable Gains Act 1992. Accordingly, a disposal of any ofthese issuer notes may give rise to a chargeable gain or an allowable loss forthe purpose of the UK taxation of chargeable gains.

 

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It isexpected that the series 4 class A2 issuer notes, the series 4 class B issuernotes and the series 4 class C issuer notes will be regarded by H.M. Revenue &Customs as constituting “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.

 

Adisposal of the issuer notes by such noteholders as described above may alsogive rise to a charge to tax on income in respect of an amount representinginterest accrued on the issuer notes since the preceding payment date. For theissuer notes which constitute variable rate securities, taxation in respect ofsuch a disposal will be computed on the basis that such amount as H.M. Revenue &Customs considers to be just and reasonable will be treated as accrued income.However, the transferee of a variable rate security will not be entitled to anyrelief on such amount. All of the issuer notes (except the series 4 class A1issuer notes) will constitute variable rate issuer notes for this purpose.

 

**Stampduty and stamp duty reserve tax**

 

No UKstamp duty or stamp duty reserve tax is payable on the issue or transfer of theoffered global issuer notes or on the issue or transfer of definitive issuernotes.

 

**UKtaxation of Funding 1 and the issuer**

 

Funding1 and the issuer will generally be subject to UK corporation tax, currently ata rate of 30 per cent. on the profit reflected in their respective profitand loss accounts as increased by the amounts of any non-deductible expenses orlosses. In respect of Funding 1, the profit in the profit and loss account willnot exceed 0.01 per cent. of the Funding 1 available revenue receipts. Inrespect of the issuer, the profit in the profit and loss account will notexceed 0.01 per cent. of the interest on the issuer term advances underthe issuer intercompany loan and any interest earned by the issuer on its ShareCapital proceeds.

 

**UKtaxation of the mortgages trustee**

 

Themortgages trustee will have no liability to UK tax in respect of any income,profit or gain arising under these arrangements. Accordingly, the mortgagestrustee will have no liability to UK tax in relation to amounts that itreceives on behalf of Funding 1 or the seller under the mortgages trust.

 

**EU Savings Directive**

 

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

 

Jerseyis not a member of the EU and therefore is not required to implement the EUSavings Tax Directive. However, the Policy & Resources Committee ofthe States of Jersey has announced that, in keeping with Jersey’s policy ofconstructive international engagement, Jersey, in line with steps proposed byother relevant third countries, proposes to introduce a retention tax system inrespect of payments of interest, or other similar income, made to an individualbeneficial owner resident in an EU Member State by a paying agent situated inJersey (the terms “beneficial owner”

 

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and “paying agent” forthis purpose are as defined in the EU Savings Tax Directive). The retention taxsystem would apply for a transitional period prior to the implementation of asystem of automatic communication to EU Member States of information regardingsuch payments. During this transitional period, such an individual beneficialowner resident in an EU Member State would be entitled to request a payingagent not to retain tax from such payments but instead to apply a system bywhich the details of such payments are communicated to the tax authorities ofthe EU Member State in which the beneficial owner is resident.

 

**United States Federal Income Taxation**

 

Thefollowing section summarizes the material US federal income taxconsequences of the purchase, ownership and disposition of the series 2 issuernotes and series 3 issuer notes (the “US notes”). In general, the summaryassumes that a holder acquires the US notes at original issuance and holdsthe 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 the issuer; (viii) personswho hold US notes through partnerships or other pass-through entities; and (ix) personsthat have a “functional currency” other than the US dollar. In addition, thissummary does not address alternative minimum tax consequences, nor does itdescribe any tax consequences arising under the laws of any taxing jurisdictionother than the US federal government.

 

Thissummary is based on the US Internal Revenue Code of 1986, as amended (the “Code”),US Treasury regulations and judicial and administrative interpretationsthereof, in each case as in effect or available on the date of filing of this Form 20-F.All of the foregoing are subject to change, and any change may applyretroactively and could affect the tax consequences described below.

 

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

 

As used in this section, the term “United States holder” meansa beneficial 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.

 

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

 

Eachof the issuer, Funding 1 and the mortgages trustee acting it its capacity astrustee of the mortgages trust covenants not to engage in any activities in theUnited States (directly or through agents), not to derive any income fromsources within the United States as determined under US federal income taxprinciples, and not to hold any property if doing so would cause it to beengaged or deemed to be engaged in a trade or business within the United Statesas determined under US federal

 

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income tax principles.Assuming compliance with these covenants, none of the issuer, Funding 1 or themortgages trustee acting in its capacity as trustee of the mortgages trust willbe subject 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).

 

**Characterizationof the US notes**

 

Althoughthere is no authority regarding the treatment of instruments that aresubstantially similar to the US notes, and while it is not free from doubt, theissuer believes that the US notes will be treated as debt for US federal incometax purposes. The issuer intends to treat the US notes as indebtedness of theissuer for all purposes, including US tax purposes. The discussion in the next section assumesthis result.

 

The USnotes will not be qualifying real property loans in the hands of domesticsavings and loan associations, real estate investment trusts, or REMICs undersections 7701(a)(19)(C), 856(c) or 860G(a)(3) of the Code,respectively.

 

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

 

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

 

It is possible that interest on the US notes that are class Band 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 and class C issuer notes and, accordingly, the issuerintends to assume that such US notes will have their principal repaid accordingto the schedule for purposes of accruing any OID. No representation ismade that the mortgage loans will pay on the basis of such prepaymentassumption or in accordance with any other prepayment scenario.

 

As analternative to the above treatments, United States holders may elect to includein gross income all interest with respect to the US notes, including statedinterest, acquisition discount, OID, *de minimis* OID,market discount, *de minimis* market discount, andunstated interest, as adjusted by any amortizable bond premium or acquisitionpremium, using the constant yield method described above.

 

Interestincome on the US notes will be treated as foreign source income for US federalincome tax purposes, which may be relevant in calculating a United Statesholder’s foreign tax credit limitation for US federal income tax purposes. Thelimitation on foreign taxes eligible for the US foreign tax credit iscalculated separately with respect to specific classes of income. The foreigntax credit rules are complex, and United States holders should consulttheir own tax advisers regarding

 

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the availability of aforeign tax credit and the application of the limitation in their particularcircumstances.

 

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

 

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

 

Subjectto the backup withholding rules discussed below, a Non-United Statesholder generally should not be subject to US federal income or withholding taxon any payments on a US note and gain from the sale, redemption or otherdisposition of a US note unless: (i) that payment and/or gain iseffectively connected with the conduct by that Non-United States holder of atrade or business in the United States; (ii) in the case of any gainrealized on the sale or exchange of a US note by an individual Non-UnitedStates holder, that holder is present in the United States for 183 days or morein the taxable year of the sale, exchange or retirement and certain otherconditions are met; or (iii) the Non-United States holder is subject totax pursuant to provisions of the Code applicable to certain expatriates. **Non-United States holders should consult their own tax advisorsregarding the US federal income and other tax consequences of owning US notes.**

 

**Alternativecharacterization of the US notes**

 

Theproper characterization of the arrangement involving the issuer and the holdersof the US notes is not clear because there is no authority on transactionscomparable to that contemplated herein. The issuer intends to treat the USnotes as debt for all US federal income tax purposes. Investors should consulttheir own tax advisors with respect to the potential impact of an alternativecharacterization of the US notes for US tax purposes.

 

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

 

If aUnited States holder were treated as owning an equity interest in a PFIC,unless a United States holder makes a “QEF election” or “mark to marketelection”, a United States holder will be subject to a special tax regime (i) inrespect of gains realized on the sale or other disposition of the relevantnotes, and (ii) in respect of distributions on the relevant notes held formore than one taxable year to the extent those distributions constitute “excessdistributions”. Although not free from doubt, the PFIC rules should notapply to gain realized in respect of any notes disposed of during the sametaxable year in which such notes are acquired. An excess distribution generallyincludes dividends or other distributions received from a PFIC in any taxableyear to the extent the amount of such distributions exceeds 125 per cent. ofthe average distributions for the three preceding years (or, if shorter, theinvestor’s holding period). Because the US notes pay interest at a floatingrate, it is

 

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possible that a US holderwill receive “excess distributions” as a result of fluctuations in the rate ofUSD-LIBOR over the term of the US notes. In general, under the PFIC rules, aUnited States holder will be required to allocate such excess distributions andany gain realized on a sale of its notes to each day during the United Statesholder’s holding period for the notes, and will be taxable at the highest rateof taxation applicable to the notes for the year to which the excessdistribution or gain is allocable (without regard to the United States holder’sother items of income and loss for such taxable year) (the “deferred tax”). Thedeferred tax (other than the tax on amounts allocable to the year ofdisposition or receipt of the distribution) will then be increased by aninterest charge computed by reference to the rate generally applicable tounderpayments of tax (which interest charge generally will be non-deductibleinterest expense for individual taxpayers).

 

**Backupwithholding and information reporting**

 

Backup withholding and information reporting requirementsmay apply to certain payments on the US notes and proceeds of the sale orredemption of the US notes to United States holders. The issuer, itsagent, a broker, or any paying agent, as the case may be, may be required towithhold tax from any payment that is subject to backup withholding if theUnited States holder fails to furnish the United States holder’s taxpayeridentification number (usually on IRS Form W-9), to certify that suchUnited 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.

 

Paymentsof principal or interest made to or through a foreign office of a custodian,nominee or other agent acting on behalf of a beneficial owner of a US notegenerally will not be subject to backup withholding. However, if suchcustodian, 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 effectively connectedwith 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 beneficial ownerotherwise 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.

 

Backupwithholding is not an additional tax. Any amounts withheld under the backupwithholding rules will be refunded or credited against the United Statesholder’s US federal income tax liability, provided that the requiredinformation is furnished to the IRS. **Holders of US notes shouldconsult their tax advisors as to their qualification for exemption from backupwithholding and the procedure for obtaining an exemption.**

 

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**Material Jersey (Channel Islands) TaxConsiderations**

 

Themortgages trustee is resident in Jersey for taxation purposes and will beliable to income tax in Jersey at a rate of 20 per cent. in respect of theprofits it makes from acting as trustee of the mortgages trust. The mortgages trusteewill not be liable for any income tax in Jersey in respect of any income itreceives in its capacity as mortgages trustee on behalf of the beneficiaries ofthe mortgages trust.

 

F.                                      *Dividends and Paying Agents*

 

Notapplicable to annual reports filed on Form 20-F.

 

G.                                     *Statement by Experts*

 

Notapplicable to annual reports filed on Form 20-F.

 

H.                                    *Documents on Display*

 

Theissuer, Funding 1 and the mortgages trustee are subject to the informationrequirements of the U.S. Securities Exchange Act of 1934, as amended, and aretherefore required to file reports, including annual reports on Form 20-F,and other information with the SEC. These materials, including this annualreport and the exhibits thereto, may be inspected and copied at the SEC’spublic reference rooms in Washington, DC, New York, NY and Chicago, IL. Pleasecall the SEC at +1-800-732-0330 for further information on the public referencerooms. Any filings made by the issuer, Funding 1 or the mortgages trustee willbe made available to the public over the Internet at the SEC’s web site athttp://www.sec.gov.

 

I.                                         *Subsidiary Information*

 

Notapplicable to annual reports filed on Form 20-F.

 

**Item11.  Quantitative and QualitativeDisclosures About Market Risk**

 

Funding1 has entered into the Funding 1 swap agreement with Halifax plc as the Funding1 swap provider and the security trustee. The issuer has entered into issuerswaps with the issuer swap providers and the security trustee. In general, theswaps are designed to do the following:

 

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

 

•                  issuer dollar currency swaps: toprotect the issuer against changes in the sterling to US dollar exchange ratefollowing the closing date and the possible variance between a LIBOR based ratefor three-month sterling deposits and a LIBOR based rate for three-month dollardeposits, applicable to the series 2 class B issuer notes and the series 2class C issuer notes, from and including the interest payment date falling in June 2005,and the series 3 issuer notes; and

 

•                  issuer euro currency swaps: toprotect the issuer against changes in the sterling to euro exchange ratefollowing the closing date and the possible variance between a LIBOR based ratefor three-month sterling deposits and either (i) a fixed rate of interestapplicable to the series 4 class A1 issuer notes up to and including theinterest payment in June 2007 payable, during this period, (A) annuallyon the interest payment date falling in

 

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June ofeach year until the occurrence of a trigger event or the enforcement of theissuer security and (B) quarterly on and following the interest paymentdate occurring immediately thereafter or (ii) a EURIBOR based rate forthree-month euro deposits applicable to the series 4 class A1 issuer notes fromand including the interest payment date falling in June 2007.

 

**TheFunding 1 swap**

 

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

 

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

 

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

 

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

 

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

 

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

 

Underthe Funding 1 swap, on each calculation date, the following amounts will becalculated:

 

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

 

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

 

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

 

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

 

(iii)                               the rates of interestpayable on the fixed rate loans,

 

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

 

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

 

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

 

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

 

Afterthese two amounts are calculated in relation to a Funding 1 interest paymentdate, the following payments will be made on that Funding 1 interest paymentdate:

 

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

 

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

 

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

 

If apayment is to be made by the Funding 1 swap provider, that payment will beincluded in the Funding 1 available revenue receipts and will be applied on therelevant Funding 1 interest payment date according to the relevant order ofpriority of payments of Funding 1. If a payment is to be made by Funding 1, itwill be made according to the relevant order of priority of payments of Funding1.

 

Thenotional amount of the Funding 1 swap in respect of a calculation period willbe an amount in sterling equal to:

 

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

 

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

 

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

 

In theevent that the Funding 1 swap is terminated prior to the service of any issuerintercompany loan acceleration notice or final repayment of any intercompanyloan, Funding 1 shall enter into a replacement Funding 1 swap on termsacceptable to the rating agencies, with the security trustee and with a swapprovider whom the rating agencies have previously confirmed in writing toFunding 1, the issuer and the security trustee will not cause the then currentratings of the issuer notes to be downgraded, withdrawn or qualified. IfFunding 1 is unable to enter into a new Funding 1 swap on terms acceptable tothe rating agencies, this may affect amounts available to pay interest on theintercompany loans.

 

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**Theissuer currency swaps**

 

Theissuer intercompany loan is denominated in sterling, and interest payable byFunding 1 to the issuer under the issuer term advances is calculated as amargin over LIBOR for three-month sterling deposits. However, some of theissuer notes are denominated in US dollars and accrue interest at either afixed rate, or a LIBOR based rate for three-month US dollar deposits. Inaddition, the series 4 class A1 issuer notes are denominated in euro and accrueinterest at a fixed rate up to the interest payment date falling in June 2007and thereafter at a EURIBOR based rate for three-month euro deposits. To dealwith the potential interest rate and/or currency mismatch between (i) itsreceipts and liabilities in respect of the issuer intercompany loan and (ii) itsreceipts and liabilities under the issuer notes, the issuer has, pursuant tothe terms of the issuer currency swaps, swapped its receipts and liabilities inrespect of all euro denominated issuer notes and all US dollar denominatedissuer notes into sterling on terms that match the issuer’s obligations underthe US dollar denominated issuer notes or the euro denominated issuer notes, asapplicable.

 

Thecurrency amount of each issuer currency swap is the principal amountoutstanding under the issuer notes to which the relevant issuer currency swaprelates. Subject, in the case of the class B and C issuer swaps, to certain deferralof interest provisions that will apply when payment of interest under thecorresponding offered issuer notes is deferred in accordance with the terms andconditions of such offered issuer notes, the issuer swap providers will pay tothe issuer amounts in US dollars or euro, as applicable that are equal to theamounts of interest to be paid on each of the classes of the offered issuernotes and the issuer will pay to the issuer swap providers the sterlinginterest amounts received on the issuer term advances corresponding to theclasses of the offered issuer notes. In order to allow for the effectivecurrency amount of each issuer currency swap to amortize at the same rate asthe relevant class of issuer notes, each issuer currency swap agreement providesthat as and when the issuer notes amortize, a corresponding portion of therelevant issuer currency swap so terminated will be swapped from sterling intoUS dollars at the relevant dollar currency exchange rate or into euro at theeuro currency exchange rate, as applicable.

 

Thepayment obligations of the series 3 issuer swap provider under the relevantissuer dollar currency swaps are guaranteed by the issuer dollar currency swapguarantor pursuant to a guarantee (the “series 3 issuer swap guarantee”).

 

In theevent that any issuer currency swap is terminated prior to the service of anissuer note acceleration notice or the final redemption of the relevant USdollar denominated or euro denominated issuer notes, as applicable, the issuershall enter into a replacement issuer currency swap in respect of that classand series of issuer notes. Any replacement issuer currency swap must beentered into on terms acceptable to the rating agencies, the issuer and thesecurity trustee and with a replacement issuer currency swap provider whom therating 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 anissuer currency swap agreement is terminated and the issuer is unable to enter intoa replacement swap as described above, then any payments received by the issuerfrom Funding 1 on each Funding 1 interest payment date shall be deposited inthe issuer bank account (or such other account opened for this purpose) andapplied by the issuer to repay the issuer notes on each interest payment dateafter exchanging at the “spot” rate, the relevant proceeds from sterling intoUS dollars or euros as required.

 

**Ratingsdowngrade of swap providers**

 

Undereach of the swap agreements, in the event that the relevant rating(s) of a swapprovider, or its respective guarantor, as applicable, is or are, as applicable,downgraded by a rating agency below the rating(s) specified in the relevantswap agreement (in accordance with the requirements of

 

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the rating agencies) forsuch swap provider, and, as a result of the downgrade, the then current ratingsof the 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 which satisfies the rating requirements of the relevant rating agency orrating agencies (as applicable), as specified in the relevant swap agreement,obtaining a guarantee from a satisfactory third party, procuring another entitywhich satisfies the rating requirements of the relevant rating agency or ratingagencies (as applicable), as specified in the relevant swap agreement, tobecome co-obligor in respect of its obligations under the relevant swap, ortaking such other action as it may agree with the relevant rating agency orrating agencies (as applicable).

 

Inlight of the credit rating of Credit Suisse First Boston International (“CSFBi”)as at the date of this filing, CSFBi, as series 4 class A1 issuer swapprovider, has provided collateral for its obligations under the series 4 classA1 issuer swap from the effective date of such issuer swap. In the event thatCSFBi’s credit rating is restored to the level required under the relevantissuer swap agreements, the obligation to post collateral will cease.

 

**Terminationof the swaps**

 

TheFunding 1 swap will terminate on the date on which the aggregate principalamount outstanding under all intercompany loans is reduced to zero.

 

Eachissuer swap other than the series 3 class A issuer swap and the series 4 classA1 issuer swap will terminate on the earlier of the interest payment datefalling in June 2042 and the date on which all of the relevant class andseries of issuer notes are redeemed in full. The series 3 class A issuer swapwill terminate on the earlier of the interest payment date falling in December 2007and the date on which the series 3 class A issuer notes are redeemed in full.The series 4 class A1 issuer swap will terminate on the earlier of the interestpayment date falling in June 2009 and the date on which the series 4 classA1 issuer notes are redeemed in full.

 

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

 

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

 

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

 

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

 

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

 

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

 

•                  in respect of the issuer swaps, atthe option of the issuer, and in respect of the Funding 1 swap, at the optionof Funding 1, upon the occurrence of an insolvency of the relevant

 

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swapprovider, or its guarantor, as applicable, or the merger of the relevant swapprovider without an assumption of its obligations under the relevant swapagreement, or if a material misrepresentation is made by the swap providerunder the relevant swap agreement, or if the relevant swap provider defaultsunder an over-the-counter derivatives transaction under another agreementbetween the issuer and such swap provider; or if a breach of a provision of therelevant swap agreement by the swap provider is not remedied within theapplicable grace period, or, if applicable, if the guarantor of the relevantswap provider fails to comply with its obligations under the guarantee;

 

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

 

•                  if the relevant swap provider or itsguarantor, as applicable, is downgraded and fails to comply with therequirements of the ratings downgrade provision contained in the relevant swapagreement; and

 

•                  In the case of the series 3 issuerswaps, at the option of the series 3 issuer swap provider but subject toobtaining the consent of the security trustee, if withholding taxes are imposedon payments made by the series 3 issuer swap guarantor under the series 3 issuerswap guarantee.

 

Uponthe occurrence of a swap early termination event, the issuer or the relevantissuer swap provider may be liable to make a termination payment to the otherparty (in the case of an issuer swap) and/or Funding 1 or the Funding 1 swapprovider may be liable to make a termination payment to the other party (in thecase of the Funding 1 swap). This termination payment will be calculated andmade in sterling. The amount of any termination payment will be based on themarket value of the terminated swap as determined on the basis of quotationssought from leading dealers as to the cost of entering into a swap with thesame terms and conditions that would have the effect of preserving the economicequivalent of the respective full payment obligations of the parties (or basedupon a good faith determination of total losses and costs (or gains) if aninsufficient number of quotations can be obtained or if basing the valuation onquotations would not produce a commercially reasonable result). Any suchtermination payment could be substantial.

 

If anyissuer swap is terminated early and a termination payment is due by the issuerto an issuer swap provider, then, pursuant to its obligations under the issuerintercompany loan, Funding 1 shall pay to the issuer an amount equal to thetermination payment due to the relevant issuer swap provider less any amountreceived by the issuer under any replacement issuer swap agreement. Thesepayments will be made by Funding 1 only after paying interest amounts due onthe issuer term advances and after providing for any debit balance on theprincipal deficiency ledger.  The issuershall apply amounts received from Funding 1 under the issuer intercompany loanin accordance with the issuer pre-enforcement revenue priority of payments or,as the case may be, the issuer post-enforcement priority of payments. Theapplication by the issuer of termination payments due to an issuer swapprovider may affect the funds available to pay amounts due to noteholders.

 

If theissuer receives a termination payment from an issuer currency swap provider,then the issuer shall use those funds towards meeting its costs in effectingcurrency exchanges at the applicable spot rate of exchange until a replacementissuer currency swap is entered into and/or to acquire a replacement issuercurrency swap.

 

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

 

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Noteholders will not receive extra amounts (over and aboveinterest and principal payable on the issuer notes) as a result of the issuerreceiving a termination payment.

 

**Transferof the swaps**

 

Eachissuer swap provider may, subject to certain conditions specified in therelevant 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**

 

NeitherFunding 1 nor the issuer is obliged under any of the swaps to gross up paymentsmade by them if withholding taxes are imposed on payments made under theFunding 1 swap or the issuer swaps.

 

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

 

Theseries 3 issuer swap guarantor will be obliged to gross up payments made by itto the issuer if withholding taxes are imposed on payments under the series 3issuer swap guarantee.   However if theseries 3 issuer swap guarantor is required to gross up a payment under theseries 3 issuer swap guarantee in respect of a relevant issuer currency swap,the series 3 issuer swap provider may, subject to the consent of the securitytrustee, terminate the relevant issuer currency swap.

 

**Item12.  Description of Securities Other thanEquity Securities**

 

Notapplicable to annual reports filed on Form 20-F.

 

**PART II**

 

**Item13.  Defaults, Dividend Arrearages andDelinquencies**

 

None.

 

**Item14.  Material Modifications to the Rightsof Security Holders and Use of Proceeds**

 

None.

 

**Item15.  Controls and Procedures**

 

Notapplicable.

 

**Item16A.  Audit Committee Financial Expert**

 

Notapplicable.

 

**Item 16B. Code of Ethics**

 

Notapplicable.

 

**Item16C.  Principal Accountant Fees andServices**

 

Notapplicable.

 

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**Item16D.  Exemptions from the ListingStandards for Audit Committees**

 

Notapplicable.

 

**Item16E.  Purchases of Equity Securities bythe Issuer and Affiliated Purchasers**

 

Notapplicable.

 

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**PART III**

 

**Item17.  Financial Statements**

 

Notapplicable.

 

**Item18.  Financial Statements**

 

Notapplicable.

 

**Item19.  Exhibits**

 

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

 

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

 

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

 

Exhibit 12:Section 302 certification.

 

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

 

Exhibit 15.2:Investor’s Report for the month of February 2004 (incorporated byreference from the Form 6-K previously filed on March 11, 2004 andrevised March 16, 2004).

 

Exhibit 15.3:Investor’s Report for the month of March 2004 (incorporated by referencefrom the Form 6-K previously filed on April 9, 2004 and revised July 13,2004).

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Exhibit 15.11:Investor’s Report for the month of November 2004 (incorporated byreference from the Form 6-K previously filed on December 8, 2004).

 

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

 

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**SIGNATURES**

 

Eachregistrant hereby certifies that it meets all of the requirements for filing onForm 20-F and that it has duly caused and authorized the undersigned tosign this annual report on its behalf.

 
|                      | PERMANENT  FINANCING (NO. 1) 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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