**As filedwith the Securities and Exchange 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 the transition period from                     to                       **

** **

**Commissionfile number:  333-115450**

 

**PERMANENT FINANCING (NO. 5) PLC**

*(Exact Nameof Registrant 1 as specified in its charter)*

 

**UnitedKingdom**

*(Jurisdictionof Incorporation or Organization)*

 

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

*(Address ofPrincipal Executive Offices)*

 

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

*(Exact Nameof Registrant 2 as specified in its charter)*

 

**UnitedKingdom**

*(Jurisdictionof Incorporation or Organization)*

 

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

*(Address ofPrincipal Executive Offices)*

 

**PERMANENT MORTGAGES TRUSTEE LIMITED**

*(Exact Nameof Registrant 3 as specified in its charter)*

 

**Jersey,Channel Islands**

*(Jurisdictionof Incorporation or Organization)*

 

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

*(Address ofPrincipal Executive Offices)*

 

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

 

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

 

Securities forwhich there is a reporting obligation pursuant to Section 15(d) ofthe Act:

 

Title of eachclass

 

$1,300,000,000series 2 class A notes due June 2011

 

$56,400,000series 2 class B notes due June 2042

 

$46,200,000series 2 class C notes due June 2042

 

$750,000,000series 3 class A notes due June 2034

 

$32,500,000series 3 class B notes due June 2042

 

$27,000,000series 3 class C notes due June 2042

 

Series 2term AAA advance(1)

 

Series 2term AA advance(1)

 

Series 2term BBB advance(1)

 

Series 3term AAA advance(1)

 

Series 3term AA advance(1)

 

Series 3term BBB advance(1)

 

Funding 1interest in the mortgages trust(1)

 

Indicate the number of outstanding shares ofeach of the issuer’s classes of capital or common stock as of the close of theperiod covered by the annual report.

 

Not applicable.

 

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

 

Yes ýNo o

 

Indicate by check mark which financialstatement item the registrant has elected to follow.

 

Not applicable.

 

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(1) Theseitems have 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. 5) PLC. The term advances are theprimary source of payments on the series 2 notes and the series 3 notes.Permanent Financing (No. 5) PLC is the registrant for the series 2 notesand the series 3 notes.

 

 

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**PRESENTATIONOF INFORMATION**

 

This annual report on Form 20-Frelates to Permanent Financing (No. 5) PLC (the “issuer”) and thefollowing securities (the “issuer notes”), which were issued pursuant to atrust deed dated July 22, 2004 (the “issuer trust deed”), between theissuer and The Bank of New York, as note trustee (the “note trustee”):

 

•                  $1,300,000,000series 2 class A notes due June 2011

•                  $56,400,000series 2 class B notes due June 2042

•                  $46,200,000series 2 class C notes due June 2042

•                  $750,000,000series 3 class A notes due June 2034

•                  $32,500,000series 3 class B notes due June 2042

•                  $27,000,000series 3 class C notes due June 2042

 

This annual report on Form 20-Falso relates to the following advances made pursuant to the intercompany loanagreement dated July 22, 2004 (the “issuer intercompany loan agreement”),between the issuer, Permanent Funding (No. 1) Limited (“Funding 1”), TheBank of New York, as security trustee (the “security trustee”) and Citibank,N.A., as agent bank:

 

•                  £694,445,000series 2 term AAA advance

•                  £30,129,000series 2 term AA advance

•                  £24,680,000series 2 term BBB advance

•                  £400,642,000series 3 term AAA advance

•                  £17,362,000series 3 term AA advance

•                  £14,424,000series 3 term BBB advance

 

This annual report on Form 20-Ffurther relates to Funding 1’s interest in the mortgages trust, comprising,among other things, the initial portfolio of loans and their related securityassigned to Permanent Mortgages Trustee Limited (the “mortgages trustee”) byHalifax plc (the “seller”) on June 14, 2002, and on several subsequentdates any new loans and their new related security assigned to the mortgagestrustee by the seller after July 22, 2004 (the “closing date”), anyincrease in the outstanding principal balance of a loan due to the borrowertaking payment holidays or making underpayments under a loan or a borrowermaking a drawing under any flexible loan, any interest, principal and otheramounts (excluding third party amounts) paid by borrowers on their loans andtheir related security, the rights under the insurance policies that areassigned to the mortgages trustee or of which the mortgages trustee has thebenefit, and amounts on deposit and interest earned on the mortgages trusteeguaranteed investment contract. The mortgages trustee guaranteed investmentcontract, or GIC, account is the bank account in which the mortgages trusteeholds any cash that is part of the trust property until it is distributed tothe beneficiaries. Any actual losses in relation to the loans, any actualreductions occurring in respect of the loans and distributions of principalmade from time to time to the beneficiaries or the mortgages trust will bededucted from the trust property. The composition of the trust property willfluctuate as drawings under flexible loans and new loans are added and as theloans that were previously part of the trust property are repaid, mature,default or are repurchased by the seller.

 

Certain terms used herein and not definedhave the same meaning ascribed to such terms in the Registration Statementfiled on Form S-11 (the “Registration Statement”) relating to thesecurities (file number 333-115450).

 

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Certain items in Form 20-F are notapplicable to annual reports filed on Form 20-F. Therefore, as usedin 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 Securitiesand Exchange 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.

 

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

 

**FORWARD-LOOKINGSTATEMENTS**

 

This annual report includes forward-lookingstatements including, but not limited to, statements made under the “RiskFactors” section. These forward-looking statements can be identified by the useof forward-looking terminology, such as the words “believes”, “expects”, “may”,“intends”, “should” or “anticipates”, or the negative or other variations ofthose terms. These statements involve known and unknown risks, uncertaintiesand other important factors that could cause the actual results and performanceof the issuer notes, the seller or the UK residential mortgage industry todiffer materially from any future results or performance expressed or impliedin the forward-looking statements. These risks, uncertainties and other factorsinclude, among others: general economic and business conditions in the UK;currency exchange and interest fluctuations; government, statutory, regulatoryor administrative initiatives affecting the seller, changes in businessstrategy, lending practices or customer relationships and other factors thatmay be referred to in this annual report.

 

Some of the most significant of these risks,uncertainties and other factors are discussed in the section of thisannual report entitled “Risk Factors”. Investors are encouraged to carefullyconsider those factors prior to making an investment decision regarding theissuer notes.

 

**INCORPORATIONOF CERTAIN DOCUMENTS BY REFERENCE**

 

Each of the issuer, Funding 1 and themortgages trustee incorporates by reference its periodic filings on Form 6-K,which contain all financial information relating to the securities relevant tothe holders of the issuer notes.

 

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**PART I**

 

**Item 1. Identity of Directors, Senior Management and Advisers**

 

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

 

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

 

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

 

**Item 3. Key Information**

 

A.*            SelectedFinancial Data*

 

Each of the issuer, Funding 1 and themortgages trustee incorporates by reference and attaches hereto as exhibits thefollowing reports, filed on Form 6-K, which include all financialinformation relating to the securities that is relevant to holders of theissuer notes:

 

•                  Investor’sReport for the month of July 2004

•                  Investor’sReport for the month of August 2004

•                  Investor’sReport for the month of September 2004

•                  Investor’sReport for the month of October 2004

•                  Investor’sReport for the month of November 2004

•                  Investor’sReport for the month of December 2004

 

B.*            Capitalizationand Indebtedness*

 

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

 

C.*            Reasonsfor the Offer and Use of Proceeds*

 

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

 

D*.            Risk Factors*

 

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

 

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

 

The issuer notes will not represent anobligation and are not the responsibility of any of Halifax plc or any of itsaffiliates, the managers, the underwriters, the mortgages trustee, the notetrustee or any other party to the transaction other than the issuer.

 

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

 

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The issuer’s ability to make payments ofprincipal and interest on the issuer notes and to pay its operating andadministrative expenses will depend primarily on the funds being received underthe issuer intercompany loan. In addition, the issuer will rely on the issuerdollar currency swaps and the issuer euro currency swaps to provide payments onthe issuer notes denominated in US dollars and euro, respectively, and theissuer will rely on the series 5 class A1 issuer interest rate swap to providepayments of interest on the series 5 class A1notes up to and including theinterest payment date falling in June 2009.

 

Funding 1 has entered into the Funding 1liquidity facility, which is available (subject to satisfying certainconditions precedent) to pay certain amounts due and payable on the termadvances made by the issuer and the previous issuers. In the event that theseller suffers certain ratings downgrades, Funding 1 will be required to fundthe liquidity reserve fund, though there can be no assurance that Funding 1will have sufficient resources to do so at such time, and Funding 1 may drawmoney from the liquidity reserve fund, to the extent it has been funded, to payamounts due to the issuer.

 

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

 

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

 

Funding 1’s ability to pay amounts due on theissuer term advances will depend upon:

 

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

 

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

 

•                  theamount of funds credited to the general reserve fund;

 

•                  theamount of funds credited to the liquidity reserve fund; and

 

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

 

According to the terms of the mortgages trustdeed, the mortgages trustee is obliged to pay to Funding 1 the Funding 1 sharepercentage of revenue receipts on the loans by crediting those amounts to the Funding1 GIC account on each distribution date. The mortgages trustee is obliged topay to Funding 1 principal receipts on the loans by crediting those amounts tothe Funding 1 GIC account as and when required pursuant to the terms of themortgages trust deed.

 

Funding 1 will be obliged to pay revenuereceipts due to the issuer under the issuer intercompany loan only to theextent that it has revenue receipts left over after making payments ranking inpriority to the issuer, such as payments of certain fees and expenses ofFunding 1 and payments on certain higher ranking term advances under anyintercompany loan agreements.

 

Funding 1 will be obliged to pay principalreceipts due to the issuer under the issuer intercompany loan only to theextent that it has principal receipts available for that purpose after 

 

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repaying amounts ranking in priority to the issuer (including repayingany higher ranking previous term advances or new term advances.

 

If there is a shortfall between the amountspayable by Funding 1 to the issuer under the issuer intercompany loan agreementand the amounts payable by the issuer on the issuer notes, the noteholders may,depending on what other sources of funds are available to the issuer and toFunding 1, not receive the full amount of interest and/or principal which wouldotherwise be due and payable on the issuer notes.

 

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

 

If Funding 1 does not make payments due andpayable on the issuer intercompany loan, then the issuer may not have enoughmoney to make payments on the issuer notes, and in addition the issuer willhave only limited recourse to the assets of Funding 1. If Funding 1 does notpay amounts under the issuer intercompany loan because it does not have enoughmoney available, those amounts will be deemed not to be due and payable, sothere will not be an event of default under the issuer intercompany loan, andthe issuer will not have recourse to the assets of Funding 1 in that instance.

 

**On the final repayment date of the issuer intercompany loan anyoutstanding amounts in respect of the issuer term AA advances and the issuerterm BBB advances will be extinguished, which would cause a loss on any class Bissuer notes and any class C issuer notes still outstanding**

 

The transaction has been structured in theexpectation that on the final repayment date of the issuer intercompany loan inJune 2042, the interest and principal due and payable on the issuer termAA advances and the issuer term BBB advances will be in an amount equal to thesum available to pay all outstanding interest and/or principal (includinginterest and/or principal deferred and unpaid) on the issuer term AA advancesand the issuer term BBB advances (after paying amounts of a higher order ofpriority as required by the Funding 1 priority of payments).

 

If there is a shortfall between the amountavailable to pay the interest and/or principal and the amount required to payall outstanding interest and/or principal on the issuer term AA advances andthe issuer term BBB advances, then the shortfall will be deemed to be not dueand payable under the issuer intercompany loan agreement and the issuer willnot have any claim against Funding 1 for the shortfall.

 

If there is such a shortfall in interestand/or principal payments under the issuer intercompany loan agreement, thenoteholders may not receive the full amount of interest and/or principal whichwould otherwise be due and payable on the class B issuer notes or the class Cissuer notes outstanding.

 

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

 

The only remedy for recovering amounts on theissuer notes is through the enforcement of the issuer security. The issuer hasno recourse to the assets of Funding 1 unless Funding 1 has also defaulted onits obligations under the issuer intercompany loan and the Funding 1 securityhas been enforced.

 

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If the security created as required by theissuer deed of charge is enforced, the proceeds of enforcement may beinsufficient to pay all principal and interest due on the issuer notes.

 

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

 

The transaction has been structured in theexpectation that:

 

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

 

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

 

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

 

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

 

However, there is no assurance that theseries 2 issuer notes will be redeemed in full before the series 3 issuernotes, the series 4 issuer notes and the series 5 issuer notes or that theseries 3 issuer notes will be redeemed in full before the series 4 issuer notesand the series 5 issuer notes or that the series 4 issuer notes will beredeemed in full before the series 5 issuer notes. In each case, redemption ofthe issuer notes is ultimately dependent on, among other things, repayment andredemptions on the loans and on the term advance rating of the issuer termadvances.

 

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

 

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

 

The issuer deed of charge requires thesecurity trustee to consider the interests of each of the issuer securedcreditors in the exercise of all of its powers, trusts, authorities, duties anddiscretions, but requires the security trustee, in the event of a conflictbetween the noteholders’

 

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interests and the interests of any of the other issuer securedcreditors, to consider only the noteholders’ interests. In certaincircumstances, the security trustee can make amendments to the documentswithout the noteholders’ prior consent.

 

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

 

Pursuant to the terms of the Funding 1 deedof charge and the issuer deed of charge, the security trustee may, without theconsent or sanction of Funding 1’s secured creditors or the issuer’s securedcreditors, concur with any person in making or sanctioning any modifications tothe transaction documents:

 

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

 

•                  whichin the opinion of the security trustee is made to correct a manifest error oran error established as such to the satisfaction of the security trustee or isof a formal, minor or technical nature.

 

The security trustee will be entitled toassume that the exercise of its discretions will not be materially prejudicialto the noteholders’ interests if each of the rating agencies has confirmed thatthe then current rating by it of the notes would not be adversely affected bysuch exercise.

 

In addition, the security trustee will giveits consent to any modifications to the mortgage sale agreement, the servicingagreement, the cash management agreement, the Funding 1 deed of charge, theFunding 1 liquidity facility agreement, the Funding 1 swap agreement, theintercompany loan terms and conditions, the bank account agreement and themaster definitions and construction schedule, that are requested by Funding 1or the cash manager, provided that Funding 1 or the cash manager certifies tothe security trustee in writing that such modifications are required in orderto accommodate:

 

i)                 the entry byFunding 1 into new intercompany loan agreements and/or the issue of new typesof notes by new issuers and/or the addition of other relevant creditors to thetransaction;

 

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

 

iii)           the issue of new notesby Funding 2;

 

iv)          the sale of new types ofloans to the mortgages trustee;

 

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

 

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

 

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vii)       the inclusion of anadditional Funding 1 liquidity facility;

 

and provided further that:

 

•                  inrespect of the matters listed in paragraphs (i) to (iv), the relevantconditions precedent have been satisfied; and

 

•                  inrespect of the matters listed in paragraphs (i) to (vii), the securitytrustee has received written confirmation from each of the rating agencies thatthe relevant modifications will not adversely affect the then current ratingsof the notes.

 

The modifications required to give effect tothe matters listed in paragraphs (i) to (vii) above may include,amongst other matters, amendments to the provisions of the Funding 1 deed ofcharge relating to the application of monies. Accordingly, there can be noassurance that the effect of the modifications to the transaction documentswill not ultimately adversely affect noteholders’ interests. Any modificationsto the documents described above will require the actual consent of the Funding1 liquidity facility provider, the Funding 1 swap provider and each of theissuer swap providers (in respect of each document to which they are a party),as applicable, such consent not to be unreasonably withheld and to be deemedgiven if no written response (affirmative or negative) is given within 10business days after the written request for consent is sent to each such party.

 

**There may be a conflict between the interests of the holders of class Aissuer notes, the holders of class B issuer notes and the holders of class Cissuer notes, and the interests of one class of noteholders may prevail overthe interests of other classes of noteholders**

 

The issuer trust deed and the terms of theissuer notes will provide that the note trustee is to have regard to theinterests of the holders of all the classes of issuer notes. There may becircumstances, however, where the interests of one class of the noteholdersconflict with the interests of another class or classes of the noteholders. Theissuer trust deed and the terms of the issuer notes will provide that where, inthe sole opinion of the note trustee there is such a conflict, then:

 

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

 

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

 

**There may be a conflict between the interests of the holders of eachseries of the class A issuer notes, the holders of each series of the class Bissuer notes and the holders of each series of the class C issuer notes, andthe interests of one series of noteholders may prevail over the interests ofother series of noteholders**

 

There may also be circumstances where theinterests of the class A noteholders of one series of the issuer notes conflictwith the interests of the class A noteholders of another series of the issuernotes. Similarly, there may be circumstances where the interests of the class B

 

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noteholders of one series of the issuer notes conflict with theinterests of the class B noteholders of another series of the issuer notes orthe interests of the class C noteholders of one series of the issuer notesconflict with the interests of the class C noteholders of another series of theissuer notes.

 

The issuer trust deed and the terms of theissuer notes will provide that where, in the sole opinion of the note trusteethere is such a conflict, then a resolution directing the note trustee to takeany action must be passed at separate meetings of the holders of each series ofthe class A issuer notes, or, as applicable, each series of the class B issuernotes or each series of the class C issuer notes. A resolution may only bepassed at a single meeting of the noteholders of each series of the relevantclass if the note trustee is, in its absolute discretion, satisfied that thereis no conflict between them.

 

Similar provisions will apply in relation torequests in writing from holders of a specified percentage of the principalamount outstanding of the issuer notes of each class within each series (theprincipal amount outstanding being converted into sterling for the purposes ofmaking the calculation). Noteholders should note that, as a result ofrepayments of principal first to the series 2 issuer notes, then to the series3 issuer notes, then to the series 4 issuer notes and then to the series 5issuer notes, the principal amount outstanding of each series of the issuernotes will change after the closing date.

 

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

 

Holdings has established a separate entity,Funding 2, which may issue notes from time to time and use the proceeds to payfor a direct interest in the trust property rather than lending the proceeds toFunding 1. Simultaneously with the acquisition by Funding 2 of an interest inthe trust property, the seller and Funding 1, as existing beneficiaries of themortgages trust, would be required to agree to a decrease in their beneficialinterests in the trust property (which would require a partial release ofsecurity by Funding 1 over its share in the trust property).

 

The seller, Funding 1 and Funding 2 wouldeach have a joint and undivided interest in the trust property but theirentitlement to the proceeds from the trust property would be in proportion totheir respective shares of the trust property. On each distribution date themortgages trustee would distribute interest and principal receipts to one, twoor all three beneficiaries, depending on the terms of the mortgages trust.

 

It is anticipated that Funding 2 will issuenotes directly or indirectly to investors from time to time backed by its shareof the trust property. Noteholders would not have a direct or indirect interestin Funding 2’s share of the trust property.

 

Amendments would be made to a number of theissuer transaction documents as a result of the inclusion of Funding 2 as abeneficiary of the mortgages trust. In particular (but without limitation),amendments would be made to:

 

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

 

•                  themortgages trust deed (i) to establish Funding 2 as a beneficiary of thetrust, (ii) to enable the acquisition by Funding 2 of an interest in thetrust property from time to 

 

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time and (iii) to regulate thedistribution of interest and principal receipts in the trust property toFunding 2 and the other beneficiaries;

 

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

 

•                  theservicing agreement to ensure that Funding 2 receives the benefit of theservicers duties under that agreement; and

 

•                  themaster definitions and construction agreement.

 

In addition, Funding 1, Funding 2 and theseller may enter into new agreements to regulate the making of decisionsbetween them.

 

There may be conflicts of interest betweenFunding 1 and Funding 2, in which case it is expected that the mortgagestrustee will follow the directions given by the relevant beneficiary (excludingthe seller) that has the largest share of the trust property at that time. Theinterests of Funding 1 may not prevail, which may adversely affect thenoteholders’ interests.

 

Noteholders’ prior consent to the inclusionof Funding 2 as a beneficiary of the mortgages trust and the subsequentamendments to the documents and/or release of security by Funding 1 will not berequired. Before becoming a beneficiary of the mortgages trust, however,Funding 2 will be required to satisfy a number of conditions, including:

 

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

 

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

 

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

 

There can be no assurance that the inclusionof Funding 2 as a beneficiary of the mortgages trust would not affect cashflowsavailable to pay amounts due on the noteholders’ issuer notes and thereforeadversely affect the noteholders’ interests.

 

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

 

It is likely that Holdings will establish newissuers to issue new notes to investors. The proceeds of each new issue will beused by the new issuer to make a new intercompany loan to Funding 1. Funding 1will use the proceeds of the new intercompany loan to:

 

•                  paythe seller in relation to the initial consideration for new loans and theirrelated security to be assigned to the mortgages trustee;

 

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•                  paythe seller for a portion of the seller share of the trust property, which willresult in an increase in Funding 1’s share of the trust property;

 

•                  refinancein whole or in part an intercompany loan or intercompany loans outstanding atthat time (and if the issuer’s intercompany loan to Funding 1 is refinanced,noteholders could be repaid early); and/or

 

•                  depositsome of those proceeds in the general reserve fund.

 

The payment and security priorities of the issuernotes relative to each other as set out in the issuer deed of charge and theissuer cash management agreement will not be affected as a result of an issueof new notes by a new issuer, because the new issue will be separatelydocumented. However, Funding 1 may be required to pay to a new issuer amountsowing under a new term advance ahead of or in the same order of priority asamounts owing to the issuer on the issuer term advances, depending on the termadvance rating, the scheduled repayment date of that new term advance and otherrules regarding the payment of interest and the repayment of principal byFunding 1. If this is the case, then the relevant new noteholders will be paidbefore the noteholders.

 

If Holdings establishes new issuers to make newintercompany loans to Funding 1, the noteholders will not have any right ofprior review or consent with respect to those new intercompany loans or thecorresponding issuance by new issuers of new notes. Similarly, the terms of theFunding 1 transaction documents (including the mortgage sale agreement, themortgages trust deed, the Funding 1 deed of charge, the definitions of thetrigger events, the criteria for the sale of new loans to the mortgages trusteeand the amount available to be drawn under the Funding 1 liquidity facility)may be amended to reflect the new issue. Noteholders’ consent to these changeswill not be required. There can be no assurance that these changes will notaffect the cashflows available to pay amounts due on the issuer notes.

 

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

 

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

 

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

 

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

 

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

 

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**some of the notes issued by the previous issuers rank ahead of some ofthe issuer notes as to payment**

 

The other issuers issued notes to investors,the equivalent net issue proceeds of which were used by the other issuers tomake intercompany loans to Funding 1. Funding 1 used most of the proceeds ofthese intercompany loans from Permanent Financing (No. 1) PLC to pay theseller for the initial loans (together with their related security) sold to themortgages trustee on the initial closing date which comprised Funding 1’soriginal share of the trust property. Funding 1 used most of the proceeds ofeach other issuers’ intercompany loan to pay the seller for loans (togetherwith their related security) sold to the mortgages trustee or to payconsideration to the seller for an increase in Funding 1’s share in themortgages trust.

 

 Thepayment and security priorities of the issuer notes relative to each other asset out in the issuer deed of charge and the issuer cash management agreementare not affected as a result of the issue of the notes by the other issuers,because the other issues were separately documented. However, Funding 1 may berequired to pay to the previous issuers amounts which are owing under one ormore previous term advances ahead of or in the same order of priority asamounts owing to the issuer on the issuer term advances, depending on the termadvance rating, the scheduled repayment date of that previous term advance andother rules regarding the payment of interest and the repayment ofprincipal by Funding 1. If this is the case, then the other noteholders will bepaid before the holders of the issuer notes.

 

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

 

If Funding 1 enters into a new intercompanyloan agreement, then if required it will also enter into a new start-up loanagreement with a new start-up loan provider and the security trustee.

 

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

 

The new issuer, any new start-up loanprovider and any new Funding 1 swap provider will become party to the Funding 1deed of charge and will be entitled to share in the security granted by Funding1 for our benefit (and the benefit of the other Funding 1 secured creditors)under the Funding 1 deed of charge. In addition, the liabilities owed to theFunding 1 liquidity facility provider and the Funding 1 swap provider which aresecured by the Funding 1 deed of charge may increase each time that Funding 1enters into a new intercompany loan agreement. These factors could ultimatelycause a reduction in the payments noteholders receive on the issuer notes.Noteholders consent to the requisite changes to the transaction documents willnot be required.

 

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

 

The security trustee will exercise its rightsunder the Funding 1 deed of charge only in accordance with directions given bythe issuers (which could be the issuer, any previous issuer or, if Funding 1enters into new intercompany loans, any new issuer) that have thehighest-ranking 

 

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outstanding term advances at that time, provided that the securitytrustee is indemnified and/or secured to its satisfaction.

 

If the security trustee receives conflictingdirections, it will follow the directions given by the relevant issuersrepresenting the largest principal amount outstanding of relevant termadvances. If the issuer is not in the group representing that largest principalamount, then its interests may not prevail. This could ultimately cause areduction in the payments the noteholders receive on the issuer notes.

 

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

 

There is no guarantee that any new loans soldto the mortgages trustee will have the same characteristics as the loans in theportfolio as of the closing date. In particular, new loans may have differentpayment characteristics than the loans in the initial portfolio. The ultimateeffect of this could be to delay or reduce the payments the noteholders receiveon the issuer notes.

 

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

 

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

 

No assurance can be given that Funding 1 willaccumulate sufficient funds during the cash accumulation period relating to theissuer series 2 term AAA advance, each scheduled amortization installment underthe issuer series 3 term AAA advance and/or each scheduled amortizationinstallment under the issuer series 4 term AAA advance to enable it to repay theseissuer term advances to the issuer so that the corresponding classes of issuernotes will be redeemed in their entirety on their scheduled redemption dates.

 

During the cash accumulation period for theissuer term advances and scheduled amortization installments, repayments ofprincipal will only be made on the issuer series 5 term AAA advances, 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 series 5 class A issuer notes,the class B issuer notes or the class C issuer notes.

 

The extent to which sufficient funds are savedby Funding 1 during a cash accumulation period or received by it from its sharein the mortgages trust for application on a scheduled repayment date willdepend on whether the actual principal prepayment rate of the loans is the sameas the assumed principal prepayment rate. If Funding 1 is not able to saveenough money during a cash accumulation period or does not receive enough moneyfrom its share in the mortgages trust for application on a scheduled repaymentdate to repay the relevant issuer term AAA advance (and, if it is unable tomake a drawing on the reserve funds to make good the shortfall) so that theissuer can redeem the class A issuer notes of the corresponding series on theirrespective scheduled redemption date(s), then Funding 1 will be required to payto the issuer on those scheduled redemption dates only the amount that it hasactually saved or received. Any shortfall will be deferred and paid onsubsequent Funding 1 interest payment dates when Funding 

 

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1 has money available to make the payment. In these circumstances,there will be a variation in the yield to maturity of the relevant class ofissuer notes.

 

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

 

The rate of prepayment of loans is influencedby a wide variety of economic, social and other factors, including prevailingmortgage market interest rates, the availability of alternative financingprograms, local and regional economic conditions and homeowner mobility. Forinstance, prepayments on the loans may be due to borrowers refinancing their loansand sales of properties by borrowers (either voluntarily or as a result ofenforcement action taken). In addition, if the seller is required to repurchasea loan or loans under a mortgage account and their related security because,for example, one of the loans does not comply with the representations andwarranties in the mortgage sale agreement, then the payment received by themortgages trustee will have the same effect as a prepayment of all of the loansunder that mortgage account. Because these factors are not within its controlor the control of Funding 1 or the mortgages trustee, the issuer cannot giveany assurances as to the level of prepayments that the portfolio mayexperience.

 

Variation in the rate of prepayments ofprincipal on the loans may affect each class of issuer notes differentlydepending upon amounts already repaid by Funding 1 to the issuer under theissuer intercompany loan and whether a trigger event has occurred, or a loan issubject to a product switch or a further advance or the security granted by theissuer under the issuer deed of charge has been enforced. If prepayments on theloans occur less frequently than anticipated, then there may not be sufficientfunds available to redeem the series 2 class A issuer notes and/or the series 3class A issuer notes and/or the series 4 class A issuer notes in full on theirrespective scheduled redemption dates.

 

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

 

Each of the loans was originated inaccordance with the seller’s lending criteria at the time of origination. Theselending criteria consider a variety of factors such as a potential borrower’scredit history, employment history and status and repayment ability, as well asthe value of the property to be mortgaged. In the event of the sale of any newloans and new related security to the mortgages trustee, the seller willwarrant that those new loans and new related security were originated inaccordance with the seller’s lending criteria at the time of their origination.However, the seller retains the right to revise its lending criteria asdetermined from time to time, and so the lending criteria applicable to anyloan at the time of its origination may not be or have been the same as thosewhen other loans were originated.

 

If new loans that have been originated underrevised lending criteria are sold to the mortgages trustee, the characteristicsof the trust property could change. This could lead to a delay or a reductionin the payments received on the issuer notes.

 

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

 

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The seller does not require a solicitor,licensed conveyancer or (in Scotland) qualified conveyancer to conduct a fullinvestigation of the title to a property in all cases. Where the borrower isremortgaging there will be a limited investigation to carry out some but notall of the searches and investigations which would normally be carried out by asolicitor conducting a full investigation of the title to a property.Properties which have undergone such a limited investigation may be subject tomatters which would have been revealed by a full investigation of title andwhich may have been remedied or, if incapable of remedy, may have resulted inthe properties not being accepted as security for a loan had such matters beenrevealed, though to mitigate against this risk search indemnity insurance isobtained in respect of such properties. The introduction of loans secured bysuch properties into the trust property could result in a change of thecharacteristics of the trust property. This could lead to a delay or areduction in the payments received on the issuer notes.

 

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

 

The loans are affected by credit, liquidityand interest rate risks. Various factors influence mortgage delinquency rates, prepaymentrates, repossession frequency and the ultimate payment of interest andprincipal, such as changes in the national or international economic climate,regional economic or housing conditions, changes in tax laws, interest rates,inflation, the availability of financing, yields on alternative investments,political developments and government policies. Other factors in borrowers’individual, personal or financial circumstances may affect the ability ofborrowers to repay loans. Loss of earnings, illness, divorce and other similarfactors may lead to an increase in delinquencies by and bankruptcies ofborrowers, and could ultimately have an adverse impact on the ability ofborrowers to repay loans.

 

In addition, the ability of a borrower tosell a property given as security for a loan at a price sufficient to repay theamounts outstanding under the loan will depend upon a number of factors,including the availability of buyers for that property, the value of thatproperty and property values in general at the time.

 

Further, the mortgage loan industry in theUnited Kingdom is highly competitive. This competitive environment may affectthe rate at which the seller originates new loans and may also affect the levelof attrition of the seller’s existing borrowers.

 

The principal source of income for repaymentof the issuer notes by the issuer is the issuer intercompany loan. Theprincipal source of income for repayment by Funding 1 of the issuerintercompany loan is its interest in the loans held on trust by the mortgagestrustee for Funding 1 and the seller. If the timing and payment of the loans isadversely affected by any of the risks described in this section, then thepayments on the issuer notes could be reduced or delayed.

 

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

 

If no trigger event has occurred and theissuer security has not been enforced in accordance with the terms of theissuer deed of charge, then payments of principal will not occur on the series2 class A issuer notes, series 3 class A issuer notes and/or series 4 class Aissuer notes before their respective scheduled redemption dates.

 

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If a trigger event occurs or the issuersecurity is enforced in accordance with the issuer deed of charge prior to thescheduled redemption dates for the series 2 class A issuer notes, series 3class A issuer notes and/or series 4 class A 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.

 

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

 

When an asset trigger event has occurred, themortgages trustee will distribute principal receipts on the loans to Funding 1and the seller proportionally and equally based on their percentage shares ofthe trust property (that is, the Funding 1 share percentage and the sellershare percentage). When an asset trigger event has occurred, after makingrequisite payments to the Funding 1 liquidity facility provider and replenishingthe reserve funds, Funding 1 will repay:

 

*firs*t*,* the term AAA advances in respect of theissuer intercompany loan, the previous intercompany loans and any newintercompany loans, until each of those term AAA advances is fully repaid;

 

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

 

*then,*the term A advances in respect of the previous intercompany loans and any new intercompanyloans, until each of those term A advances is fully repaid; and

 

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

 

If an asset trigger event occurs, any series2 class A issuer notes and/or series 3 class A issuer notes and/or series 4class A 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 a non-asset trigger event occurs, any series 2 class A issuer notes,series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates**

 

If a non-asset trigger event has occurred butan asset trigger event has not occurred, the mortgages trustee will distributeall principal receipts to Funding 1 until the Funding 1 share percentage of thetrust property is zero. When a non-asset trigger event has occurred, aftermaking requisite payments to the Funding 1 liquidity facility provider and toreplenish the reserve funds, Funding 1 will repay:

 

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

 

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

 

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

 

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

 

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

 

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

 

If the issuer security is enforced, then themortgages trustee will distribute funds as required under the terms of thetransaction agreements. In these circumstances, any series 2 class A issuernotes, series 3 class A issuer notes and/or series 4 class A issuer notes thenoutstanding will not be repaid on their scheduled redemption dates and there isalso a risk that those class A issuer notes may not be repaid by their finalmaturity dates.

 

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

 

If the servicer at its discretion decides togrant a borrower a further advance under a loan which has been sold to themortgages trustee, then the seller will be required to repurchase that loanunder the relevant mortgage account and its related security from the mortgagestrustee save for any loan in arrears at a price equal to the outstandingprincipal balance of those loans together with any accrued and unpaid interestand expenses to the date of purchase. The yield to maturity of the issuer notesmay be affected by the repurchase of loans subject to further advances.

 

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

 

Loans subject to product switches will not berepurchased unless on any distribution date, the seller is in breach of theconditions precedent to the sale of new loans to the mortgages trustee. Fromand including that date to but excluding the date when those conditionsprecedent have been satisfied, the seller will be required to repurchase anyloans and their related security that are subject to product switches. Theseller will be required to repurchase the relevant loan or loans under therelevant mortgage account and their related security from the mortgages trusteeat a price equal to the outstanding principal balance of those loans togetherwith accrued and unpaid interest and expenses to the date of purchase.

 

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A loan will be subject to a product switch ifthe borrower and the seller agree on or the servicer offers a variation in thefinancial terms and conditions applicable to the relevant borrower’s loan,other than:

 

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

 

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

 

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

 

•                  anyvariation imposed by statute;

 

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

 

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

 

The yield to maturity of the issuer notes maybe affected by the repurchase of loans subject to product switches.

 

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

 

The ratings assigned to each class of issuernotes address the likelihood of full and timely payment to the noteholders ofall payments of interest on each interest payment date under those classes ofissuer notes. The ratings also address the likelihood of “ultimate” payment ofprincipal on the final maturity date of each class of issuer notes. Any ratingagency may lower its rating or withdraw its rating if, in the sole judgment ofthe rating agency, the credit quality of the issuer notes has declined or is inquestion. If any rating assigned to the issuer notes is lowered or withdrawn,the market value of the issuer notes may be reduced. A change to the ratingsassigned to each class of issuer notes will not affect the term advance ratingsassigned to each issuer term advance in the intercompany loans.

 

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

 

The class B issuer notes and the class Cissuer notes are subordinated in right of payment of interest to the class Aissuer notes. The class C issuer notes are subordinated in right of payment ofinterest to the class B issuer notes. However, the transaction has beenstructured in the expectation that the series 2 issuer notes will be repaid infull prior to the redemption of the series 3 class A issuer notes, the series 4class A issuer notes and the series 5 class A issuer notes and so on for eachclass of each series of issuer notes.

 

Accordingly, there is no assurance that thesesubordination rules will protect the holders of class A issuer notes orthe holders of class B issuer notes from all risk of loss.

 

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

 

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

 

If on a Funding 1 interest payment date:

 

•                  thereis a debit balance on the BBB principal deficiency sub-ledger, the A principaldeficiency sub-ledger or the AA principal deficiency sub-ledger afterapplication of the Funding 1 available revenue receipts on that Funding 1 interestpayment date; or

 

•                  theadjusted general reserve fund level is less than the general reserve fundthreshold; or

 

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

 

then to the extent that any term AAA advance remains outstanding(whether or not such term AAA advance is then due and payable) after theallocation of principal on that Funding 1 interest payment date to those termadvances, the issuer term AA advances and issuer term BBB advances will not beentitled to principal repayments until the relevant circumstance as describedabove has been remedied or otherwise ceases to exist. In addition, if any termAA advance remains outstanding (whether or not such term AA advance is then dueand payable) after the allocation of principal on that Funding 1 interestpayment date to those term advances, the issuer term BBB advances will not beentitled to principal repayments until the relevant circumstances as describedabove have been remedied or otherwise cease to exist and if any term A advanceremains outstanding (whether or not such term A advance is then due andpayable) after the allocation of principal on that Funding 1 interest paymentdate to those term advances, the issuer term BBB advance will not be entitledto principal repayments until the relevant circumstances as described abovehave been remedied or otherwise cease to exist. This means that payments ofprincipal on the class C issuer notes of all series and, as applicable, theclass B issuer notes of all series will be deferred until the earlier of thetime when the relevant circumstance described in this risk factor has beenremedied (if ever) and the final maturity date of the relevant issuer notes.

 

Furthermore, if, on a Funding 1 interestpayment date prior to the issuer step-up date:

 

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

 

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

 

•                  thereis a cash accumulation shortfall at that time;

 

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

 

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

 

If the loans comprising the trust property donot perform as expected at any time after the repayment of previous series ofissuer notes, then the unpaid series of issuer notes will be adverselyaffected.

 

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

 

Repayments of principal and payments ofinterest on the series 2 class issuer notes and the series 3 issuer notes willbe made in US dollars and on the series 4 issuer notes will be made in euro,but the issuer term advances made by the issuer to Funding 1 and repayments ofprincipal and payments of interest by Funding 1 to the issuer under the issuerintercompany loan will be in sterling.

 

To hedge its currency exchange rate exposure,including the interest rate exposure connected with that currency exposure, theissuer has entered into the issuer dollar currency swaps for the series 2 andseries 3 issuer notes with the issuer dollar currency swap providers and theissuer euro currency swaps for the series 4 issuer notes with the issuer eurocurrency swap provider.

 

If the issuer fails to make timely paymentsof amounts due under an issuer swap, then the issuer will have defaulted underthat issuer swap. Each issuer swap provider is obliged only to make paymentsunder an issuer swap if and for so long as the issuer make payments under thesame. If an issuer swap provider is not obliged to make payments, or if itexercises any right to terminate that it may have under the relevant issuerswap, or if it defaults in its obligations to make payments of amounts in USdollars or euro, as applicable, equal to the full amount to be paid by it onthe payment dates under the relevant issuer swap (which are the same dates asthe interest payment dates in respect of the issuer notes), the issuer will beexposed to changes in US dollar/sterling or euro/sterling currency exchangerates and in the associated interest rates on these currencies. Unless areplacement issuer swap is entered into, as a result of any adverse movementsin the relevant spot exchange rates, the issuer may have insufficient funds tomake payments due on the issuer notes of any class and any series that are thenoutstanding.

 

Each issuer swap provider will be obliged togross up payments made by it to the issuer if withholding taxes are imposed onpayments under the relevant issuer swap and the AIG issuer swap guarantor willbe obliged to gross up payments made by it to the issuer if withholding taxesare imposed on payments under the AIG issuer swap guarantee. However, if such agross up is required, the relevant issuer swap provider may, subject to obtainingthe consent of the security trustee, terminate the relevant issuer swap. If itdoes terminate the relevant issuer swap, the issuer will be exposed to changesin currency exchange rates and in the associated interest rates on thesecurrencies. Unless a replacement issuer swap is entered into, the issuer mayhave insufficient funds to make payments due on the issuer notes of any classand any series that are then outstanding.

 

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

 

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To the extent that it has funds available, oneach quarterly Funding 1 interest payment date Funding 1 will pay to the issuerinterest and, if applicable, principal due on the issuer series 5A1 term AAAadvance. Up to and including the interest payment date falling in June 2009,on each quarterly interest payment date in relation to its obligations underthe series 5 class A1 issuer interest rate swap, the issuer will pay the amountso received to the series 5 class A1 issuer interest rate swap provider. Theseries 5 class A1 issuer interest rate swap provider will not be obliged tomake any corresponding swap payments to us until the interest payment date inrespect of the series 5 class A1 issuer notes. This interest payment dateoccurs semi-annually up to and including the earliest to occur of (i) theinterest payment date falling in June 2009 in respect of the series 5class A1 issuer notes, (ii) the occurrence of a trigger event and (iii) enforcementof the issuer security, and quarterly on and following the interest paymentdate occurring immediately thereafter. Therefore, under the series 5 class A1issuer interest rate swap, the date on which the series 5 class A1 issuerinterest rate swap provider pays amounts due to the issuer may be as long asnine months after a date on which the issuer pay amounts due to it.

 

If the series 5 class A1 issuer interest rateswap provider does not meet its payment obligations to the issuer under theseries 5 class A1 issuer interest rate swap on any semi-annual interest paymentdate and does not make a termination payment that has become due from it to theissuer, the issuer may have a larger shortfall in funds with which to makeinterest payments on the issuer notes than if its payment obligations werequarterly and therefore coincidental with the issuers payment obligations underthe series 5 class A1 issuer interest rate swap. Hence, the difference intiming between the issuers obligations and the obligations of the series 5class A1 issuer interest rate swap provider under the series 5 class A1 issuerinterest rate swap may affect our ability to make payments on the issuer notesof any class and any series.

 

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

 

The mortgages trustee GIC provider and theFunding 1 GIC provider are required to satisfy certain criteria (includingcertain criteria and/or permissions set or required by the Financial servicesAuthority (the “FSA”) from time to time) in order to continue to receivedeposits in the mortgages trustee GIC account and the Funding 1 GIC accountrespectively. If either the mortgages trustee GIC provider or the Funding 1 GICprovider ceases to satisfy those criteria then the relevant account may betransferred to another entity that does satisfy those criteria. In thesecircumstances the new GIC provider may not offer a GIC on terms as favorable asthose provided by the mortgages trustee GIC provider or the Funding 1 GICprovider.

 

The criteria referred to above include arequirement that the short-term, unguaranteed and unsecured ratings of themortgages trustee GIC provider or the Funding 1 GIC provider, as the case maybe, are at least A-1+ by Standard & Poor’s, F1+ by Fitch and P-1by Moody’s, unless each rating agency confirms that its then current rating ofthe notes would not be adversely affected as a result of such ratings fallingbelow these minimum ratings.

 

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

 

If any of the issuer swaps terminate, theissuer may as a result be obliged to make a termination payment to the relevantissuer swap provider. The amount of the termination payment will be based onthe cost of entering into a replacement issuer swap. Under the issuer intercompanyloan agreement, Funding 1 will be required to pay the issuer an amount equal to

 

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any termination payment due by the issuer to the relevant issuer swapprovider. Funding 1 will also be obliged to pay the issuer any extra amountswhich it may be required to pay to enter into a replacement swap.

 

The issuer cannot give noteholders anyassurance that Funding 1 will have the funds available to make that payment orthat the issuer will have sufficient funds available to make any terminationpayment under any of its issuer swaps or to make subsequent payments tonoteholders in respect of the relevant series and class of issuer notes. Norcan the issuer give noteholders any assurance that it will be able to enterinto a replacement issuer swap or, if one is entered into, that the creditrating of the replacement issuer swap provider will be sufficiently high toprevent a downgrading of the then current ratings of the issuer notes by therating agencies.

 

Except where the relevant issuer swapprovider has caused the relevant issuer swap to terminate by its own default,any termination payment due by the issuer will rank equally not only withpayments due to the holders of the series and class of issuer notes which rankequally with the series and class of issuer notes to which the relevant issuerswap relates but also with payments due to the holders of any other series andclass of issuer notes which rank equally with the series and class of issuernotes to which the relevant issuer swap relates. Any additional amountsrequired to be paid by the issuer following termination of the relevant issuerswap (including any extra costs incurred (for example, from entering into “spot”currency transactions or interest rate swaps) if the issuer cannot immediatelyenter into a replacement swap) will also rank equally not only with paymentsdue to the holders of the series and class of issuer notes to which therelevant issuer swap relates but also with payments due to the holder of anyother series and class of issuer notes which rank equally with the series andclass of issuer notes to which the relevant issuer swap relates. Furthermore,any termination payment or additional payment or additional amounts required tobe paid by the issuer following termination of an issuer swap will rank aheadof payments due to the holders of any series and class of issuer notes whichranks below the series and class of issuer notes to which the relevant issuerswap relates. Therefore, if the issuer is obliged to make a termination paymentto the relevant issuer swap provider or to pay any other additional amount as aresult of the termination of the relevant issuer swap, this may affect thefunds which the issuer has available to make payments on the issuer notes ofany class and any series.

 

**Risks associated with the Funding 1 swap**

 

To provide a hedge against (a) 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 (b) the rate of interestpayable by Funding 1 on the intercompany loans, Funding 1 has entered into theFunding 1 swap agreement. If Funding 1 fails to make timely payments under theFunding 1 swap, it will have defaulted under the Funding 1 swap. The Funding 1swap provider is obliged only to make payments under the Funding 1 swap if andfor so long as Funding 1 makes payments under the same. If the Funding 1 swapprovider is not obliged to make payments, or if it exercises any right toterminate that it may have under the Funding 1 swap, or if it defaults in itsobligation to make payments under the Funding 1 swap, Funding 1 will be exposedto the variance between the rates of interest payable on the loans and the rateof interest payable by it under the intercompany loans unless a replacementFunding 1 swap is entered into. If the Funding 1 swap terminates, Funding 1 mayas a result be obliged to make a termination payment to the Funding 1 swapprovider. Any variance between the rates of interest payable on the loans andthe rate of interest payable by Funding 1 under the intercompany loans and anytermination payment payable by it to the Funding 1 swap provider may adversely 

 

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affect the ability of Funding 1 to meet its obligations under theissuer intercompany loan agreement.

 

Funding 1 will receive interest on thevariable rate loans, which is based on HVR 1 or HVR 2. The payment obligationsof Funding 1 under the Funding 1 swap will, among other things, be based on theaverage of the standard variable mortgage rates or their equivalent charged toexisting borrowers on residential mortgage loans as published from time totime, after excluding the highest and the lowest rate, of Abbey National plc,HSBC Bank plc, Cheltenham & Gloucester plc, Nationwide BuildingSociety, Northern Rock plc, National Westminster Bank Plc, and Woolwich plc(and where those banks have more than one standard variable rate, the highestof those rates). While it is anticipated that such average rate will broadlytrack both HVR 1 and HVR 2, the variance between such average rate and HVR 1and HVR 2, respectively, may affect the ability of Funding 1 to meet itspayment obligations under the Funding 1 swap agreement.

 

**The issuer relies on third parties to perform services in relation tothe issuer notes, and the noteholders may be adversely affected if they fail toperform their obligations**

 

The issuer is a party to contracts with anumber of other third parties that have agreed to perform services in relationto the issuer notes. For example, the issuer swap providers have agreed toprovide their respective issuer swaps, the corporate services provider has agreedto provide corporate services and the paying agents and the agent bank haveagreed to provide payment and calculation services in connection with theissuer notes. In the event that any of these parties were to fail to performtheir obligations under the respective agreements to which they are a party,the noteholders may be adversely affected.

 

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

 

If, on any Funding 1 interest payment date,revenue receipts available to Funding 1 (including the reserve funds) areinsufficient to enable Funding 1 to pay interest on the issuer term advances,previous term advances and any new term advances and other expenses of Funding1 ranking higher in seniority to interest due on these term advances, thenFunding 1 may use principal receipts on the loans received by it in themortgages trust to make up the shortfall.

 

Funding 1 will use principal receipts thatwould have been applied to repay the term advances with the lowest term advancerating to pay interest on those other term advances and senior expensesdescribed in the preceding paragraph where there is a shortfall of monies topay those amounts. At the closing date, the relevant term advances with thelowest term advance rating include the issuer term BBB advances. If Funding 1uses principal to repay interest and senior expenses in this manner, there willbe less principal available to repay the issuer term BBB advances.

 

Funding 1 will be obliged to keep a ledgerthat records any principal applied to pay interest and senior expenses (as wellas any losses on the loans causing a principal deficiency). When the amountrecorded on the ledger is equal to the principal amount outstanding of the termBBB advances, then Funding 1 will use principal receipts that would have beenapplied to repay the term advance with the next lowest ranking term advancerating to pay interest on the term advances and senior expenses where there isa shortfall of money to pay those amounts. When the amount recorded on theprincipal deficiency ledger exceeds the principal amount outstanding on theterm A advances, Funding 1 will use principal receipts that would have beenapplied to repay

 

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the term AA advances to pay those amounts. When the amount recorded onthe principal deficiency ledger exceeds the principal amount outstanding on theterm AA advances, Funding 1 will use principal receipts that would have been appliedto repay the term AAA advances to pay those amounts.

 

During the term of the transaction, however,it is expected that any principal deficiencies of this sort will be recoupedfrom subsequent excess revenue receipts and amounts standing to the credit ofthe reserve funds. The revenue receipts will be applied first to cover anyprincipal deficiency in respect of the term advances with the highest termadvance rating, and then the term advances with the next highest-ranking termadvance rating, and so on down to the term advances with the lowest termadvance rating.

 

If there are insufficient funds availablebecause of income or principal deficiencies, then one or more of the followingconsequences may occur:

 

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

 

•                  theremay be insufficient funds to repay the principal due and payable on any of theissuer term BBB advances and the issuer term AA advances prior to their finalrepayment dates unless the other net income of Funding 1 is sufficient, aftermaking other prior ranking payments, to reduce any principal deficiency inrespect of the term BBB advances, term A advances and term AA advances;

 

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

 

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

 

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

 

Any losses from loans included in the trustproperty will be allocated to Funding 1 and the seller proportionally on eachdistribution date in accordance with the Funding 1 share percentage and theseller share percentage of the trust property. The seller’s share of the trustproperty therefore does not provide credit enhancement for the Funding 1 shareof the trust property or the issuer notes. Losses on the loans in the trustproperty are allocated proportionately between the seller and Funding 1depending on their respective shares in the trust property.

 

**The issuer will only have recourse to the seller if there is a breachof warranty by the seller, but otherwise the seller’s assets will not beavailable to the issuer as a source of funds to make payments on the issuernotes**

 

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

 

The issuer, Funding 1 and the mortgagestrustee will not have any recourse to the seller of the loans, other than inrespect of a breach of warranty under the mortgage sale agreement.

 

The issuer, Funding 1, the mortgages trustee,and the security trustee will not undertake any investigations, searches orother actions on any loan or its related security and each of them will relyinstead on the warranties given in the mortgage sale agreement by the seller.

 

If any of the warranties made by the seller (a) inthe case of each loan in the portfolio, was materially untrue on the date thatnew loan was assigned to the mortgages trustee or (b) in the case of eachnew loan, is materially untrue on the date that new loan is assigned to themortgages trustee, then the seller will be required to remedy the breach within20 London business days of the seller becoming aware of the same or of receiptby it of a notice from the mortgages trustee.

 

If the seller fails to remedy the breachwithin 20 London business days, then the seller will be required to repurchasethe loan or loans under the relevant mortgage account and their relatedsecurity at their outstanding principal balance as of the date of repurchasetogether with any arrears of interest and accrued and unpaid interest andexpenses. There can be no assurance that the seller will have the financialresources to repurchase the loan or loans under the relevant mortgage accountand their related security. However, if the seller does not repurchase thoseloans and their related security when required, then the seller’s share of thetrust property will be deemed to be reduced by an amount equal to the principalamount outstanding of those loans together with any arrears of interest andaccrued and unpaid interest and expenses.

 

Other than as described here, neither thenoteholders nor the issuer will have any recourse to the assets of the seller.

 

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

 

Each loan in the portfolio is repayableeither on a principal repayment basis or an interest-only basis. Of the loansin the portfolio as January 1, 2005, approximately 33.27 per cent., wereinterest-only loans. For interest-only loans, because the principal is repaidin a lump sum at the maturity of the loan, the borrower is recommended to havesome repayment mechanism such as an investment plan in place which is intendedto provide sufficient funds to repay the principal at the end of the term.However, the seller does not ensure that a repayment mechanism is in place inall cases and does not take security over these repayment mechanisms. Theborrower is also recommended to take out a life insurance policy in relation tothe loan but, as with repayment mechanisms, the seller does not take securityover these life insurance policies.

 

The ability of a borrower to repay theprincipal on an interest-only loan at maturity depends on the borrower’sresponsibility to ensure that sufficient funds are available from an investmentplan or another source, such as ISAs, pension policies, personal equity plansor endowment policies, as well as the financial condition of the borrower, taxlaws and general economic conditions at the time.

 

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There can be no assurance that the borrowerwill have the funds required to repay the principal at the end of the term. Ifa borrower cannot repay the loan and a loss occurs on the loan, then this mayaffect repayments of principal on the issuer notes if that loss cannot be curedby application of excess Funding 1 available revenue receipts.

 

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

 

The sale by the seller to the mortgagestrustee of the English mortgages will take effect in equity only. The sale bythe seller to the mortgages trustee of the Scottish mortgages has been giveneffect by a Scottish declaration of trust by the seller (and any sale ofScottish mortgages in the future will be given effect by further Scottishdeclarations of trust) by which the beneficial interest in the Scottishmortgages has been or will be transferred to the mortgages trustee. In eachcase this means that legal title to the loans in the trust property remainswith the seller, but the mortgages trustee has all the other rights andbenefits relating to ownership of each loan and its related security (whichrights and benefits are subject to the trust in favor of the beneficiaries).The mortgages trustee has the right to demand that the seller give it legaltitle to the loans and the related security in the circumstances and until thenthe mortgages trustee will not give notice of the sale of the English Mortgagesto any borrower or apply to the Land Registry or the Central Land ChargesRegistry to register or record its equitable interest in the English mortgagesor take any steps to complete or perfect its title to the Scottish mortgages.Because the mortgages trustee has not obtained legal title to the loans ortheir related security, there are risks, as follows:

 

•                  first,if the seller wrongly sold a loan which has already been assigned to themortgages trustee to another person, and that person acted in good faith anddid not have notice of the interests of the mortgages trustee or thebeneficiaries in the loan, then she or he might obtain good title to the loan,free from the interests of the mortgages trustee and the beneficiaries. If thisoccurred then the mortgages trustee would not have good title to the affectedloan and its related security and it would not be entitled to payments by aborrower in respect of that loan. This may affect the ability of the issuer torepay the issuer notes; and

 

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

 

However, if a borrower exercises any set-offrights, then an amount equal to the amount set off will reduce the total amountof the seller share of the trust property only, and the minimum seller sharehas been sized in an amount expected to cover this risk, although there is noassurance that it will. If the minimum seller share is exhausted, then theamount of any set-offs would be applied to reduce the Funding 1 share of thetrust property.

 

Once notice has been given to borrowers ofthe transfer of the loans and their related security to the mortgages trustee,independent set-off rights which a borrower has against the seller willcrystallize (such as, for example, set-off rights associated with borrowersholding deposits with the seller) and further rights of independent set-offwould cease to accrue from that

 

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date and no new rights of independent set-off could be assertedfollowing that notice. Set-off rights arising under transaction set-off (whichare set-off claims arising out of a transaction connected with the loan) willnot be affected by that notice.

 

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

 

The seller has made, and in the future maymake, an equitable assignment of the relevant loans and their related security,or in the case of Scottish loans a transfer of the beneficial interest in therelevant loans and their related security, to the mortgages trustee, with legaltitle being retained by the seller. Therefore, the rights of the mortgagestrustee may be subject to the direct rights of the borrowers against theseller, including rights of set-off existing prior to notification to theborrowers of the sale of the mortgages. Although the mortgages trust does notcurrently include flexible loans or delayed cashbacks, those loans may be addedto the mortgages trust in the future. Set-off rights (including analogous rightsin Scotland) may occur if the seller fails to advance to a borrower a drawingor permit the borrower to make an underpayment or take a payment holiday undera flexible loan when the borrower is entitled to draw additional amounts ormake an underpayment or take a payment holiday under a flexible loan or if theseller fails to pay to a borrower any delayed cashback which the seller hadagreed to pay to that borrower after completion of the relevant loan.

 

If the seller fails to advance the drawing orpermit the borrower to make an underpayment or take a payment holiday or paythe delayed cashback, then the relevant borrower may set off any damages claim(or exercise analogous rights in Scotland) arising from the seller’s breach ofcontract against the seller’s (and, as assignee or holder of the beneficialinterest in the loans and their related security, the mortgages trustee’s)claim for payment of principal and/or interest under the loan as and when itbecomes due. These set-off claims will constitute transaction set-off asdescribed in the immediately preceding risk factor.

 

The amount of the claim in respect of adrawing will, in many cases, be the cost to the borrower of finding analternative source of finance although, in the case of flexible loans or delayedcashbacks which are Scottish, it is possible that the borrower’s right ofset-off could extend to the full amount of the relevant drawing: the borrowermay obtain a loan elsewhere, in which case the damages would be equal to anydifference in the borrowing costs together with any consequential losses,namely the associated costs of obtaining alternative funds (for example, legalfees and survey fees). If the borrower is unable to obtain an alternative loan,he or she may have a claim in respect of other losses arising from the seller’sbreach of contract where there are special circumstances communicated by theborrower to the seller at the time the mortgage was taken out or whichotherwise were reasonably foreseeable. In either case, the damages claim willbe limited by general legal principles concerning remoteness of loss andmitigation. These include (i) the principle that something, which is areal possibility but would only occur in a small minority of cases, will notusually fall within the contractual measure of damages, and (ii) theborrower’s duty to mitigate his loss.

 

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

 

A borrower may also attempt to set-offagainst his or her mortgage payments an amount greater than the amount of hisor her damages claim (or exercise analogous rights in Scotland). In that case,the servicer will be entitled to take enforcement proceedings against theborrower

 

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although the period of non-payment by the borrower is likely tocontinue until a judgment is obtained.

 

The exercise of set-off rights by borrowerswould reduce the incoming cashflow to the mortgages trustee during theexercise. However, the amounts set-off will be applied to reduce the sellershare of the trust property only.

 

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

 

The minimum seller share has been sized in anamount expected to cover this risk, although there is no assurance that itwill. If the minimum seller share is not sufficient in this respect then thereis a risk that noteholders may not receive all amounts due on the issuer notesor that payments may not be made when due.

 

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

 

The seller has been appointed by themortgages trustee and the beneficiaries as servicer to service the loans. Ifthe servicer breaches the terms of the servicing agreement, then the mortgagestrustee, Funding 1 and/or the security trustee will be entitled to terminatethe appointment of the servicer and appoint a new servicer in its place.

 

There can be no assurance that a substituteservicer with sufficient experience of administering mortgages of residentialproperties would be found who would be willing and able to service the loans onthe terms of the servicing agreement. In addition, as described below, anysubstitute servicer may be required to be authorized under FSMA (as definedbelow) in order to administer loans that constitute regulated mortgagecontracts. The ability of a substitute servicer fully to perform the requiredservices would depend, among other things, on the information, software andrecords available at the time of the appointment. Any delay or inability toappoint a substitute servicer may affect payments on the loans and hence ourability to make payments when due on the issuer notes.

 

The noteholders should note that the servicerhas no obligation itself to advance payments that borrowers fail to make in atimely fashion.

 

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

 

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

 

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

 

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In the United Kingdom, the Office of FairTrading (the “OFT”) is responsible for the issue of licenses under, and thesuperintendence of the working and the enforcement of the Consumer Credit Act(the “CCA”), related consumer credit regulations and other consumer protectionlegislation. The OFT may review businesses and operations, provide guidelinesto follow and take actions when necessary with regard to the mortgage market inthe United Kingdom.

 

Currently, a credit agreement is regulated bythe CCA where: (a) the borrower is or includes an individual; (b) theamount of “credit” as defined in the CCA does not exceed the financial limit,which is £25,000 for credit agreements made on or after May 1, 1998, orlower amounts for credit agreements made before that date; and (c) thecredit agreement is not an exempt agreement under the CCA, for example, aregulated mortgage contract under the FSMA (as defined below).

 

Any credit agreement that is wholly or partlyregulated by the CCA or to be treated as such has to comply with requirementsunder the CCA as to licensing of lenders and brokers, documentation andprocedures of credit agreements, and (in so far as will be applicable)pre-contract disclosure. If it does not comply with those requirements, then tothe extent that the credit agreement is regulated by the CCA or to be treatedas such, it is unenforceable against the borrower: (a) without an order ofthe OFT, if the lender or any broker does not hold the required license at therelevant time; (b) totally, if the form to be signed by the borrower isnot signed by the borrower personally or omits or mis-states a ‘‘prescribedterm’’; or (c) without a court order in other cases and, in exercising itsdiscretion whether to make the order, the court would take into account anyprejudice suffered by the borrower and any culpability of the lender.

 

Any credit agreement for a loan or furtheradvance might be wholly or partly regulated by the CCA or treated as suchbecause of technical rules on: (a) determining whether any creditunder the CCA arises, or whether the financial limit of the CCA is exceeded; (b) determiningwhether the credit agreement is an exempt agreement under the CCA; and (c) changesto credit agreements.

 

A court order under section 126 of theCCA is necessary to enforce a land mortgage securing a credit agreement to theextent that the credit agreement is regulated by the CCA or to be treated assuch. In dealing with such application, the court has the power, if it appearsjust to do so, to amend the credit agreement or to impose conditions upon itsperformance or to make a time order (for example, giving extra time for arrearsto be cleared).

 

Under section 75 of the CCA in certaincircumstances: (a) the lender is liable to the borrower in relation tomisrepresentation and breach of contract by a supplier in a transactionfinanced by the lender, where the related credit agreement is or is treated asentered into under pre-existing arrangements, or in contemplation of futurearrangements, between the lender and the supplier; and (b) the lender hasan indemnity from the supplier against such liability, subject to any agreementbetween the lender and the supplier.

 

In November 2002, the UK Department ofTrade and Industry (the “DTI”) announced its intention that a credit agreementwill be regulated by the CCA where, for credit agreements made after thischange is implemented: (a) the borrower is or includes an individual, savefor partnerships of four or more partners; (b) irrespective of the amountof credit (although in July 2003, the DTI announced its intention that thefinancial limit will remain for certain business-to-business lending); and (c) thecredit agreement is not an exempt agreement. In December 2003,

 

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the DTI published a White paperproposing amendments to the CCA and to secondary legislation made under it.

 

In June 2004, secondary legislation wasmade on: (a) amending requirements as to documentation of creditagreements, coming into force on May 31, 2005, or August 31, 2005 foragreements given to the borrower for signature but not made before May 31,2005; (b) pre-contract disclosure, coming into force on May 31, 2005;and (c) replacing the formula for calculating the maximum amount 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 Parliamentpublished a consumer Credit Bill proposing to amend the CCA by, among otherthings: (a) changing the definition of a credit agreement regulated by theCCA to that announced by the DTI as described above; and (b) repealing therule that, to the extent that a credit agreement is regulated by the CCAor 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.

 

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

 

The seller has interpreted certain technical rules underthe CCA in a way common with many other lenders in the mortgage market. If suchan interpretation 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. Court decisionshave been made on technical rules under the CCA against certain mortgagelenders, but such decisions are very few and are generally county courtdecisions not binding on other courts.

 

The seller has given or, as applicable, willgive warranties to the mortgages trustee in the mortgage sale agreement that,among other things, each loan and its related security is enforceable (subjectto certain exemptions). If a loan or its related security does not comply withthese warranties, and if the default cannot be or is not cured within 20 Londonbusiness days, then the seller will be required to repurchase the loans underthe relevant mortgage account and their related security from the mortgagestrustee.

 

In the United Kingdom, regulation ofresidential mortgage business by the FSA under the Financial Services andMarkets Act 2000 (the “FSMA”) came into force on October 31, 2004, thedate 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.

 

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

 

The main effects are that, unless anexclusion or exemption applies: (a) each entity carrying on a regulatedmortgage activity has to hold authorization and permission from the FSA tocarry on that activity; and (b) generally, each financial promotion inrespect of an agreement relating to a qualifying credit has to be issued orapproved by a person holding authorization and permission from the FSA. Ifrequirements as to authorization and permission of lenders and brokers or as toissue and approval of financial promotions are not complied with, a regulatedmortgage contract will be unenforceable against the borrower except with theapproval of a court. An unauthorized person who administers a regulatedmortgage contract entered into on or after N(M) may commit a criminal offence,but this will not render the contract unenforceable against the borrower.

 

Any credit agreement intended to be aregulated mortgage contract under the FSMA might instead be wholly or partlyregulated by the CCA or treated as such, or unregulated, because of technical rules on:(a) determining whether the credit agreement falls within the definitionof “regulated mortgage contract”; and (b) changes to credit agreements.

 

The seller is required to hold authorisizationand permission to enter into and to administer and, where applicable, to adviseon regulated mortgage contracts. Subject to any exemption, brokers will berequired to hold authorization and permission to arrange and, where applicable,to advise on regulated mortgage contracts.

 

The issuer and mortgages trustee are not anddo not propose to be authorized persons under the FSMA. The issuer andmortgages trustee will not require authorization in order to acquire legal orbeneficial title to a regulated mortgage contract. The issuer and mortgagestrustee do not carry on the regulated activity of administering in relation toregulated mortgage contracts by having them administered pursuant to anadministration agreement by an entity having the required FSA authorization andpermission. If such administration agreement terminates, however, the issuerand mortgages trustee will have a period of not more than one month in which toarrange for mortgage administration to be carried out by a replacementadministrator having the required FSA authorization and permission. Inaddition, from N(M) no variation has been or will be made to the loans and nofurther advance has been or will be made to a loan, where it will result in theissuer, Funding 1, Funding 2 or the mortgages trustee arranging, advising on,administering or entering into a regulated mortgage contract or agreeing tocarry on any of these activities, if the issuer Funding 1, Funding 2 or themortgages trustee would be required to be authorized under the FSMA to do so.

 

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

 

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regime came into force on October 31,2004 for mortgages and on January 14, 2005 for general insurance.

 

A borrower who is a private person is entitledto claim damages for loss suffered as a result of any contravention by anauthorized person of an FSA rule, and may set-off the amount of the claimagainst the amount owing by the borrower under the loan or any other loan thatthe borrower has taken (or exercise analogous rights in Scotland). Any suchset-off may adversely affect the issuer’s ability to make payments on theissuer notes.

 

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

 

No assurance can be given that additionalregulations from the OFT, the FSA or any other regulatory authority will notarise with regard to the mortgage market in the United Kingdom generally, theseller’s particular sector in that market or specifically in relation to theseller. Any such action or developments or compliance costs may have a materialadverse effect on the seller, the issuer and/or the servicer and theirrespective businesses and operations. This may adversely affect our ability tomake payments in full on the issuer notes when due.

 

Prior to M(N), in the United Kingdom,self-regulation of mortgage business existed under the Mortgage Code (the “CMLCode”) issued by the Council of Mortgage Lenders (the “CML”). Halifaxsubscribed to the CML Code and on and from N(M), as an authorized person, has beensubject to the FSA requirements in MCOB. Membership of the CML and compliancewith the CML Code were voluntary. The CML Code sets out minimum standards ofgood mortgage business practice, from marketing to lending procedures anddealing with borrowers experiencing financial difficulties. Since April 30,1998 lender-subscribers to the CML Code may not accept mortgage businessintroduced by intermediaries who were not registered with (before November 1,2000) the Mortgage Code Register of Intermediaries or (on and after November 1,2000 until October 31, 2004) the Mortgage Code Compliance Board.

 

In September 2002, the EuropeanCommission published a proposal for a directive of the European Parliament andof the Council on the harmonization of the laws, regulations and administrativeprovisions of the member states concerning credit for consumers and suretyagreements entered into by consumers. In its original form, the proposal doesnot include a financial limit for regulated agreements (unlike the existingDirective 87/102/EEC, as amended, which provides that (subject to certainexceptions) loans not exceeding euro 20,000 are regulated by such Directive)and requires specified requirements to be met in respect of certain mortgageloan products (including new credit agreements for further drawings undercertain flexible mortgages and for further advances and amortization tables forrepayment mortgages). If the proposal comes into force in its original form,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.

 

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There has been significant opposition fromthe European Parliament to the original form of the proposed directive. On February 13,2004, the Committee of Legal Affairs and the Internal Market published theEuropean Parliament’s amendments to the proposed draft. These amendmentsprovide that (subject to certain exceptions) loans not exceeding euro 100,000will be regulated, but that the proposed directive will not apply to any loansecured by a land mortgage or, in Scotland, a standard security, and will notapply to any credit agreement or surety agreement made before nationalimplementing legislation comes into force. In October 2004, the EuropeanCommission published an amended form of the proposed directive. In this amendedform, the proposed directive provides that (subject to certain exceptions)loans not exceeding euro 100,000 will be regulated, and that it will indeedapply to any loan secured by a land mortgage or, in Scotland a standardsecurity that includes an equity release component, but it is unclear whetherit will apply to any credit agreement or surety agreement made before nationalimplementing legislation comes into force. There are differences in opinion asto the extent to which mortgage loans should be included in the scope of theproposed directive, which may be substantially further amended before it isultimately brought into effect.

 

The proposal is unlikely to come into forcebefore 2006 as the co-decision procedure of the European Parliament and of theCouncil, from the publication of the proposal to the coming into force of thenew consumer credit directive, is likely to take at least two years and memberstates will then have a further two years in which to bring nationalimplementing legislation into force. The DTI has consulted with consumer andindustry organizations in relation to this proposal and in February 2005published a consultation paper on the form of the proposed directive publishedby the European Commission in October 2004.

 

Until the final text of the directive isdecided and the details of the United Kingdom implementing legislation arepublished, it is not certain what effect the adoption and implementation of thedirective would have on the seller, the issuer, the servicer, the mortgagestrustee, Funding1, Funding 2 and their respective businesses and operations.This may adversely affect the issuer’s ability to make payments in full on theissuer notes when due.

 

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

 

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

 

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

 

•                  theOFT and any “qualifying body” within the UTCCR (such as the FSA) may seek toenjoin (or in Scotland interdict) a business from relying on unfair terms.

 

The UTCCR will not generally affect “coreterms” which define the main subject matter of the contract, such as theborrower’s obligation to repay the principal, but may affect terms that are notconsidered to be core terms, such as the lender’s power to vary the interestrate.

 

For example, if a term permitting the lenderto vary the interest rate (as the seller is permitted to do) is found to beunfair, the borrower will not be liable to pay the increased rate or,

 

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to the extent that she or hehas paid it, will be able, as against the lender, or any assignee such as themortgages trustee, to claim repayment of the extra interest amounts paid or toset-off the amount of the claim against the amount owing by the borrower underthe loan or any other loan that the borrower has taken. Any such non-recovery,claim or set-off may adversely affect the issuer’s ability to make payments onthe issuer notes.

 

In February 2000, the OFT issued aguidance note on what the OFT considers to be fair terms and unfair terms forinterest variation in mortgage contracts. Where the interest variation termdoes not provide for precise and immediate tracking of an external rate outsidethe lender’s control, and if the borrower is locked in, for example by an earlyrepayment charge that is considered to be a penalty, the term is likely to beregarded as unfair under the UTCCR unless the lender (i) notifies theaffected 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 forEngland and Wales and the Scottish Law Commission issued a joint consultationLCCP No. 166/SLCDP 119 on proposals to rationalize the UK’s UnfairContract Terms Act 1977 and the 1999 Regulations into a single piece oflegislation and a final report, together with a bill on unfair terms, waspublished in February 2005. The Law Commissions have a duty under section 3of the UK’s Law Commissions Act 1965 to keep the law under review for a numberof purposes, including its simplification. The proposals are primarily tosimplify the legislation on unfair terms. It is not proposed that there shouldbe any significant increase in the extent of controls over terms in consumercontracts. Some changes are proposed, however, such as that (a) a consumermay also challenge a negotiated term in agreement on the basis that it is “unfair”and “unreasonable” within the legislation and therefore not binding on theconsumer; and (b) in any challenge by a consumer (but not by the OFT or aqualifying body) of a standard term or a negotiated term, the burden of prooflies on the business to show that the term is fair and reasonable. It is tooearly to tell how the proposals, if enacted, would affect the loans.

 

No assurance can be given that changes in theUTCCR, if enacted, or changes to guidance on interest variation terms, ifadopted, will not have a material adverse effect on the seller, the issuer, theservicer, the mortgages trustee, Funding 1, Funding 2 and their respectivebusinesses and operations. This may adversely affect the issuer’s ability tomake payments in full on the issuer notes when due.

 

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

 

Under FSMA, the Financial Ombudsman Serviceis required to make decisions on, among other things, complaints relating toactivities and transactions under its jurisdiction on the basis of what, in theOmbudsman’s opinion, would be fair and reasonable in all circumstances of thecase, taking into account, among other things, law and guidance. Complaintsbrought before the Financial Ombudsman Service for consideration must bedecided on a case-by-case basis, with reference to the particular facts of anyindividual case. Each case would first be adjudicated

 

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by an adjudicator. Either partyto the case may appeal against the adjudication. In the event of an appeal, thecase proceeds to a final decision by the Ombudsman.

 

In January 2002, the Ombudsman made adetermination on the seller’s appeal to an earlier decision by an adjudicatorat the Financial Ombudsman Service concerning a case involving HVR 1 and HVR 2.In March 2001, two joint borrowers with a capped rate loan originated whenHalifax offered only a single standard variable base rate contacted Halifax andrequested that their loan be linked to HVR 2. Halifax informed the borrowersthat, because they were still in their product period, they could eithertransfer to HVR 2 when their product period expired or transfer to HVR 2immediately and pay the applicable early repayment fee. The borrowerscomplained to the Financial Ombudsman Service and, on January 29, 2002, onappeal by Halifax, the Ombudsman determined in the borrowers’ favor andrecommended that Halifax recalculate the borrowers’ mortgage by reference toHVR 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.

 

The Ombudsman’s decision only applies to thetwo borrowers and their particular circumstances, though other borrowers mayalso complain to the Ombudsman. In March 2002, the seller announced thatborrowers under loans who were in similar circumstances and who had asked to betransferred to HVR 2 when it was available would be invited to make a productswitch to HVR 2 and to obtain a refund for all overpayments of interest since thedate they had asked to be transferred. For each of those loans, the borrowerswould also receive £150 for any inconvenience caused. The borrowers under loanswho requested to be transferred after HVR 2 was withdrawn and before theannouncement in March 2002 were not offered a switch or a refund, thoughthe seller has given or will give each of these customers an ex gratia paymentof £100.

 

Since then, further decisions by theOmbudsman in similar cases have confirmed that affected borrowers were only entitledto a refund of overpayments of interest from the date when they asked to betransferred to HVR 2 and not from the date when HVR 2 first became available,and also that affected borrowers were not entitled to apply to be transferredto HVR 2 after it was withdrawn.

 

The seller does not believe that anyOmbudsman’s decision to date or any other decision by any competent authorityin the future (in respect of the seller’s two variable base rates, HVR 1 andHVR 2) would affect the yield on the loans in such a way as to have a materialadverse effect on our ability to meet our obligations on the issuer notes.

 

As regards other borrowers, in the event thata decision (in respect of the seller’s variable base rate) by the Ombudsman orany other competent authority finds that a borrower’s loan should be linked toHVR 2, then that borrower may set-off the overpaid sum against the amount owingunder his or her loan if the seller does not reimburse that borrower. Any suchnon-recovery, claim or set-off ultimately may adversely affect the issuer’sability to make payments on the issuer notes.

 

As the Financial Ombudsman Service isrequired to make decisions on the basis of, among other things, the principlesof fairness, it is not possible to predict how any future decision of theFinancial Ombudsman Service would affect the ability of the issuer to repay theissuer notes.

 

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

 

Funding 1 and the issuer will generally besubject to UK corporation tax, currently at a rate of 30 per cent., on theprofit reflected in their respective profit and loss accounts as increased bythe amount of any non-deductible expenses or losses. If the tax payable byFunding 1 or the issuer is greater than expected because, for example,non-deductible expenses or losses are greater than expected, the fundsavailable to make payments on the noteholders’ issuer notes will be reduced andthis may adversely affect the issuer’s ability to make payments on the issuernotes.

 

The UK corporation tax position of the issuerand Funding 1, however, also depends to a significant extent on the accountingtreatment applicable to it. From January 1, 2005, the accounts of theissuer are required to comply with International Financial Reporting Standards(“IFRS”) or with new UK Financial Reporting Standards reflecting IFRS (“new UKGAAP”). Funding 1 may also choose to comply with IFRS. There is concern thatcompanies such as the issuer and Funding 1 might under either IFRS or new UKGAAP, suffer timing differences that could result in profits or losses foraccounting purposes, and accordingly for tax purposes (unless tax legislationprovides otherwise), which bear little or no relationship to the company’s cashposition. However, the Finance Act 2005 requires “securitisation companies” toprepare tax computations for accounting periods beginning on or after January 1,2005 and ending before January 1, 2007 on the basis of UK GAAP asapplicable up to December 31, 2004, notwithstanding the requirement toprepare statutory accounts under IFRS or new UK GAAP. The issuer and Funding 1will each be a “securitisation company” for these purposes.

 

The stated policy of H.M. Revenue &Customs is that the tax neutrality of securitisation special purpose companiesin general should not be disrupted as a result of the transition to IFRS or newUK GAAP and that they are working with participants in the securitisationindustry to identify appropriate means of preventing any such disruption. TheFinance Act 2005 enables regulations to be made to establish such a regime.However, if measures are not introduced by H.M. Revenue & Customs todeal with the corporation tax position of such companies in respect ofaccounting periods ending on or after January 1, 2007, then profits orlosses could arise in the issuer and/or Funding 1 as a result of theapplication of IFRS or new UK GAAP which could have tax effects not contemplatedin the cashflows for the transaction and as such adversely affect the issuerand/or Funding 1 and therefore payments on the issuer notes.

 

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

 

In the event that amounts due under theissuer notes are subject to withholding tax, the issuer will not be obliged topay additional amounts in relation thereto. The issuer may, in certaincircumstances, redeem the issuer notes.

 

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

 

If the United Kingdom joins the EuropeanMonetary Union prior to the maturity of the issuer notes, investors cannot beassured that this would not adversely affect payments on their issuer notes.

 

It is possible that prior to the maturity ofthe issuer notes the United Kingdom may become a participating member state inthe European economic and monetary union and that the

 

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euro may become the lawfulcurrency of the United Kingdom. In that event, (a) all amounts payable inrespect of any issuer notes denominated in sterling may become payable in euro;(b) applicable provisions of law may allow or require the issuer tore-denominate such issuer notes into euro and take additional measures inrespect of such issuer notes; and (c) the introduction of the euro as thelawful currency of the United Kingdom may result in the disappearance ofpublished or displayed rates for deposits in pounds sterling used to determinethe rates of interest on such issuer notes or changes in the way those ratesare calculated, quoted and published or displayed. The introduction of the eurocould also be accompanied by a volatile interest rate environment, which couldadversely affect a borrower’s ability to repay its loan as well as adverselyaffect investors. It cannot be said with certainty what effect, if any,adoption of the euro by the United Kingdom will have on investors in the issuernotes.

 

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

 

The structure of the issue of the issuernotes and the ratings which are assigned to them are based on English law and(in relation to the Scottish loans) Scots law in effect as at the date of thisprospectus. The issuer cannot provide assurance as to the impact of anypossible change to English or Scots law or administrative practice in theUnited Kingdom after the date of this Form 20-F.

 

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

 

Secondary legislation has now been enactedwhich excludes certain special purpose companies in relation to capital marketstransactions from the optional moratorium provisions. Such exceptions include(amongst other matters) (i) a company which is a party to an agreementwhich is or forms part of a capital market arrangement (as defined in thesecondary legislation) under which (a) a party has incurred or when theagreement was entered into was expected to incur a debt of at least £10 millionunder the arrangement and (b) the arrangement involves the issue of acapital markets investment (also defined, but generally a rated, listed ortraded bond) and (ii) a company which at the date of filing for amoratorium has incurred a liability (including a present, future or contingentliability) of at least £10 million. While the issuer, the mortgages trustee andFunding 1 should fall within the exceptions, there is no guidance as to how thelegislation will be interpreted and the Secretary of State for Trade andIndustry may by regulation modify the exception. No assurance may be given thatany modification of the eligibility requirements for “small” companies and/orthe exceptions will not be detrimental to the interests of the noteholders.

 

If the issuer and/or the mortgages trusteeand/or Funding 1 is determined to be a “small” company and determined not tofall within one of the exceptions (by reason of modification of the

 

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exceptions or otherwise), thenthe enforcement of the issuer security by the security trustee may, for aperiod, be prohibited by the imposition of a moratorium.

 

*Enterprise Act 2002*.On September 15, 2003, the corporate insolvency provisions of theEnterprise Act 2002 came into force, amending certain provisions of theInsolvency Act 1986 (as amended, the “Insolvency Act”). These provisionsintroduced significant reforms to corporate insolvency law. In particular thereforms restrict the right of the holder of a floating charge created after September 15,2003 to appoint an administrative receiver (unless an exception applies) andinstead gives primacy to collective insolvency procedures (in particular,administration).

 

The holder of a floating charge createdbefore September 15, 2003 over the whole or substantially the whole of theassets of a company (such as the security trustee under the Funding 1 deed ofcharge) retains the ability to block the appointment of an administrator byappointing an administrative receiver, who will primarily act in the interestsof the floating charge holder.

 

The Insolvency Act contains provisions thatcontinue to allow for the appointment of an administrative receiver in relationto certain transactions in the capital markets. The relevant exception providesthat the right to appoint an administrative receiver is retained for certaintypes of security (such as the issuer security) that form part of a capitalmarkets arrangement (as defined in the Insolvency Act) that involvesindebtedness of at least £50 million (or, when the relevant security documentwas entered into (being in respect of the transactions described in theprospectus, relating to the issuer notes and the issued deed of charge), aparty to the relevant transaction (such as the issuer) was expected to incur adebt of at least £50 million) and the issue of a capital markets investment(also defined, but generally a rated, listed or traded bond). The Secretary ofState for Trade and Industry may, by secondary legislation, modify the capitalmarket exception and/or provide that the exception shall cease to have effect.No assurance can be given that any such modification or provision in respect ofthe capital market exception, or its ceasing to be applicable to thetransactions described in this document will not adversely affect payments onthe issuer notes. In addition, as the provisions of the Enterprise Act havenever been considered judicially, no assurance can be given as to whether theEnterprise Act could have a detrimental effect on the interests of thenoteholders.

 

The Insolvency Act also contains a newout-of-court route into administration for a qualifying floating charge holder,the directors or the company itself. The relevant provisions provide for anotice period during which the holder of the floating charge can either agreeto the administrator proposed by the directors of the company or appoint analternative administrator, although the moratorium will take effect immediatelyafter notice is given. If the qualifying floating charge holder does notrespond to the directors’ notice of intention to appoint, the directors’, or asthe case may be, the company’s appointee will automatically take office afterthe notice period has elapsed. Where the holder of a qualifying floating chargewithin the context of a capital market transaction retains the power to appointan administrative receiver, such holder may prevent the appointment of anadministrator (either by the new out-of-court route or by the court basedprocedure), by appointing an administrative receiver prior to the appointmentof the administrator being completed.

 

The new administration provisions of theInsolvency Act give primary emphasis to the rescue of the company as a goingconcern. The purpose of realizing property to make a distribution to one ormore secured creditors is subordinated to the primary purposes of rescuing thecompany as a going concern or achieving a better result for the creditors as awhole than would be likely if the company were wound up. No assurances can begiven that the primary

 

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purposes of the new provisionswill not conflict with the interests of noteholders were the issuer eversubject to administration.

 

In addition to the introduction of aprohibition on the appointment of an administrative receiver as set out above, section 176Aof the Insolvency Act provides that in relation to floating charges createdafter September 15, 2003 any receiver (including an administrativereceiver), liquidator or administrator of a company is required to make a “prescribedpart” of the company’s “net property” available for the satisfaction ofunsecured debts in priority to the claims of the floating charge holder. Thecompany’s “net property” is defined as the amount of the chargor’s propertywhich would be available for satisfaction of debts due to the holder(s) of anydebentures secured by a floating charge and so refers to any floating chargerealizations less any amounts payable to the preferential creditors or inrespect of the expenses of the liquidation or administration. The “prescribedpart” is defined in The Insolvency Act 1986 (Prescribed Part) Order 2003 (SI2003/2097) to be an amount equal to 50 per cent. of the first £10,000 offloating charge realizations plus 20 per cent. of the floating chargerealizations thereafter, provided that such amount may not exceed £600,000.

 

This obligation does not apply if the netproperty is less than a prescribed minimum and the relevant officeholder is ofthe view that the cost of making a distribution to unsecured creditors would bedisproportionate to the benefits. The relevant officeholder may also apply tocourt for an order that the provisions of section 176A of the InsolvencyAct should not apply on the basis that the cost of making a distribution wouldbe disproportionate to the benefits.

 

Floating charge realizations upon theenforcement of the issuer security and the security created by the secondsupplemental Funding 1 deed of charge may be reduced by the operation of these “ringfencing” provisions.

 

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

 

Unless the global issuer notes are exchangedfor definitive issuer notes, which will only occur under a limited set ofcircumstances, the noteholders’ beneficial ownership of the issuer notes willonly be recorded in book-entry form with DTC, Euroclear or Clearstream,Luxembourg. The lack of issuer notes in physical form could, among otherthings:

 

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

 

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

 

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

 

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

 

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The issuer has agreed to submit to thenon-exclusive jurisdiction of the courts of England, and it may be necessaryfor noteholders to bring a suit in England to enforce their rights against theissuer.

 

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

 

The Basel Committee on Banking Supervisionpublished the text of the new framework on June 26, 2004 under the title “BaselII: International Convergence of Capital Measurement and Capital Standards: aRevised Framework”. This new framework (the “Framework”), which places enhancedemphasis on market discipline and sensitivity to risk, will serve as the basisfor national rule-making and approval processes to continue and for bankingorganizations to complete their preparations for implementation of theFramework. The Committee confirmed that it is currently intended that thevarious approaches under the Framework will be implemented in stages, some fromyear-end 2006, the most advanced at year-end 2007. As and when implemented(including through the EU Capital Requirements Directive), the Framework couldaffect the risk—weighting of the issuer notes in respect of certain investorsif those investors are subject to the Framework following its implementation.Consequently, investors should consult their own advisers as to the consequencesto and effect on them of the proposed implementation of the Framework. Nopredictions can be made as to the precise effects of potential changes whichmight result upon the implementation of the Framework.

 

The issuer may, under certain circumstancesrelating to implementation of the New Basel Capital Accord in the UnitedKingdom, require investors to sell their issuer notes or redeem their issuernotes.

 

**Item 4. Information on the Company**

 

A.*            History and Development of the Company*

 

Not applicable.

 

B.*            Business Overview*

 

Not applicable.

 

C.*            Organizational Structure*

 

Not applicable.

 

D.*            Property, Plants and Equipment*

 

The issuer

 

The property of the issuer consists primarilyof its right to receive payments of interest and principal from Funding 1 onthe various term advances made under the issuer intercompany loan agreement.

 

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Funding 1

 

The property of Funding 1 consists primarilyof its interest in the trust property held by the mortgages trustee (whichentitles Funding 1 to receive certain payments of principal and interest fromthe trust property according to the terms of the mortgages trust deed) andamounts available under a reserve fund.

 

The mortgages trustee

 

The trust property includes the portfolio ofloans and their related security assigned to the mortgages trustee by theseller on June 14, 2002, and on several subsequent dates, any new loansand their new related security assigned to the mortgages trustee by the sellerafter the closing date, any increase in the outstanding principal balance of aloan due to the borrower taking payment holidays or making underpayments undera loan or a borrower making a drawing under any flexible loan, any interest,principal and other amounts (excluding third party amounts) paid by borrowerson their loans and their related security, the rights under the insurancepolicies that are assigned to the mortgages trustee or of which the mortgagestrustee has the benefit, and amounts on deposit and interest earned on themortgages trustee guaranteed investment contract. Any actual losses in relationto the loans, any actual reductions occurring in respect of the loans anddistributions of principal made from time to time to the beneficiaries or themortgages trust will be deducted from the trust property. The composition ofthe trust property will fluctuate as drawings under flexible loans and newloans are added, as borrowers take payment holidays or make underpayments undera loan and as the loans that were previously part of the trust property arerepaid, mature, default or are repurchased by the seller.

 

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

 

A.*            Operating Results*

 

Not applicable.

 

B.*            Liquidity and Capital Resources*

 

Not applicable.

 

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

 

Not applicable.

 

D*.            Trend Information*

 

Not applicable.

 

E.*             Off-balance Sheet Arrangements*

 

Not applicable.

 

F.*             Tabular Disclosure of Contractual Obligations*

 

Not applicable.

 

G*.            Safe Harbor*

 

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Not applicable.

 

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

 

A.*            Directors and Senior Management*

 

The following sets out the names, businessaddresses and business occupations of the directors of the issuer, Funding 1and the mortgages trustee. Because each of the issuer, Funding 1 and themortgages trustee is organized as a special purpose company and will be largelypassive, it is expected that the directors of each entity in that capacity willmanage its operations to the extent necessary.

 

The issuer

 
| **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   |

 

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  |

 

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| David Balai |   | HBOS Treasury Services plc  33 Old Broad Street  London EC2N 1HZ |   | Head of Mortgage Securitisation and Covered  Bonds |
|-------------|--------|------------------------------------------------------------------|--------|----------------------------------------------------|

 

David Balai is an employee of a company inthe same group of companies as the seller.

 

B.*            Compensation*

 

The issuer

 

In accordance with the issuer corporateservices agreement entered into between the issuer, the seller, the securitytrustee, the note trustee, Holdings and Structured Finance Management Limited (“SFM”),the seller and SFM will each provide directors and other corporate services forthe issuer in consideration for a payment of a separate fee payable by theissuer to SFM. No other remuneration is paid to any director or officer inconnection with such director’s or officer’s activities on behalf of theissuer.

 

Funding 1

 

In accordance with the Funding 1 corporateservices agreement entered into between Funding 1, the seller, the securitytrustee, the note trustee, Holdings, Permanent PECOH Limited, SFM, and SFMCorporate Services Limited (“SFM Corporate”), the seller and SFM will eachprovide directors and SFM will provide other corporate services for Funding 1in consideration for a payment of a separate fee payable by Funding 1 to SFM.No other remuneration is paid to any director or officer in connection withsuch director’s or officer’s activities on behalf of Funding 1.

 

The mortgages trustee

 

In accordance with the mortgages trusteecorporate services agreement entered into between the mortgages trustee, thesecurity trustee, the note trustee and SFM Offshore Limited (“SFM Offshore”),the seller and SFM Offshore will each provide directors and SFM Offshore willprovide other corporate services for the mortgages trustee in consideration fora payment of a separate fee payable by the mortgages trustee to SFM Offshore.No other remuneration is paid to any director or officer in connection withsuch director’s or officer’s activities on behalf of the mortgages trustee.

 

C.            *Board Practices*

 

Not applicable.

 

D.            *Employees*

 

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

 

E.             *Share Ownership*

 

Not applicable.

 

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**Item 7. Major Shareholders and Related Party Transactions**

 

A.            *Major Shareholders*

 

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

 

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

 

Neither SFM Corporate nor SFM Offshore isaffiliated with Halifax plc.

 

B.            *Related Party Transactions*

 

None, other than with respect to the makingof payments in respect to the securities as described in the RegistrationStatement and “Item 3.D — Risk Factors”.

 

C.            *Interests of Experts and Counsel*

 

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

 

**Item 8. Financial Information**

 

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

 

The issuer, Funding 1 and the mortgagestrustee know of no material legal or arbitration proceedings involving theirrespective companies that may have significant effects on the registrants’ financialposition or profitability, including governmental proceedings pending or knownto be contemplated and any material proceeding in which any director oraffiliate is either a party adverse to a registrant or has a material interestadverse to a registrant.

 

**Item 9. The Offer and Listing**

 

A.*            Offer and Listing Details*

 

Not applicable.

 

B.*            Plan of Distribution*

 

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

 

C.*            Markets*

 

The principal trading market for each classof the issuer notes is the London Stock Exchange. The issuer notes have beenlisted on the London Stock Exchange since July 22, 2004.

 

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D.*            Selling Shareholders*

 

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

 

E.*             Dilution*

 

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

 

F.*             Expenses of the Issue*

 

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

 

**Item 10. Additional Information**

 

A.*            Share Capital*

 

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

 

B.*            Memorandum and Articles of Association*

 

The memorandum and articles of associationfor each of the issuer, Funding 1 and the mortgages trustee are incorporated byreference from the Registration Statement. Please also see the description ofthe issuer, Funding 1 and the mortgages trustee set forth in the RegistrationStatement.

 

C.            *Material Contracts*

 

Not applicable other than with respect tocontracts relating to the issuer notes, which were described in theRegistration Statement.

 

D.*            Exchange Controls*

 

None.

 

E.*             Taxation*

 

**UnitedKingdom Taxation**

 

The following section summarizes thematerial UK tax consequences of the purchase, ownership and disposition of theissuer notes based on current law and practice in the UK. The summary assumesthat the profit in Funding 1’s profit and loss account will not exceed0.01 per cent. of the Funding 1 available revenue receipts and that theprofit in the issuer’s profit and loss account will not exceed 0.01 percent. of the interest on the issuer term advances under the issuer intercompanyloan and any interest earned by the issuer on its Share Capital proceeds arecorrect. It further assumes that all payments made pursuant to the finaldocumentation are calculated on arm’s length terms. The summary does notpurport to be a complete analysis of all tax considerations of the purchase,ownership and disposition of the issuer notes. It relates to the position ofpersons who are the absolute beneficial owners of issuer notes and may notapply to certain classes of persons such as dealers or persons connected withthe issuer. Noteholders who may be subject to tax in a jurisdiction other thanthe UK or who may be unsure as to their tax position should seek their ownprofessional advice.

 

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**Taxation of US residents**

 

As discussed in more detail below, no UKwithholding tax will be required in relation to interest payments on the issuernotes provided that the issuer notes are listed on a “recognised stock exchange”,which includes the London Stock Exchange. If the issuer notes cease to belisted on a “recognised stock exchange”, an amount must be withheld on accountof UK income tax at the lower rate (currently 20 per cent.), subject to anydirection to the contrary from H.M. Revenue & Customs in respect ofsuch relief as may be available pursuant to the provisions of an applicabledouble taxation treaty.

 

Residents of the US are generally not subjectto tax in the UK on payments on the issuer notes under the terms of the doubletaxation treaty between the US and the UK (the “Treaty”), subject to completionof administrative formalities, except where the issuer notes are effectivelyconnected with a permanent establishment or a fixed base of the noteholdersituated in the UK or where the amounts paid on the issuer notes not exceed thereturn on comparable debt instruments, in which event the UK may tax the excessin accordance with UK domestic law.

 

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

 

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

 

Funding 1and the issuer will generally be subject to UK corporation tax, currently at arate of 30 per cent, on the profit reflected in their respective profit andloss accounts as increased by the amounts of any non-deductible expenses orlosses.

 

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

 

**Withholding tax**

 

There will be no UK withholding tax inrelation to interest payments on the issuer notes provided that, so far asconcerns deduction by the issuer or its paying agents, the issuer notes arelisted on a “recognised stock exchange”, as defined in Section 841 of theIncome and Corporation Taxes Act 1988 (“ICTA”). The London Stock Exchange iscurrently a recognised stock exchange for this purpose. If the issuer notescease to be listed on a “recognised stock exchange”, an amount must be withheldon account of UK income tax at the lower rate (currently 20 per cent.) frominterest paid on them, subject to any direction to the contrary by H.M. Revenue &Customs in respect of such relief as may be available pursuant to the provisionsof an applicable double taxation treaty or to the interest being paid topersons (including companies within the charge to UK corporation tax) and incircumstances specified in Section 349A to 349D of the ICTA.

 

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Noteholders who are individuals may wish tonote that H.M. Revenue & Customs has power to obtain information(including the name and address of the beneficial owner of the interest) fromany person in the UK who either pays interest to, or receives interest for thebenefit of, an individual. Information so obtained may, in certaincircumstances, be exchanged by H.M. Revenue & Customs with the taxauthorities of other jurisdictions.

 

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

 

Interest on the issuer notes has a UK source.Accordingly, payments of interest on the issuer notes will in principle bewithin the charge to UK tax even if paid without withholding or deduction.However, other than where the provisions of the Treaty apply to allow certaininterest paid to residents of the US to be taxed in the UK, such payments willnot be chargeable to UK tax in the hands of a noteholder who is not residentfor tax purposes in the UK unless such noteholder carries on a trade,profession or vocation through a branch or agency (or, in the case of anoteholder which is a company which carries on a trade through a permanentestablishment) in the UK in connection with which the payments are received orto which the issuer notes are attributable, in which case (subject toexemptions for interest received by certain categories of agent such as somebrokers and investment managers) tax may be levied on the UK branch or agencyor permanent establishment.

 

**Taxation of returns: companies within thecharge to UK corporation tax**

 

In general, noteholders who are within thecharge to UK corporation tax (other than authorized unit trusts) will normallybe subject to tax on all profits and gains, including interest and profit andgains attributable to currency regulations, arising on or in connection withthe issuer notes under the loan relationship rules. Any such profits and gainswill generally fall to be calculated in accordance with the statutoryaccounting treatment of the issuer notes in the hands of the relevantnoteholder, and will generally be charged to tax as income in respect of eachaccounting period to which they are allocated, in accordance with thataccounting treatment. Relief may be available in respect of losses or forrelated expenses on a similar basis.

 

**Taxation of returns: other noteholders**

 

Noteholders who are not within the charge toUK corporation tax and who are resident or ordinarily resident in the UK fortax purposes or who carry on a trade, profession or vocation in the UK througha branch or agency in connection with which interest on the issuer notes isreceived or to which the issuer notes are attributable will generally be liableto UK tax on the amount of any interest received in respect of the issuernotes. As the series 2 issuer notes and series 3 issuer notes are denominatedin US dollars and the series 4 issuer notes are denominated in euro, they willnot constitute “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.

 

It is expected that the series 5 class A2issuer notes, the series 5 class B issuer notes and the series 5 class C issuernotes will be regarded by H.M. Revenue & Customs as constituting “qualifyingcorporate bonds” within the meaning of Section 117 of the Taxation ofChargeable Gains Act 1992. Accordingly, a disposal of any of these issuer notesis not

 

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expected to give rise to achargeable gain or an allowable loss for the purpose of the UK taxation ofchargeable gains.

 

A disposal of the issuer notes by such noteholdersas described above may also give rise to a charge to tax on income in respectof an amount representing interest accrued on the issuer notes since thepreceding payment date. For the issuer notes which constitute variable ratesecurities, taxation in respect of such a disposal will be computed on thebasis that such amount as H.M. Revenue & Customs considers to be justand reasonable will be treated as accrued income. However, the transferee of avariable rate security will not be entitled to any relief on such amount. Allof the issuer notes will constitute variable rate issuer notes for thispurpose.

 

**Stamp duty and stamp duty reserve tax**

 

No UK stamp duty or stamp duty reserve tax ispayable on the issue or transfer of the offered global issuer notes or on theissue or transfer of definitive issuer notes.

 

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

 

Funding 1 and the issuer will generally besubject to UK corporation tax, currently at a rate of 30 per cent. on theprofit reflected in their respective profit and loss accounts as increased bythe amounts of any non-deductible expenses or losses. In respect of Funding 1,the profit in the profit and loss account will not exceed 0.01 per cent.of the Funding 1 available revenue receipts. In respect of the issuer, theprofit in the profit and loss account will not exceed 0.01 per cent. ofthe interest on the issuer term advances under the issuer intercompany loan andany interest earned by the issuer on its share capital proceeds.

 

**UK taxation of the mortgages trustee**

 

The mortgages trustee will have no liabilityto UK tax in respect of any income, profit or gain arising under thesearrangements. Accordingly, the mortgages trustee will have no liability to UKtax in relation to amounts that it receives on behalf of Funding 1 or theseller under the mortgages trust.

 

**EU SavingsDirective**

 

On June 3, 2003, the European Union (“EU”)Council of Economics and Finance Ministers adopted a directive regarding thetaxation of savings income in the form of interest payments (the “EU SavingsTax Directive”). It is proposed that, subject to a number of importantconditions being met, each EU Member State will, from July 1, 2005, berequired to provide to the tax authorities of another EU Member State detailsof payments of interest (or other similar income) paid by a person within itsjurisdiction to or for the benefit an individual resident in that other EUMember State. However, Austria, Belgium and Luxembourg will instead (unlessduring that period they elect otherwise) apply a withholding system for atransitional period in relation to such payments (the ending of suchtransitional period being dependent upon the conclusion of certain otheragreements relating to information exchange with certain other countries).

 

Jersey is not a member of the EU andtherefore is not required to implement the EU Savings Tax Directive. However,the Policy & Resources Committee of the States of Jersey has announcedthat, in keeping with Jersey’s policy of constructive international engagement,Jersey, in line with steps proposed by other relevant third countries, proposesto introduce a retention tax

 

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system in respect of paymentsof interest, or other similar income, made to an individual beneficial ownerresident in an EU Member State by a paying agent situated in Jersey (the terms “beneficialowner” and “paying agent” for this purpose are as defined in the EU savings taxdirective). The retention tax system would apply for a transitional periodprior to the implementation of a system of automatic communication to EU MemberStates of information regarding such payments. During this transitional period,such an individual beneficial owner resident in an EU Member State would beentitled to request a paying agent not to retain tax from such payments butinstead to apply a system by which the details of such payments arecommunicated to the tax authorities of the EU Member State in which thebeneficial owner is resident.

 

**UnitedStates Federal Income Taxation**

 

The following section summarizes thematerial US federal income tax consequences of the purchase, ownership anddisposition of the series 2 issuer notes and series 3 issuer notes (the “USnotes”). In general, the summary assumes that a holder acquires the USnotes at original issuance and holds the US notes as capital assets. It doesnot purport to be a comprehensive description of all the taxconsiderations that may be relevant to a decision to purchase the US notes.In particular, it does not discuss special tax considerations thatmay apply to certain types of taxpayers, including, without limitation,the following: (i) financial institutions; (ii) insurance companies; (iii) dealersor traders in stocks, securities, notional principal contracts or currencies; (iv) tax-exemptentities; (v) regulated investment companies; (vi) persons that willhold the US notes as part of a “hedging” or “conversion” transaction or as aposition in a “straddle” for US federal income tax purposes; (vii) personsthat own (or are deemed to own) 10 per cent. or more of the voting shares ofthe issuer; (viii) persons who hold US notes through partnerships or otherpass-through entities; and (ix) persons that have a “functional currency”other than the US dollar. In addition, this summary does not addressalternative minimum tax consequences, nor does it describe any tax consequencesarising under the laws of any taxing jurisdiction other than the USfederal government.

 

This summary is based on the US Internal RevenueCode of 1986, as amended (the “Code”), US Treasury regulations and judicial andadministrative interpretations thereof, in each case as in effect or availableon the date of filing of this Form 20-F. All of the foregoing are subjectto change, and any change may apply retroactively and could affect the taxconsequences described below.

 

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

 

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

 

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partnership. Partners of partnerships holding US notes shouldconsult their own tax advisers. A “Non-United States holder” is a beneficialowner of US notes that is not a United States holder.

 

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

 

Each of the issuer, Funding 1 and themortgages trustee acting it its capacity as trustee of the mortgages trustcovenants not to engage in any activities in the United States (directly orthrough agents), not to derive any income from sources within the United Statesas determined under US federal income tax principles, and not to hold anyproperty if doing so would cause it to be engaged or deemed to be engaged in atrade or business within the United States as determined under US federalincome tax principles. Assuming compliance with these covenants, none of theissuer, Funding 1 or the mortgages trustee acting in its capacity as trustee ofthe mortgages trust will be subject to US federal income tax. No election willbe made to treat the issuer, Funding 1 or the mortgages trustee or any of theirassets as a REMIC (a type of securitization vehicle having a special tax statusunder the Code).

 

**Characterization of the US notes**

 

Although there is no authority regarding thetreatment of instruments that are substantially similar to the US notes, andwhile it is not free from doubt, the issuer believes that the US notes will betreated as debt for US federal income tax purposes. The issuer intends to treatthe US notes as indebtedness of the issuer for all purposes, including US taxpurposes. The discussion in the next section assumes this result.

 

The US notes will not be qualifying realproperty loans in the hands of domestic savings and loan associations, realestate investment trusts, or REMICs under sections 7701(a)(19)(C), 856(c) or860G(a)(3) of the Code, respectively.

 

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

 

*Qualified Stated Interest and Original IssueDiscount.*The issuer intends to treat interest on theUS notes as “qualified stated interest” under US Treasury regulations relatingto original issue discount (hereafter the “OID regulations”). As a consequence,discount on the US notes arising from an issuance at less than par will only berequired to be accrued under the OID regulations if such discount exceeds astatutorily defined *de minimis*amount. Qualified stated interest, which generally must be unconditionallypayable at least annually, is taxed under a holder’s normal method of accountingas ordinary interest income. *De minimis*original issue discount (“OID”) is included in income on a *pro rata*basis as principal payments are made on the US notes.

 

It is possible that interest on the 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

 

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according to the schedule forpurposes of accruing any OID. No representation is made that the mortgage loanswill pay on the basis of such prepayment assumption or in accordance with anyother prepayment scenario.

 

As an alternative to the above treatments,United States holders may elect to include in gross income all interest withrespect to the US notes, including stated interest, acquisition discount, OID, *de minimis* OID, market discount, *de minimis*market discount, and unstated interest, as adjusted by any amortizable bondpremium or acquisition premium, using the constant yield method describedabove.

 

Interest income on the US notes will betreated as foreign source income for US federal income tax purposes, which maybe relevant in calculating a United States holder’s foreign tax creditlimitation for US federal income tax purposes. The limitation on foreign taxeseligible for the US foreign tax credit is calculated separately with respect tospecific classes of income. The foreign tax credit rules are complex, andUnited States holders should consult their own tax advisers regarding theavailability of a foreign tax credit and the application of the limitation intheir particular circumstances.

 

*Sales and Retirement.*In general, a United States holder of a US note will have a tax basis in suchUS note equal to the cost of the US note to such holder, and reduced by anypayments thereon other than payments of stated interest. Upon a sale orexchange of the US note, a United States holder will generally recognize gainor loss equal to the difference between the amount realized (less any accruedinterest, which would be taxable as such) and the holder’s tax basis in the USnote. Such gain or loss will be long-term capital gain or loss if the UnitedStates holder has held the US note for more than one year at the time ofdisposition. **Investors should consult their own taxadvisors with respect to the treatment of capital gains (which may be taxed atlower rates than ordinary income for taxpayers who are individuals, trusts or estatesthat hold the US notes for more than one year) and capital losses (thedeductibility of which is subject to limitations).**

 

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

 

Subject to the backup withholding rules discussedbelow, a Non-United States holder generally should not be subject to US federalincome or withholding tax on any payments on a US note and gain from the sale,redemption or other disposition of a US note unless: (i) that paymentand/or gain is effectively connected with the conduct by that Non-United Statesholder of a trade or business in the United States; (ii) in the case ofany gain realized on the sale or exchange of a US note by an individualNon-United States holder, that holder is present in the United States for 183 daysor more in the taxable year of the sale, exchange or retirement and certainother conditions are met; or (iii) the Non-United States holder is subjectto tax 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.**

 

**Alternative characterization of the US notes**

 

The proper characterization of thearrangement involving the issuer and the holders of the US notes is not clearbecause there is no authority on transactions comparable to that contemplatedherein. The issuer intends to treat the US notes as debt for all US federalincome tax purposes. Investors should consult their own tax advisors with respectto the potential impact of an alternative characterization of the US notes forUS tax purposes.

 

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One possible alternative characterization isthat the US Internal Revenue Service (“IRS”) could assert that the class C orany other class of US notes should be treated as equity in the issuer for USfederal income tax purposes. If the class C or any other class of US notes weretreated as equity, United States holders of such notes would be treated as owningequity in a passive foreign investment company (“PFIC”) which, depending on thelevel of ownership of such United States holder and certain other factors,might also constitute an interest in a controlled foreign corporation for suchUnited States holder. This would have certain timing and character consequencesfor United States holders and could require certain elections and disclosuresthat would need to be made shortly after acquisition to avoid potentiallyadverse US tax consequences.

 

If a United States holder were treated asowning an equity interest in a PFIC, unless a United States holder makes a “QEFelection” or “mark to market election”, a United States holder will be subjectto a special tax regime (i) in respect of gains realized on the sale orother disposition of the relevant notes, and (ii) in respect ofdistributions on the relevant notes held for more than one taxable year to theextent those distributions constitute “excess distributions”. Although not freefrom doubt, the PFIC rules should not apply to gain realized in respect ofany notes disposed of during the same taxable year in which such notes areacquired. An excess distribution generally includes dividends or otherdistributions received from a PFIC in any taxable year to the extent the amountof such distributions exceeds 125 per cent. of the average distributions forthe three preceding years (or, if shorter, the investor’s holding period).Because the US notes pay interest at a floating rate, it is possible that a USholder will receive “excess distributions” as a result of fluctuations in therate of USD-LIBOR over the term of the US notes. In general, under the PFICrules, a United States holder will be required to allocate such excessdistributions and any gain realized on a sale of its notes to each day duringthe United States holder’s holding period for the notes, and will be taxable atthe highest rate of taxation applicable to the notes for the year to which theexcess distribution or gain is allocable (without regard to the United Statesholder’s other items of income and loss for such taxable year) (the “deferredtax”). The deferred tax (other than the tax on amounts allocable to the year ofdisposition or receipt of the distribution) will then be increased by aninterest charge computed by reference to the rate generally applicable tounderpayments of tax (which interest charge generally will be non-deductibleinterest expense for individual taxpayers).

 

**Backup withholding and information reporting**

 

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

 

Payments of principal or interest made to orthrough a foreign office of a custodian, nominee or other agent acting onbehalf of a beneficial owner of a US note generally will not be

 

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

 

Backup withholding is not an additional tax.Any amounts withheld under the backup withholding rules will be refundedor credited against the United States holder’s US federal income tax liability,provided that the required information is furnished to the IRS. **Holders of US notes should consult their tax advisors as to theirqualification for exemption from backup withholding and the procedure forobtaining an exemption.**

 

**MaterialJersey (Channel Islands) Tax Considerations**

 

The mortgages trustee is resident in Jerseyfor taxation purposes and will be liable to income tax in Jersey at a rate of20 per cent. in respect of the profits it makes from acting as trustee of themortgages trust. The mortgages trustee will not be liable for any income tax inJersey in respect of any income it receives in its capacity as mortgagestrustee on behalf of the beneficiaries of the mortgages trust.

 

F.             *Dividends and Paying Agents*

 

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

 

G.            *Statement by Experts*

 

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

 

H.            *Documents on Display*

 

The issuer, Funding 1 and the mortgagestrustee are subject to the information requirements of the U.S. SecuritiesExchange Act of 1934, as amended, and are therefore required to file reports,including annual reports on Form 20-F, and other information with the SEC.These

 

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materials, including thisannual report 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*

 

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

 

**Item 11. Quantitative and Qualitative Disclosures About Market Risk**

 

Funding 1 has entered into the Funding 1 swapagreement with Halifax plc as the Funding 1 swap provider and the securitytrustee. The issuer has entered into issuer swaps with the issuer swapproviders and the security trustee. In general, the swaps are designed to dothe following:

 

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

 

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

 

•                  issuereuro currency swaps: to protect the issuer against changes in the sterling toeuro exchange rate following the closing date and the possible variance betweena LIBOR based rate for three-month sterling deposits and a EURIBOR based ratefor three-month euro deposits applicable to the series 4 class A1 issuer notes,the series 4 class B issuer notes, the series 4 class C issuer notes; and

 

•                  issuerinterest rate swap: to protect the issuer against the possible variance betweena LIBOR-based rate for three-month sterling deposits and a fixed rate ofinterest applicable to the series 5 class A1 issuer notes up to and includingthe interest payment date in June 2009 payable, during this period,semi-annually on the interest payment dates falling in December and June ofeach year until the occurrence of a trigger event or the enforcement of theissuer security.

 

**The Funding 1 swap**

 

Some of the loans in the portfolio pay avariable rate of interest for a period of time which may either be linked tothe mortgages trustee variable base rate or linked to a variable interest rateother than the mortgages trustee variable base rate, such as a rate set by theBank of England. Other loans pay a fixed rate of interest for a period of time.However, the interest rate payable by Funding 1 with respect to the issuer termadvances is calculated as a margin over LIBOR for three-month sterlingdeposits. To provide a hedge against the possible variance between:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

(i)                                     theaverage of the standard variable mortgage rates or their equivalent charged toexisting borrowers on residential mortgage loans as published from time totime, after excluding the highest and the lowest rate, of Abbey National plc,HSBC Bank plc, 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)                               therates of interest payable on the fixed rate loans,

 

for the relevant calculation period to the notional amount of theFunding 1 swap (known as the “calculation period Funding 1 amount”). “Calculationdate” is defined as the first day (or if not a London Business Day, the nextsucceeding London Business Day) of each month and any other day on whichFunding 1 acquires a further interest in the trust property from and includingthe calculation date immediately preceding the effective date. “London BusinessDay” is defined as a day (other than a Saturday or Sunday) on which banks aregenerally open for business in London.

 

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

 

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

 

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

 

After these two amounts are calculated inrelation to a Funding 1 interest payment date, the following payments will bemade on that Funding 1 interest payment date:

 

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

 

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

 

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

 

If a payment is to be made by the Funding 1swap provider, that payment will be included in the Funding 1 available revenuereceipts and will be applied on the relevant Funding 1 interest payment dateaccording to the relevant order of priority of payments of Funding 1. If apayment is to be made by Funding 1, it will be made according to the relevantorder of priority of payments of Funding 1.

 

The notional amount of the Funding 1 swap inrespect of a calculation period will be an amount in sterling equal to:

 

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

 

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

 

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

 

In the event that the Funding 1 swap isterminated prior to the service of any issuer intercompany loan acceleration noticeor final repayment of any intercompany loan, Funding 1 shall enter into areplacement Funding 1 swap on terms acceptable to the rating agencies, with thesecurity trustee and with a swap provider whom the rating agencies havepreviously confirmed in writing to Funding 1, the issuer and the securitytrustee will not cause the then current ratings of the issuer notes to bedowngraded, withdrawn or qualified. If Funding 1 is unable to enter into a newFunding 1 swap on terms acceptable to the rating agencies, this may affectamounts available to pay interest on the intercompany loans.

 

**The issuer currency swaps**

 

The issuer intercompany loan is denominatedin sterling, and interest payable by Funding 1 to the issuer under the issuerterm advances is calculated as a margin over LIBOR for three-month sterlingdeposits. However, some of the issuer notes are denominated in US dollars andaccrue interest at either a LIBOR based rate for one-month US dollar depositsor a LIBOR based rate for three-month US dollar deposits. In addition, theseries 4 class A1 issuer notes, series 4 class B issuer notes, and series 4class C issuer notes are denominated in euro and accrue

 

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interest at a EURIBOR-basedrate for three-month euro deposits. To deal with the potential interest rateand currency mismatch between (i) its receipts and liabilities in respectof the issuer intercompany loan and (ii) its receipts and liabilitiesunder the issuer notes, the issuer has, pursuant to the terms of the issuercurrency swaps, swapped its receipts and liabilities in respect of all eurodenominated issuer notes and all US dollar denominated issuer notes intosterling on terms that match the issuer’s obligations under the US dollardenominated issuer notes or the euro denominated issuer notes, as applicable.

 

The currency amount of each issuer currencyswap is the principal amount outstanding under the issuer notes to which therelevant issuer currency swap relates. Subject, in the case of the class B andC issuer swaps, to certain deferral of interest provisions that will apply whenpayment of interest under the corresponding offered issuer notes is deferred inaccordance with the terms and conditions of such offered issuer notes, the issuerswap providers will pay to the issuer amounts in US dollars or euro, asapplicable that are equal to the amounts of interest to be paid on each of theclasses of the offered issuer notes and the issuer will pay to the issuer swapproviders the sterling interest amounts received on the issuer term advancescorresponding to the classes of the offered issuer notes. In order to allow forthe effective currency amount of each issuer currency swap to amortize at thesame rate as the relevant series and class of issuer notes, each issuercurrency swap agreement provides that as and when the issuer notes amortize, acorresponding portion of the relevant issuer currency swap so terminated willbe swapped from sterling into US dollars at the relevant US dollar currencyexchange rate or into euro at the euro currency exchange rate, as applicable.

 

The payment obligations of the series 2 swapprovider under the relevant issuer currency swaps are guaranteed by the UBSissuer swap guarantor pursuant to a guarantee (the “UBS issuer swap guarantee”).

 

The payment obligations of the series 3issuer swap provider under the relevant issuer currency swaps are guaranteed bythe AIG issuer swap guarantor pursuant to a guarantee (the “AIG issuer swapguarantee”).

 

The payment obligations of the series 4issuer euro currency swap provider under the relevant issuer currency swaps areguaranteed by the Swiss Re issuer swap guarantor pursuant to a guarantee (the “SwissRe issuer swap guarantee”).

 

In the event that any issuer currency swap isterminated prior to the service of an issuer note acceleration notice or thefinal redemption of the relevant US dollar denominated or euro denominatedissuer notes, as applicable, the issuer shall enter into a replacement issuercurrency swap in respect of that class and series of issuer notes. Anyreplacement issuer currency swap must be entered into on terms acceptable tothe rating agencies, the issuer and the security trustee and with a replacementissuer currency swap provider whom the rating agencies have previouslyconfirmed in writing to the issuer and the security trustee will not cause thethen current ratings of the issuer notes to be downgraded, withdrawn orqualified. If the issuer is unable to enter into any replacement issuer currencyswaps on terms acceptable to the rating agencies, this may affect amountsavailable to pay amounts due under the issuer notes.

 

If an issuer currency swap agreement isterminated and the issuer is unable to enter into a replacement swap asdescribed above, then any payments received by the issuer from Funding 1 oneach Funding 1 interest payment date shall be deposited in the issuer bankaccount (or such other account opened for this purpose) and applied by theissuer to repay the issuer notes on each

 

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interest payment date afterexchanging at the “spot” rate, the relevant proceeds from sterling into USdollars or euros as required.

 

**The issuer interest rate swap**

 

To the extent that it has funds available, oneach quarterly Funding 1 interest payment date, Funding 1 will pay to theissuer interest and, if applicable, principle due on the issuer series 5A1 termAAA advance at a Libor-based rate for three month sterling deposits. The series5 class A1 issuer notes, until the interest payment date falling in June 2009accrues interest at a fixed rate in sterling. To deal with the potentialinterest rate mismatch between (i) its receipts in respect of the series5A1 term AAA advance and (ii) its liabilities in respect of interestpayable on the series 5 class A1 issuer notes, the issuer has, pursuant to theterms of the series 5 class A1 issuer interest rate swap, swapped its receiptsin respect of the series 5 A1 term AAA advance on terms that match the issuer’sobligation to pay interest under the series 5 class A1 issuer notes.

 

In the event that the issuer interest rateswap is terminated prior to the service of an issuer note acceleration noticeor the interest payment date falling in June 2009, the issuer shall enterinto a replacement issuer interest rate swap. Any replacement issuer interestrate swap must be entered into on terms acceptable to the rating agencies, theissuer and the security trustee and with a replacement issuer interest rateswap provider whom the rating agencies have previously confirmed in writing tothe issuer and the security trustee will not cause the current ratings of theissuer notes to be downgraded, withdrawn or qualified. If the issuer is unableto enter into a replacement issuer interest rate swap on terms acceptable tothe rating agencies, this may affect amounts available to pay amounts due underthe issuer notes.

 

If an issuer interest rate swap agreement isterminated and the issuer is unable to enter into a replacement swap asdescribed above, then any interest payments received by the issuer in respectof the series 5 class A1 term AAA advance on each Funding 1 interest paymentdate shall be deposited in the issuer bank account (or such account opened forthis purpose) applied by the issuer to pay interest to the holders of theseries 5 class A1 issuer notes on each interest payment date.

 

**Ratings downgrade of swap providers**

 

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

 

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**Termination of the swaps**

 

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

 

Each issuer swap other than the series 2class A issuer swap, the series 3 class A issuer swap and the series 5 class A1issuer swap, will terminate on the earlier of the interest payment date fallingin June 2042 and the date on which all of the relevant class and series ofissuer notes are redeemed in full. The series 2 class A issuer swap willterminate on the earlier of the interest payment date falling in June 2011and the date on which the series 2 class A issuer notes are redeemed in full.The series 3 class A issuer swap will terminate on the earlier of the interestpayment date falling in June 2034 and the date on which the series 3 classA issuer notes are redeemed in full. The series 5 class A1 issuer swap willterminate on the earlier of the interest payment date falling in June 2009and the date on which the series 5 Class A1 issuer notes are redeemed infull.

 

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

 

•                  ifthere is a failure by a party to pay any amounts due under that swap and anyapplicable grace period has expired;

 

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

 

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

 

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

 

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

 

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

 

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

 

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applicable, the guarantor of the relevantswap provider fails to comply with its obligations under the guarantee;

 

•                  ifa change in law resulting in the obligations of one of the parties becomingillegal;

 

•                  inthe case of the series 1 issuer swap provider and the series 2 issuer swapprovider, if withholding taxes are imposed on payments made by the issuer swapprovider due to a change in law and, in respect of the series 3 issuer swaps,at the option of the series 3 issuer swap provider but subject to obtaining theconsent of the security trustee, if withholding taxes are imposed on paymentsmade by the AIG issuer swap guarantor under the AIG issuer swap guarantee; and

 

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

 

Upon the occurrence of a swap earlytermination event, the issuer or the relevant issuer swap provider may beliable to make a termination payment to the other party (in the case of anissuer swap) and/or Funding 1 or the Funding 1 swap provider may be liable tomake a termination payment to the other party (in the case of the Funding 1swap). This termination payment will be calculated and made in sterling. Theamount of any termination payment will be based on the market value of theterminated swap as determined on the basis of quotations sought from leadingdealers as to the cost of entering into a swap with the same terms andconditions that would have the effect of preserving the economic equivalent ofthe respective full payment obligations of the parties (or based upon a goodfaith determination of total losses and costs (or gains) if an insufficientnumber of quotations can be obtained or if basing the valuation on quotationswould not produce a commercially reasonable result). Any such terminationpayment could be substantial.

 

If any issuer swap is terminated early and atermination payment is due by the issuer to an issuer swap provider, then,pursuant to its obligations under the issuer intercompany loan, Funding 1 shallpay to the issuer an amount equal to the termination payment due to therelevant issuer swap provider less any amount received by the issuer under anyreplacement issuer swap agreement. These payments will be made by Funding 1 onlyafter paying interest amounts due on the issuer term advances and afterproviding for any debit balance on the principal 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 the issuer receives a termination paymentfrom an issuer currency swap provider, then the issuer shall use those fundstowards meeting its costs in effecting currency exchanges at the applicablespot rate of exchange until a replacement issuer currency swap is entered intoand/or to acquire a replacement issuer currency swap.

 

If the issuer receives a termination paymentfrom the issuer interest rate swap provider, then the issuer shall depositthose funds in the issuer bank account (or such other account opened for suchpurpose) and apply the funds to pay interest on the series 5 class A1 issuernotes until a replacement issuer interest rate swap is entered into and/oracquire a replacement issuer interest rate swap.

 

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Noteholders will not receive extra amounts(over and above interest and principal payable on the issuer notes) as a resultof the issuer receiving a termination payment.

 

**Transfer of the swaps**

 

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

 

**Taxation**

 

Neither Funding 1 nor the issuer is obligedunder any of the swaps to gross up payments made by them if withholding taxesare imposed on payments made under the Funding 1 swap or the issuer swaps.

 

Each swap provider will generally be obliged togross up payments made by it to Funding 1 or the issuer, as appropriate, ifwithholding taxes are imposed on payments made under the Funding 1 swap or theissuer swaps.

 

However, if an issuer swap provider isrequired to gross up a payment under the issuer swaps, the relevant issuer swapprovider may, subject to the consent of the security trustee, terminate therelevant issuer swaps.

 

The AIG issuer swap guarantor will be obligedto gross up payments made by it to the issuer if withholding taxes are imposedon payments under the AIG issuer swap guarantee. However, if the AIG issuerswap guarantor is required to gross up a payment under the AIG issuer swapguarantee in respect of a relevant currency swap, the series 3 issuer swapprovider may, subject to the consent of the security trustee, terminate therelevant issuer currency swap.

 

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

 

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

 

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**PART II**

 

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

 

None.

 

**Item 14. Material Modifications to the Rights of Security Holders and Use ofProceeds**

 

None.

 

**Item 15. Controls and Procedures**

 

Not applicable.

 

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

 

Notapplicable.

 

**Item 16B. Code of Ethics**

 

Notapplicable.

 

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

 

Not applicable.

 

**Item 16D. Exemptions from the Listing Standards for Audit Committees**

 

Not applicable.

 

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

 

Not applicable.

 

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**PART III**

 

**Item 17. Financial Statements**

 

Not applicable.

 

**Item 18. Financial Statements**

 

Not applicable.

 

**Item 19. Exhibits**

 

The following documents are filed as part ofthe 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 therights of the security holders as described in the Registration Statement areincorporated by reference from the Registration Statement.

 

Exhibit 12: Section 302certification.

 

Exhibit 15.1: Investor’s Report for themonth of July 2004 (incorporated by reference from the Form 6-Kpreviously filed on August 12, 2004).

 

Exhibit 15.2:Investor’s Report for the month of August 2004 (incorporated by referencefrom the Form 6-K previously filed on September 9, 2004).

 

Exhibit 15.3:Investor’s Report for the month of September 2004 (incorporated byreference from the Form 6-K previously files on October 13, 2004).

 

Exhibit 15.4:Investor’s Report for the month of October 2004 (incorporated by referencefrom the Form 6-K previously files on November 17, 2004).

 

Exhibit 15.5:Investor’s Report for the month of November 2004 (incorporated byreference from the Form 6-K previously files on December 8, 2004).

 

Exhibit 15.6:Investor’s Report for the month of December 2004 (incorporated byreference from the Form 6-K previously files on January 14, 2004 andrevised January 18, 2004).

 

Exhibit 15.7:Servicer compliance statement.

 

Exhibit 15.8: Attestation report ofindependent accountants.

 

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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. 5) 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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