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FORM 10-QSB

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES AND
EXCHANGE ACT OF 1934



For the quarterly period ended
September 30, 2003



Commission File Number
0-



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KH FUNDING COMPANY

(Exact name of small business issuer as specified in its charter)



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|Maryland                                                       |  | 6162                                                     |  | 52-1886133                          
|-------------------------------------------------------------- |  | -------------------------------------------------------- |  | ------------------------------------
|(state or other jurisdiction of incorporation or organization) |  | (Primary Standard Industrial Classification Code Number) |  | (IRS Employer Identification Number)



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10801 Lockwood Drive, Suite 370

Silver Spring, Maryland 20901

(301) 592-8100

(address and telephone number of principal executive office)



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Check whether
the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.



YES  x    NO ̈



State the number of shares outstanding of each of the issuers class of Common Stock as
of the latest practicable date.



|Class                                   |  | Outstanding as of November 1, 2003
|--------------------------------------- |  | ----------------------------------
|Common Stock, $0.01 par value per share |  | 1,987,366                         



Transitional Small Business Disclosure
Format (Check One);



YES ̈NO  x



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PART I  FINANCIAL INFORMATION



ITEM 1. UNAUDITED
FINANCIAL STATEMENTS



|                                             | 
|-------------------------------------------- | 
|BALANCE SHEETS                               | 
|                                             | 
|STATEMENTS OF OPERATIONS                     | 
|                                             | 
|STATEMENTS OF CHANGE IN STOCKHOLDERS EQUITY | 
|                                             | 
|STATEMENTS OF CASH FLOWS                     | 
|                                             | 
|NOTES TO INTERIM FINANCIAL INFORMATION       | 



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KH FUNDING COMPANY

BALANCE SHEETS



|                                                                                                                                         |  | September 30, 2003 |            |   | September 30, 2002 |  
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ------------------ | -
|                                                                                                                                         |  | (unaudited)        |            |   |                    |  
|Assets                                                                                                                                   |  |                    |            |   |                    |  
|Notes ReceivableHeld for Yield                                                                                                          |  | $                  | 15,511,137 |   |                    | $
|Accrued Interest Receivable                                                                                                              |  |                    | 421,388    |   |                    |  
|Cash                                                                                                                                     |  |                    | 2,186,080  |   |                    |  
|Prepaid Expenses                                                                                                                         |  |                    | 294,125    |   |                    |  
|Other Receivables                                                                                                                        |  |                    | 76,099     |   |                    |  
|Investments:                                                                                                                             |  |                    |            |   |                    |  
|Marketable securities                                                                                                                    |  |                    | 1,325,552  |   |                    |  
|Other                                                                                                                                    |  |                    | 191,872    |   |                    |  
|Property and EquipmentNet                                                                                                               |  |                    | 42,943     |   |                    |  
|Real Estate Owned:                                                                                                                       |  |                    |            |   |                    |  
|Rental Property                                                                                                                          |  |                    | 1,004,738  |   |                    |  
|Held for Resale                                                                                                                          |  |                    | 55,267     |   |                    |  
|Other Assets                                                                                                                             |  |                    | 8,552      |   |                    |  
|                                                                                                                                         |  |                    |            |   |                    |  
|Total Assets                                                                                                                             |  | $                  | 21,117,753 |   |                    | $
|                                                                                                                                         |  |                    |            |   |                    |  
|                                                                                                                                         |  |                   
|Liabilities and Stockholders Equity                                                                                                     |  |                    |            |   |                    |  
|                                                                                                                                         |  |                   
|Liabilities                                                                                                                              |  |                    |            |   |                    |  
|Participation Loans                                                                                                                      |  | $                  | 824,305    |   |                    | $
|Notes and Accrued Interest Payable                                                                                                       |  |                    | 19,470,550 |   |                    |  
|Borrowings                                                                                                                               |  |                    |           |   |                    |  
|Accounts Payable and Accrued Payroll Liabilities                                                                                         |  |                    | 4,397      |   |                    |  
|Escrows                                                                                                                                  |  |                    | 21,202     |   |                    |  
|                                                                                                                                         |  |                    |            |   |                    |  
|                                                                                                                                         |  |                   
|Total Liabilities                                                                                                                        |  |                    | 20,320,454 |   |                    |  
|                                                                                                                                         |  |                   
|Stockholders Equity                                                                                                                     |  |                    |            |   |                    |  
|Common Stock (5,000,000 shares authorized; 1,987,366 shares and 1,992,506 shares, respectively, issued and outstanding; $0.01 par
value) |  |                    | 19,851     |   |                    |  
|Paid-in-Capital                                                                                                                          |  |                    | 1,181,905  |   |                    |  
|Accumulated Deficit                                                                                                                      |  |                    | (239,716   | ) |                    |  
|Less Subscription and Note Receivable                                                                                                    |  |                    | (185,450   | ) |                    |  
|Cumulative other comprehensive income                                                                                                    |  |                    | 20,709     |   |                    |  
|                                                                                                                                         |  |                    |            |   |                    |  
|                                                                                                                                         |  |                   
|Total Stockholders Equity                                                                                                               |  |                    | 797,299    |   |                    |  
|                                                                                                                                         |  |                    |            |   |                    |  
|                                                                                                                                         |  |                   
|Total Liabilities and Stockholders Equity                                                                                               |  | $                  | 21,117,753 |   |                    | $
|                                                                                                                                         |  |                    |            |   |                    |  



The accompanying notes
are an integral part of these statements.



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KH FUNDING COMPANY

STATEMENTS OF OPERATIONS



|                                                  |  | For the Three MonthsEnded September 30, |         |      | For the Nine Months Ended September 30,
|------------------------------------------------- |  | --------------------------------------- | ------- | ---- | ---------------------------------------
|                                                  |  | 2003                                    |         | 2002 |                                        
|                                                  |  | (unaudited)                             |         |      | (unaudited)                            
|Interest Income                                   |  |                                         |         |      |                                        
|Interest and Fees on Loans                        |  | $                                       | 462,936 |      | $                                      
|Interest on Bank Accounts                         |  |                                         | 2,229   |      |                                        
|Interest on InvestmentsMarketable Securities     |  |                                         | 18,525  |      |                                        
|                                                  |  |                                         |         |     
|Other Interest                                    |  |                                         | 32,183  |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Total Interest Income                             |  |                                         | 515,873 |      |                                        
|                                                  |  |                                         |         |     
|Interest Expense                                  |  |                                         |         |      |                                        
|Interest and Fees on Borrowing                    |  |                                         | 276,046 |      |                                        
|Interest on Participation                         |  |                                         | 19,453  |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Total Interest Expense                            |  |                                         | 295,499 |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Net Interest Income                               |  |                                         | 220,374 |      |                                        
|                                                  |  |                                         |         |     
|Provision for Loan Losses                         |  |                                         | 60,000  |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Net Interest Income after Provision for Loan Loss |  |                                         | 160,374 |      |                                        
|                                                  |  |                                         |         |     
|Non-interest Income                               |  |                                         |         |      |                                        
|Rental Income                                     |  |                                         | 17,853  |      |                                        
|Other                                             |  |                                         | 1,878   |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Total Non-Interest Income                         |  |                                         | 19,731  |      |                                        
|                                                  |  |                                         |         |     
|Non-interest Expense                              |  |                                         |         |      |                                        
|Payroll                                           |  |                                         | 64,802  |      |                                        
|Insurance                                         |  |                                         | 13,607  |      |                                        
|Depreciation                                      |  |                                         | 12,674  |      |                                        
|Rent                                              |  |                                         | 10,158  |      |                                        
|Legal and Accounting                              |  |                                         | 14,875  |      |                                        
|Bank Charges                                      |  |                                         | 5,618   |      |                                        
|Other                                             |  |                                         | 41,546  |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Total Non-Interest Expense                        |  |                                         | 163,280 |      |                                        
|                                                  |  |                                         |         |      |                                        
|                                                  |  |                                         |         |     
|Net Income (Loss)                                 |  | $                                       | 16,825  |      | $                                      
|                                                  |  |                                         |         |      |                                        



The accompanying notes
are an integral part of these statements.



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KH FUNDING COMPANY

STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY



|                                                                 |        | Common Stock |   |        | Paid-inCapital |        |   | AccumulatedDeficit |   |           | Subscriptionsand NoteReceivable |  |   | ChangeinMarketValue |   |  | TotalStockholdersEquity |         
|---------------------------------------------------------------- | ------ | ------------ | - | ------ | -------------- | ------ | - | ------------------ | - | --------- | ------------------------------- |  | - | ------------------- | - |  | ------------------------ | --------
|                                                                 | Shares |              |   | Amount |                |        |   |                    |   |          
|Balance at December 31, 2001, as restated                        |        | 1,811,625    |   |        | $              | 18,117 |   |                    | $ | 1,268,587 |                                 |  | $ | (321,142            | ) |  | $                        | (185,450
|Additional Stock Issued                                          |        | 180,881      |   |        |                | 1,808  |   |                    |   | 450,053   |                                 |  |   |                    |   |  |                          |        
|Dividend Declared                                                |        |             |   |        |                |       |   |                    |   | (286,094  | )                               |  |   |                    |   |  |                          |        
|                                                                 |        |              |   |        |                |        |  
|Comprehensive Income:                                            |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|Net Income for the Year Ended December 31, 2002                  |        |              |   |        |                |        |   |                    |   |           |                                 |  |   | 29,076              |   |  |                          |        
|Change in market Value                                           |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                    |   |  |                          |        
|                                                                 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|                                                                 |        |              |   |        |                |        |  
|Total Comprehensive Income, 2002                                 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|                                                                 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|Balance at December 31, 2002                                     |        | 1,992,506    |   |        |                | 19,925 |   |                    |   | 1,432,546 |                                 |  |   | (292,066            | ) |  |                          | (185,450
|Additional Stock Issued                                          |        | 2,660        |   |        |                | 27     |   |                    |   | 5,013     |                                 |  |   |                     |   |  |                          |         
|Stock Redeemed                                                   |        | (10,100      | ) |        |                | (101   | ) |                    |   | (23,539   | )                               |  |   |                     |   |  |                          |         
|Dividend Declared                                                |        |              |   |        |                |        |   |                    |   | (232,115  | )                               |  |   |                     |   |  |                          |         
|Comprehensive Income:                                            |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|Net Income for the Nine months Ended September 30, 2003          |        |              |   |        |                |        |   |                    |   |           |                                 |  |   | 52,350              |   |  |                          |         
|Change in Market Value                                           |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|                                                                 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|                                                                 |        |              |   |        |                |        |  
|Total Comprehensive Income, Nine months Ended September 30, 2003 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|                                                                 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         
|                                                                 |        |              |   |        |                |        |  
|Balance at September 30, 2003 (unaudited)                        |        | 1,985,066    |   |        | $              | 19,851 |   |                    | $ | 1,181,905 |                                 |  | $ | (239,716            | ) |  | $                        | (185,450
|                                                                 |        |              |   |        |                |        |   |                    |   |           |                                 |  |   |                     |   |  |                          |         



The accompanying notes
are an integral part of these statements.



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KH FUNDING COMPANY

STATEMENTS OF CASH FLOWS



|                                                        |  | For the Nine Months Ended September 30, |            
|------------------------------------------------------- |  | --------------------------------------- | -----------
|                                                        |  | 2003                                    |            
|                                                        |  | (unaudited)                             |            
|Increase (Decrease) in Cash                             |  |                                         |            
|                                                        |  |                                        
|Cash Flows from Operating Activities                    |  |                                         |            
|Interest Received from Borrower                         |  | $                                       | 1,213,140  
|Other Receipts                                          |  |                                         | 117,279    
|Interest Paid on Notes                                  |  |                                         | (509,988   
|Paid-for Goods and Services                             |  |                                         | (550,751   
|                                                        |  |                                         |            
|                                                        |  |                                        
|Net Cash Provided by Operating Activities               |  |                                         | 269,680    
|                                                        |  |                                         |            
|                                                        |  |                                        
|Cash Flows from Investing Activities                    |  |                                         |            
|Principal Repayments from Borrowers                     |  |                                         | 4,830,365  
|Loans Made to Borrowers                                 |  |                                         | (4,593,624 
|Purchase (Sale) of Property and Equipment               |  |                                         | (2,043     
|Payments for Other Receivables                          |  |                                         | 28,939     
|Payments on Other Real Estate Owned                     |  |                                         | (16,250    
|Other Assets                                            |  |                                         | 2,000      
|Purchase of marketable securities and other investments |  |                                         | (637,312   
|                                                        |  |                                         |            
|                                                        |  |                                        
|Net Cash Used in Investing Activities                   |  |                                         | (387,925   
|                                                        |  |                                        
|Cash Flows from Financing Activities                    |  |                                         |            
|Proceeds (Redemption) of Common Stock                   |  |                                         | (18,600    
|Proceeds from Investors Notes                          |  |                                         | 16,880,241 
|Increase (Decrease) in Escrow                           |  |                                         | (2,902     
|Principal Payments on Investor Notes                    |  |                                         | (15,309,422
|Increase (Decrease) in Participation Loans              |  |                                         | (253,425   
|Increase (Decrease) in Borrowings                       |  |                                         | (333,877   
|Payment of Dividends                                    |  |                                         | (232,116   
|                                                        |  |                                         |            
|                                                        |  |                                        
|Net Cash Provided by Financing Activities               |  |                                         | 729,899    
|                                                        |  |                                         |            
|                                                        |  |                                        
|Net Increase in Cash                                    |  |                                         | 611,654    
|Cash Balance, beginning of interim period               |  |                                         | 1,574,426  
|                                                        |  |                                         |            
|Cash Balance, end of interim period                     |  | $                                       | 2,186,080  
|                                                        |  |                                         |            



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KH FUNDING COMPANY

STATEMENTS OF CASH FLOWS

(Continued)



|                                                                                        |  | For the Nine Months Ended September 30, |         
|--------------------------------------------------------------------------------------- |  | --------------------------------------- | --------
|                                                                                        |  | 2003                                    |         
|                                                                                        |  | (unaudited)                             |         
|Reconciliation of Net Income (Loss) to Net Cash from Operating Activities               |  |                                         |         
|Net Income (Loss)                                                                       |  | $                                       | 52,350  
|Adjustments to Reconcile Net Income (Loss) to Net Cash provided by Operating Activities |  |                                         |         
|Depreciation                                                                            |  |                                         | 38,025  
|Accretion of Interest on Note                                                           |  |                                         | 3,011   
|Gain (Loss) on Disposition of Fixed Assets                                              |  |                                         |        
|(Increase) Decrease in Prepaid Expenses                                                 |  |                                         | (127,450
|Loan Loss Reserve Expense                                                               |  |                                         | 132,000 
|Increase (Decrease) in Interest Receivable (included in Notes Receivable)               |  |                                         | (196,899
|Recovery of prior write-off                                                             |  |                                         | 4,815   
|Increase in Interest Payable (included in Notes Payable)                                |  |                                         | 414,201 
|(Decrease) Increase in Accounts Payable and Accrued Payroll Liabilities                 |  |                                         | (4,367  
|Change in Accrued Late Charges                                                          |  |                                         | (9,811  
|Amortization of points/fees                                                             |  |                                         | (36,195 
|                                                                                        |  |                                         |         
|                                                                                        |  |                                        
|Net Cash Provided by Operating Activities                                               |  | $                                       | 269,680 



The accompanying notes
are an integral part of these statements.



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KH FUNDING COMPANY



NOTES TO
INTERIM UNAUDITED FINANCIAL INFORMATION



NOTE AACCOUNTING POLICIES
AND OTHER DATA



The financial statements for the three and
nine month periods ended September 30, 2003 and 2002 are unaudited and include all adjustments which, in the opinion of management, are necessary to present fairly the results of operations for the periods then ended. All such adjustments are of a
normal and recurring nature. These financial statements should be read in conjunction with the financial statements contained in Form SB-2 of KH Funding Company (the Company) filed on October 28, 2003 (and effective on November 3, 2003)
with the Securities and Exchange Commission.



The accompanying
unaudited financial statements have been prepared in conformity with generally accepted accounting principles in the United States (GAAP) for interim financial information, as well as in accordance with the instructions to
Form 10-QSB. Accordingly, the information and footnotes required by GAAP for complete financial statements are not included. Operating results for interim periods reflected do not necessarily indicate the results that may be expected for a full
fiscal year. You should read these financial statements in conjunction with the financial statements and the accompanying notes included in the Companys Form SB-2 filed with the Securities and Exchange Commission on October 28, 2003 and
declared effective November 3, 2003.



NOTE BALLOWANCE FOR LOAN LOSSES



Analysis of the allowance for loan loss is as follows:



|                              |  | Nine Month Period EndedSeptember 30, |        
|----------------------------- |  | ------------------------------------ | -------
|                              |  | 2003 (unaudited)                     |        
|Beginning balance             |  | $                                    | 175,899
|Additions charged to expenses |  |                                      | 132,000
|Write-off of loans            |  |                                      | (89,880
|Recovery of prior write-offs  |  |                                      | 4,815  
|                              |  |                                      |        
|                              |  | $                                    | 228,833
|                              |  |                                      |        





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KH FUNDING COMPANY



NOTES TO INTERIM UNAUDITED FINANCIAL INFORMATION



The following information is presented as of:



|                                                                                             |  | December 31, 2002 |         | September 30, 2003 (unaudited)
|-------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ------------------------------
|Total recorded investment in impaired loans at the end of the period                         |  | $                 | 193,305 |                               
|Amount of that recorded investment for which there is a related allowance for credit losses  |  | $                 | 131,518 |                               
|Amount of related allowance for credit losses associated with such investment                |  | $                 | 127,232 |                               
|Amount of that recorded investment for which there is no related allowance for credit losses |  | $                 | 61,877  |                               



The following average
information is presented for the year and periods ended:



|                                                                                                                  |  | 12/31/02 |         | 09/30/03 (unaudited) |   | 09/30/02 (unaudited)
|----------------------------------------------------------------------------------------------------------------- |  | -------- | ------- | -------------------- | - | --------------------
|The average recorded investment in impaired loans during the period.                                              |  | $        | 268,780 |                      | $ | 168,743             
|The related amount of interest income recognized within that period when the loans were impaired.                 |  | $        |        |                      | $ |                    
|The amount of income recognized using a cash basis during the time within that period that the loan was impaired. |  | $        |        |                      | $ |                    



NOTE CINVESTMENTS



Marketable securities consists of the following at the
periods indicated:



|                                 |  | September 30, 2003 (unaudited)
|-------------------------------- |  | ------------------------------
|                                 |  | Cost                          
|Corporate Bonds                  |  | $                             
|Money Market Fund                |  |                               
|Accrued Interest-Corporate Bonds |  |                               
|                                 |  |                               
|                                 |  | $                             





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KH FUNDING COMPANY



NOTES TO INTERIM UNAUDITED FINANCIAL INFORMATION



NOTE DOTHER RECEIVABLES



Other receivables consists of the following as of September 30, 2003:



|Interest receivable on Subscription and Note Receivable |  | $ | 53,553  |  
|------------------------------------------------------- |  | - | ------- | -
|Advance on contract services                            |  |   | 28,064  |  
|Short term note receivable-sale of foreclosure property |  |   | 29,800  |  
|Short term note receivableemployee                     |  |   | 100     |  
|Other accounts receivable                               |  |   | 6,762   |  
|Pending Transfer                                        |  |   | (42,180 | )
|                                                        |  |   |         |  
|                                                        |  | $ | 76,099  |  



NOTE ERELATED PARTY
TRANSACTIONS



The Company engaged in the following related
party transactions:



Included in notes receivable at December
31, 2002, are six notes totaling $822,727, and 6 notes totaling $817,700 as of September 30, 2003, from officers, stockholders and a company controlled by an officer. These notes all have annual maturities and are due in full on the maturity date
unless extended by the Company. The interest rates on these notes range between 5.99% and 12.5%.



Included in the notes payable balance at December 31, 2002, are 51 notes totaling $6,163,393, and 48 notes totaling $5,605,245 as of September 30, 2003,
which are held by stockholders. These notes were all issued at the rate in effect for the applicable term selected as of the date the note was issued.



NOTE FSUBSEQUENT MATERIAL EVENTS



On November 3, 2003, our registration statement on Form SB-2 (333- 106501) was declared effective by the U.S. Securities and Exchange Commission. We
registered $30,000,000 of Series 3 Senior Secured Investment Debt Securities and $10,000,000 of Series 4 Subordinated Unsecured Investment Debt Securities.





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|ITEM | 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
|---- | ------------------------------------------------------------



Managements Discussion and Analysis or Plan of Operation and other sections contain forward-looking statements that are based on managements expectations,
estimates, projections and assumptions. Words such as expects, anticipates, plans, believes, estimates and variations of such words and similar expressions are intended to identify such
forward-looking statements that include, but are not limited to, projections of revenues, earnings, segment performance, cash flows and contract awards. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict. Therefore, actual future results and trends may differ materially from
what is indicated in forward-looking statements due to a variety of factors.



MANAGEMENTS DISCUSSION AND ANALYSIS



Overview



KH Funding Company conducts both
mortgage and investment banking operations from its headquarters in Silver Spring, Maryland. Its primary business activities consist of originating, acquiring and servicing mortgage loans, and issuing interest-bearing debt securities to investors.
We emphasize the direct origination of small commercial real estate mortgage loans and investment property residential mortgage loans. We purchase first and second trust residential loans nationwide from other lenders and banks.



Our net income depends largely upon our net interest income, which is the
difference between interest income from loans and investments, referred to as interest-earning assets, and interest expense on investor notes and other borrowed funds, referred to as interest-bearing liabilities. Our net interest income may be
affected by general economic conditions, policies established by regulatory authorities and competition.



Recent Developments



Initial Public Offering. On November 3, 2003, our registration statement on Form SB-2 (333- 106501) was declared effective by the U.S. Securities and Exchange Commission. We registered $30,000,000 of Series 3 Senior Secured
Investment Debt Securities and $10,000,000 of Series 4 Subordinated Unsecured Investment Debt Securities. We do not expect any trading market to develop for the Notes. The offering is not underwritten and the Notes will be sold on a best efforts
basis, with no broker dealers involved in the sale of the Notes. The Notes will only be offered by Mr. Robert L. Harris, our President and Chief Executive Officer, who will not be compensated for such services. The offering will terminate one year
after the effective date of the prospectus.



Comparison of Financial
Condition at September 30, 2003 and December 31, 2002



Assets. Total assets increased $1.23 million, from $19.89 million at December 31, 2002 to $21.12 million at September 30, 2003. The size of our loan portfolio was mostly unchanged at



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the beginning and end of the period, but during the nine months $4.83 million in loans were acquired and $4.59 million were paid off. Approximately half of
the $1.23 million increase was in cash, and approximately half in bonds.



Liabilities. Total liabilities increased $1.40 million, from $18.92 million at December 31, 2002 to $20.32 million at September 30, 2003. The increase was in notes payable to investors, which increased from
$17.48 million at December 31, 2002 to $19.47 million at September 30, 2003, and an increase in participation loans from $1.08 million to $1.72 million.



Equity. Total stockholders equity decreased from $971,057 at December 31, 2002 to $797,299 at September 30, 2003. The decrease was due
primarily to the payment of dividends in excess of profits during the period.



Delinquent Loans.We sometimes make what are known as hard collateral loans, or loans based largely on collateral value, where the value of the collateral is below 70% of the loan amount. As of
September 30, 2003 we had twenty-one loans on our books that were more than 90 days late but are still accruing interest. The total amount due on these loans was $2,108,448. Eleven of the loans, owing $1,913,683 are hard collateral first trust loans
on which we do not expect to lose any significant amount, and the other ten loans are paying currently or we anticipate that they will be doing so shortly. For these loans we feel justified in continuing to accrue interest because we believe we will
be paid in full. These loans are monitored more closely for trouble than any other loans in our portfolio.



Non-accrual Loans. As of September 30, 2003, there were 21 loans more than ninety days delinquent in non-accrual status with a value of $756,234.
The bulk of these loans are first trust loans that are well collateralized. In the event we have to foreclose on any of these loans, we do not expect to lose significant sums. We have a general reserve of $94,131, as part of our total reserve of
$228,833.



Comparison of Operating Results for Nine Months Ended September
30, 2003 and 2002



The average yield earned on loans
receivable was 10.69% for the nine months ended September 30, 2003, and 11.20% for the nine months ended September 30, 2002. The decrease was due mainly to borrowers paying off some of the higher interest rate loans. The average rate paid on
investor accounts declined to 5.99% in the nine months ended September 30, 2003 from 6.44% in the nine months ended September 30, 2002, due primarily to rollover by investors of maturing higher interest rate notes. Overall, the net margin on
interest declined to 4.70% for the nine months ended September 30, 2003, from 4.76% for the nine months ended September 30, 2002. The net margin is at note rates and excludes fee income and expense.



Net Income. Net income for the nine months ended September 30, 2003
was $52,350, compared to $3,669 for the nine months ended September 30, 2002. This increase was realized by an improvement in all components of net income. Higher interest earnings relative to interest cost, improved non-interest income, and modest
increases in expenses with no one expense item being significantly higher than in the prior year period.



Interest Income. Total interest income was $1,504,154 for the nine months ended September 30, 2003, compared to $1,271,412 for the same period in
2002. The additional income resulted from growth in the average amount of interest-earning assets between the two



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periods. The interest income includes point and fee income and interest earned on bank investments and marketable securities.



Interest Expense. Interest expense was $926,872 for the nine months
ended September 30, 2003, and $836,305 for the same period in 2002. The additional expense resulted from an increase in investor accounts and loan participations, which are treated as financings, and the accompanying interest expense for the
participants share. The interest expense includes fees paid for loan purchases.



Provision for Loan Losses. We added $132,000 to our reserve for loan losses during the nine months ended September 30, 2003, compared to $72,000 for the nine months ended September 30, 2002. This increased the
reserve to an amount deemed by management to be sufficient to meet all anticipated loan losses plus a general amount to meet unforeseen loan losses. The adequacy of the allowance is periodically reviewed and adjusted by management based upon past
experience, the value of the underlying collateral for specific loans, known or inherent risks in the loan portfolio and current economic conditions.



Non-Interest Income. We had non-interest income of $56,280 during the nine months ended September 30, 2003 and $41,336 for the same period in 2002.
The majority of which was from rental income from real estate owned.



Non-Interest (Operating) Expense. We experienced an increase in non-interest expense to $457,287 for the nine months ended September 30, 2003 from $401,733 for the nine months ended September 30, 2002. The majority of the increase
was for labor, outside services and depreciation.



Income
Taxes. KH Funding Company is a Subchapter S corporation under the Internal Revenue code and accordingly no items appear for income taxes.



Liquidity and Capital Resources



KH Funding Companys primary sources of capital are the proceeds from the sale of securities to investors, principal and interest payments on loans,
sales of participation interests in loans and rental income. While maturities and scheduled amortization of loans and investments are predictable sources of funds, the sale and redemption of investor notes and mortgage loan prepayments are greatly
influenced by interest rate trends, economic conditions and competition. Our One Day Demand Notes cause a lot of turnover in our cash positions.



The table below illustrates the Sales of Notes versus Redemptions for the years indicated:



|Year |  | Notes Sold |            | NotesRedeemed |   | Percentage | 
|---- |  | ---------- | ---------- | ------------- | - | ---------- | 
|1998 |  | $          | 5,300,897  |               | $ | 1,431,853  | 
|1999 |  | $          | 7,376,780  |               | $ | 5,455,205  | 
|2000 |  | $          | 10,367,351 |               | $ | 10,661,308 | 
|2001 |  | $          | 14,418,456 |               | $ | 11,280,177 | 
|2002 |  | $          | 22,926,619 |               | $ | 18,681,654 | 





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During the past few years, the combination of generally low interest rates on deposit products at
commercial banks, the poor performance of the stock market and increasing referrals from customers have positioned KH Funding to experience solid growth in the number of new investors attracted to its investment products. Based on its monitoring of
historic trends and its current pricing strategy for investor accounts, management believes KH Funding Company will retain a large portion of its existing investors and will experience a significant increase of funds from new investors in the
future.



Redemption of Notes Payable. Management
believes that the risk of not being able to fund redemption requests only exists if the requests for redemption exceed the amount of readily available cash, i.e., if our liquidity is insufficient to fund redemptions. Upon the sale of a note, the
funds for redemption are immediately available. Of course, part of our investment strategy is to invest funds that will be invested with us for a longer period into higher yielding, slightly less liquid investments, such as bonds; nevertheless, the
funds are still available, just not immediately. Only holders of one-day demand notes can ask for funds sooner than thirty days, and we make an effort to keep funds available for these requests. For example, at September 30, 2003 we had outstanding,
$2.9 million of one-day demand notes and $3.5 million in cash and cash equivalents. At December 31, 2002 we had outstanding, $1.9 million of one-day demand notes and $2.4 million in cash and cash equivalents. In each instance, we would have been
able to fund redemption requests from available funds for all one-day demand notes. Only holders of thirty-day demand notes can ask for funds sooner than 90 days, and if necessary, we can sell participation interests in our loans (notes receivables)
to have the funds available to meet requests from these note holders. Only holders of fixed-term notes, prior to maturity, can ask for funds in 90 days, and if necessary, we can sell loans (notes receivables) in bulk to fund requests from these note
holders. For example, at December 31, 2002 we held $10,210,750 in first trust residential and commercial property loans that could be sold in part, to a participant bank, or in whole, to other lenders, at or above par value. Further, we held
$5,087,998 in business line-of-credit loans and second trust loans which earn higher yields than the first trust loans and can also be sold, although they generally take longer to sell and are normally sold at a discount. The significance of the
company holding these notes that could be sold is that their value is more than necessary to meet the notes payable maturities for year ended December 31, 2003 of $8,636,783 of 30-day demand and 1-year, 3-year and 5-year fixed notes, under which the
investor could request redemption.



We will strive to maintain
liquid resources in excess of demand obligations. This is accomplished by always watching our demand obligations and tailoring our purchase of loans and cash positions according to such obligations.



Plan to Raise Additional Capital. We intend to continue to expand our
operations through future offerings of debt, and possibly through the sale of loan participation interests and sales of capital stock. We believe that our checking account access feature for our one-day demand notes will be popular with investors,
and we expect that we will be able to attract more investors to our longer-term fixed rate notes because we now offer trust services for IRA accounts through our Trust Services Department.



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Known Trends, Events or Uncertainties



Impact of Inflation and Interest Rates. The financial statements of KH Funding and notes thereto, presented elsewhere
herein, have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the
change in the relative purchasing power of money over time and due to inflation. The impact of inflation is generally to increase the value of underlying collateral for the loans made by KH Funding to its borrowers. Unlike typical industrial
companies, nearly all the assets and liabilities of KH Funding are monetary in nature. As a result, interest rates have a greater impact on our performance than the effects of inflation generally.



Stockholders equity. Total stockholders equity has
decreased as a percentage of total assets over the last five years, from 11.8% at December 31, 1998 to 3.8% at September 30, 2003. During this time period total stockholders equity in dollars has remained fairly constant while total assets in
dollars have increased, causing the equity-to-assets ratio to decrease. Although the ratio has decreased and is a smaller percentage compared to what it has been in the past, management believes the current ratio is still adequate for
noteholders protection. Managements belief is based in part upon the fact that historically we have had loan losses of less than 1% per year, and the ratio is more than four times that amount.



Recent Accounting Pronouncements



We have evaluated the impact on financial results, financial condition and
cash flows of recently adopted accounting standards that are not yet effective for possible impact on the Company. These include SFAS 150, Accounting of Certain Financial Instruments with Characteristics of both Liabilities and Equity and FIN
46, Consolidation of Variable Interest Entities. None of these are expected to have an impact on the Company.



The preceding paragraphs discussing the Companys financial condition contain forward-looking statements. The factors affecting the ability of the Company to meet
its funding requirements and manage its cash resources include, among other things, the amount and timing of product sales, inventory turnover, the magnitude of fixed costs, sales growth and the ability to obtain working capital, all of which
involve risks and uncertainties that are difficult to predict.



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ITEM 3. CONTROLS AND PROCEDURES



Based on their most recent evaluation, which was completed within 90 days of the filing of this Form 10-QSB, Robert L.
Harris, the Companys Chief Executive Officer and Louise B. Sehman, the Companys Chief Financial Officer, have concluded that the Companys disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) are
effective to ensure that information required to be disclosed by the Company in this report is accumulated and communicated to the Companys management, including its principal executive officer and principal financial officer, as appropriate,
to be recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commissions rules and forms.



There were no significant changes in the Companys internal controls or other factors that could significantly affect these controls subsequent to
the date of their evaluation and there were no corrective actions with regard to significant deficiencies and material weaknesses.



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PART II  OTHER INFORMATION



Item 1. Legal Proceedings



The Company is not engaged in any material legal proceedings at the present time. From time to time, the Company is a party to legal proceedings within
the normal course of business wherein it enforces its security interest in loans made by it and other matters of a like kind.



Item 2. Changes in Securities and Use of Proceeds



Not applicable



Item 3. Defaults Upon Senior Securities



Not applicable



Item 4. Submission of Matters to a Vote of Security Holders



Not applicable



Item 5. Other Information



Not applicable



Item 6. Exhibits and Report on Form 8-K

| | (a) | Exhibits
| | --- | --------

| | 
| | 

|Exhibit 31.1 |  | Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                           
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 31.2 |  | Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                           
|Exhibit 32.1 |  | Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|Exhibit 32.2 |  | Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



| | (b) | Reports on Form 8-K
| | --- | -------------------



None



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SIGNATURE



In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



KH FUNDING COMPANY

(Registrant)



Date: November 14, 2003



/s/    Louise B. Sehman

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Louise B. Sehman

Chief Financial Officer, Secretary and Treasurer



(Ms. Sehman is the Principal Financial and Accounting Officer and has been duly authorized to sign on behalf of the Registrant.)