----

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**FORM      10-QSB **

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**U.S.      SECURITIES AND EXCHANGE COMMISSION **

**WASHINGTON,      D.C. 20549 **

**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, 2006 **

**Commission      File Number 333-124155 **

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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)** |

**10801      Lockwood Drive, Suite 370 **

**Silver      Spring, Maryland 20901 **

**(301)      592-8100 **

**(address      and telephone number of principal executive office) **

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| **Class**                                              |   | **Outstanding                as of September 30, 2006** |
|--------------------------------------------------------|--------|---------------------------------------------------------|
| Common                Stock, $0.01 par value per share |   | 2,729,951                                               |

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**PART      I - FINANCIAL INFORMATION **

|                                                                                                                                                                                |   | **PAGE NOS.**   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|
| **ITEM                1. FINANCIAL STATEMENTS**                                                                                                                                     |   |                      |
|                                                                                                                                                                                |   |                      |
| BALANCE                SHEETS - September 30, 2006 (UNAUDITED) and December 31,                2005                                                                                 |   | F-2                       |
|                                                                                                                                                                                |   |                      |
| STATEMENTS                OF OPERATIONS (UNAUDITED), nine months ended September 30, 2006 and                2005                and three months ended September 30, 2006 and 2005 |   | F-3                       |
|                                                                                                                                                                                |   |                      |
| STATEMENTS                OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED), nine months ended                September                30, 2006 and 2005                         |   | F-4                       |
|                                                                                                                                                                                |   |                      |
| STATEMENTS                OF CASH FLOWS (UNAUDITED), nine months ended September 30, 2006 and                2005                                                                   |   | F-5                       |
|                                                                                                                                                                                |   |                      |
| NOTES                TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)                                                                                                                    |   | F-6                - F-13 |

----

**KH      FUNDING COMPANY **

**BALANCE      SHEETS **

|                                                                                                                                                                                                                                           |   | **September                30,****2006**  |       | **December                31,****2005**  |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|------------|-----------------------------------------------|--------|
|                                                                                                                                                                                                                                           |   | **(unaudited)**                                |       |                                          |   |
| **Assets**                                                                                                                                                                                                                                     |   |                                           |       |                                          |   |
| Cash                                                                                                                                                                                                                                           |   | $                                              | 5,264,632  |                                          | $      | 6,579,242 |   |
| Investments                Available for Sale:                                                                                                                                                                                                 |   |                                           |            |                                          |   |  |   |
| Marketable                Securities - at fair value                                                                                                                                                                                           |   |                                           | 258,983    |                                          |   | 598,609 |   |
| Other                                                                                                                                                                                                                                          |   |                                           | 50,872     |                                          |   | 50,872 |   |
| Loans,                Less Allowance for Loan Losses (September 30, 2006) $423,367 and                (December                31, 2005) $369,791                                                                                              |   |                                           | 54,042,910 |                                          |   | 40,678,941 |   |
| Accrued                Interest Receivable                                                                                                                                                                                                     |   |                                           | 1,944,317  |                                          |   | 1,405,424 |   |
| Other                Receivables                                                                                                                                                                                                               |   |                                           | 468,604    |                                          |   | 126,269 |   |
| Prepaid                Expenses                                                                                                                                                                                                                |   |                                           | 320,505    |                                          |   | 374,762 |   |
| Property                and Equipment—Net                                                                                                                                                                                                |   |                                           | 125,502    |                                          |   | 137,623 |   |
| Real                Estate Owned:                                                                                                                                                                                                              |   |                                           |       |                                          |   |   |   |
|                                                                                                                                                                                                                                           |   |                                           |       |                                          |   |   |   |
| Rental                Property                                                                                                                                                                                                                 |   |                                           | 1,042,009  |                                          |   | 622,513 |   |
| Held                for Resale                                                                                                                                                                                                                 |   |                                           | 245,479    |                                          |   | 180,302 |   |
| Other                Assets                                                                                                                                                                                                                    |   |                                           | 15,988     |                                          |   | 15,988 |   |
| **Total                Assets**                                                                                                                                                                                                                |   | $                                              | 63,779,801 |                                          | $      | 50,770,545 |   |
|                                                                                                                                                                                                                                           |   |                                           |       |                                          |   |   |   |
| **Liabilities                and Stockholders’ Equity**                                                                                                                                                                                  |   |                                           |            |                                          |   |  |   |
|                                                                                                                                                                                                                                           |   |                                           |       |                                          |   |   |   |
| **Liabilities**                                                                                                                                                                                                                                |   |                                           |            |                                          |   |  |   |
| Notes                and Accrued Interest Payable                                                                                                                                                                                              |   | $                                              | 62,109,794 |                                          | $      | 49,681,335 |   |
| Accrued                Long Term Lease Obligation                                                                                                                                                                                              |   |                                           | 17,300     |                                          |   | - |   |
| Accounts                Payable and Accrued Payroll Liabilities                                                                                                                                                                                |   |                                           | 925        |                                          |   | 2,730 |   |
| Escrows                and Deposits                                                                                                                                                                                                            |   |                                           | 149,960    |                                          |   | 171,673 |   |
| **Total                Liabilities**                                                                                                                                                                                                           |   |                                           | 62,277,979 |                                          |   | 49,855,738 |   |
|                                                                                                                                                                                                                                           |   |                                           |            |                                          |   |  |   |
| **Stockholders’                Equity**                                                                                                                                                                                                  |   |                                           |            |                                          |   |  |   |
| Common                Stock (5,000,000 shares authorized; 2,729,951 shares (September 30,                2006)                and 2,555,556 shares (December 31, 2005), issued and outstanding;                $0.01                par value) |   |                                           | 27,299     |                                          |   | 25,556 |   |
| Paid-in-Capital                                                                                                                                                                                                                                |   |                                           | 1,932,552  |                                          |   | 1,603,852 |   |
| Accumulated                Deficit                                                                                                                                                                                                             |   |                                           | (224,233   | )                                             |   | (429,688 | ) |
| Less                Subscription Note Receivable                                                                                                                                                                                               |   |                                           | (185,450   | )                                             |   | (185,450 | ) |
| Accumulated                Other Comprehensive Loss                                                                                                                                                                                            |   |                                           | (48,346    | )                                             |   | (99,463 | ) |
|                                                                                                                                                                                                                                           |   |                                           |       |                                          |   |   |   |
| **Total                Stockholders’ Equity**                                                                                                                                                                                            |   |                                           | 1,501,822  |                                          |   | 914,807 |   |
|                                                                                                                                                                                                                                           |   |                                           |            |                                          |   |  |   |
| **Total                Liabilities and Stockholders’ Equity**                                                                                                                                                                            |   | $                                              | 63,779,801 |                                          | $      | 50,770,545 |   |

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**KH      FUNDING COMPANY **

**STATEMENTS      OF OPERATIONS (UNAUDITED) **

|                                                                  |   | For                  the Three Months Ended September                  30, |      | For                  the Nine Months Ended September                  30,  |   |
|-----------------------------------------------------------------------|--------|----------------------------------------------------------------------------|-----------|---------------------------------------------------------------------------------|--------|
|                                                                  |   | 2006                                                                       |      | 2005                                                                            |   | 2006 |   | 2005 |   |
| **Interest                  Income**                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |
| Interest                  and Fees on Loans                           |   | $                                                                          | 1,616,788 |                                                                            | $      | 885,296 |   | $ | 4,295,628 |   | $ | 2,307,585 |   |
| Interest                  on Bank Accounts                            |   |                                                                       | 15,281    |                                                                            |   | 32,281 |   |   | 112,233 |   |   | 74,920 |   |
| Interest                  on Investments —Marketable Securities |   |                                                                       | 6,996     |                                                                            |   | 7,708 |   |   | 22,461 |   |   | 22,422 |   |
| Total                  Interest Income                                |   |                                                                       | 1,639,065 |                                                                            |   | 925,285 |   |   | 4,430,322 |   |   | 2,404,927 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| **Interest                  Expense**                                 |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| Interest                  and Fees on Notes Payable                   |   |                                                                       | 1,078,502 |                                                                            |   | 644,936 |   |   | 2,910,264 |   |   | 1,609,293 |   |
| Interest                  on Participations                           |   |                                                                       | -         |                                                                            |   | 3,669 |   |   | - |   |   | 10,899 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| Total                  Interest Expense                               |   |                                                                       | 1,078,502 |                                                                            |   | 648,605 |   |   | 2,910,264 |   |   | 1,620,192 |   |
| Net                  Interest Income                                  |   |                                                                       | 560,563   |                                                                            |   | 276,680 |   |   | 1,520,058 |   |   | 784,735 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| **Provision                  for Loan Losses**                        |   |                                                                       | 55,832    |                                                                            |   | 39,000 |   |   | 175,103 |   |   | 104,000 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| Net                  Interest Income after Provision for Loan Losses  |   |                                                                       | 504,731   |                                                                            |   | 237,680 |   |   | 1,344,955 |   |   | 680,735 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| **Non-interest                  Income**                              |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| Rental                  Income                                        |   |                                                                       | 13,628    |                                                                            |   | 14,030 |   |   | 38,387 |   |   | 46,636 |   |
| Loss                  on Sale of Real Estate Owned                    |   |                                                                       | (130,795  | )                                                                               |   | (21,694 | ) |   | (156,482 | ) |   | (21,694 | ) |
| Other                                                                 |   |                                                                       | 8,133     |                                                                            |   | 5,671 |   |   | 16,837 |   |   | 16,012 |   |
| Total                  Non-Interest Income (Loss)                     |   |                                                                       | (109,034  | )                                                                               |   | (1,993 | ) |   | (101,258 | ) |   | 40,954 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| **Non-interest                  Expense**                             |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| Salaries                  and Wages                                   |   |                                                                       | 97,752    |                                                                            |   | 88,617 |   |   | 291,707 |   |   | 263,289 |   |
| Professional                  Fees                                    |   |                                                                       | 51,664    |                                                                            |   | 36,616 |   |   | 135,343 |   |   | 92,758 |   |
| Offering                  Costs                                       |   |                                                                       | 54,663    |                                                                            |   | 52,312 |   |   | 168,488 |   |   | 140,392 |   |
| Administration                                                        |   |                                                                       | 19,583    |                                                                            |   | 26,044 |   |   | 85,626 |   |   | 70,438 |   |
| Real                  Estate Maintenance                              |   |                                                                       | 36,704    |                                                                            |   | 4,832 |   |   | 82,496 |   |   | 21,915 |   |
| Insurance                                                             |   |                                                                       | 18,282    |                                                                            |   | 13,454 |   |   | 56,573 |   |   | 47,448 |   |
| Stock-Based                  Compensation                             |   |                                                                       | 21,275    |                                                                            |   | - |   |   | 36,700 |   |   | - |   |
| Depreciation                                                          |   |                                                                       | 14,609    |                                                                            |   | 12,716 |   |   | 43,745 |   |   | 36,296 |   |
| Rent                                                                  |   |                                                                       | 29,171    |                                                                            |   | 11,207 |   |   | 89,665 |   |   | 33,623 |   |
| Bank                  Charges                                         |   |                                                                       | 13,591    |                                                                            |   | 5,655 |   |   | 25,275 |   |   | 18,698 |   |
| Other                                                                 |   |                                                                       | 3,178     |                                                                            |   | 6,569 |   |   | 22,624 |   |   | 17,130 |   |
| Total                  Non-Interest Expense                           |   |                                                                       | 360,472   |                                                                            |   | 258,022 |   |   | 1,038,242 |   |   | 741,987 |   |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| **Net                  Income (Loss)**                                |   | $                                                                          | 35,225    |                                                                            | $      | (22,335 | ) | $ | 205,455 |   | $ | (20,298 | ) |
|                                                                  |   |                                                                       |      |                                                                            |   |   |   |   |   |   |   |   |   |
| Basic                  Earnings (Loss) Per Share                      |   | $                                                                          | 0.01      |                                                                            | $      | (0.01 | ) | $ | 0.08 |   | $ | (0.01 | ) |
| Diluted                  Earnings (Loss) Per Share                    |   | $                                                                          | 0.01      |                                                                            | $      | (0.01 | ) | $ | 0.08 |   | $ | (0.01 | ) |
| Cash                  Dividends Paid Per Common Share                 |   | $                                                                          | 0.02      |                                                                            | $      | 0.02 |   | $ | 0.06 |   | $ | 0.08 |   |

*The      accompanying notes are an integral part of these statements. *

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**KH      FUNDING COMPANY**

**STATEMENTS      OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED) **

**FOR      THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 **

|                                                                  |   | **Common                    Stock** |      |       |   |                   |   |                    **Subscriptions** |      | **Accumulated                    Other **  |   |                    **Total**                  |   |
|-----------------------------------------------------------------------|--------|-------------------------------------|-----------|------------|--------|------------------------|--------|-------------------------------------------|-----------|------------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                                  |   | **Shares**                     |      | **Amount** |   | **Paid-in****Capital** |   | **Accumulated****Deficit**                |      | **and                      Note****Receivable**      |   | **Comprehensive                    Income (Loss)** |   | **Stockholders’****Equity** |   |
| **Balances                    at January 1, 2005**                    |   |                                | 2,505,556 |       | $      | 25,056                 |   | $                                         | 1,750,443 |                                                 | $      | (385,373                                           | )      | $ | (185,450 | ) | $ | (8,824 | ) | $ | 1,195,852 |   |
|                                                                  |   |                                |      |       |   |                   |   |                                      |      |                                                 |   |                                               |   |   |   |   |   |   |   |   |   |   |
|     Dividend                    Paid              |   |                                | -         |       |   | -                      |   |                                      | (195,980  | )                                                    |   | -                                                  |   |   | - |   |   | - |   |   | (195,980 | ) |
| **Comprehensive                    Income:**                          |   |                                |      |       |   |                   |   |                                      |      |                                                 |   |                                               |   |   |   |   |   |   |   |   |   |   |
| Net                    Loss for the Period ending September 30, 2005  |   |                                | -         |       |   | -                      |   |                                      | -         |                                                 |   | (20,298                                            | )      |   | - |   |   | - |   |   | (20,298 | ) |
| Change                    in Fair Value of Investments                |   |                                | -         |       |   | -                      |   |                                      | -         |                                                 |   | -                                                  |   |   | - |   |   | (58,797 | ) |   | (58,797 | ) |
|                                                                  |   |                                |           |       |   |                        |   |                                      |           |                                                 |   |                                                    |   |   |  |   |   |  |   |   |   |   |
| Total                    Comprehensive Loss for the Period            |   |                                | -         |       |   | -                      |   |                                      | -         |                                                 |   | -                                                  |   |   | - |   |   | - |   |   | (79,095 | ) |
|                                                                  |   |                                |           |       |   |                        |   |                                      |           |                                                 |   |                                                    |   |   |  |   |   |  |   |   |  |   |
| **Balances                    at September 30, 2005**                 |   |                                | 2,505,556 |       | $      | 25,056                 |   | $                                         | 1,554,463 |                                                 | $      | (405,671                                           | )      | $ | (185,450 | ) | $ | (67,621 | ) | $ | 920,777 |   |
|                                                                  |   |                                |           |       |   |                        |   |                                      |           |                                                 |   |                                                    |   |   |  |   |   |  |   |   |  |   |
| **Balances                    at January 1, 2006**                    |   |                                | 2,555,556 |       | $      | 25,556                 |   | $                                         | 1,603,852 |                                                 | $      | (429,688                                           | )      | $ | (185,450 | ) | $ | (99,463 | ) | $ | 914,807 |   |
|                                                                  |   |                                |      |       |   |                   |   |                                      |      |                                                 |   |                                               |   |   |   |   |   |   |   |   |   |   |
| Additional                    Stock Issued                            |   |                                | 174,395   |       |   | 1,743                  |   |                                      | 481,441   |                                                 |   | -                                                  |   |   | - |   |   | - |   |   | 483,184 |   |
| Stock-based                    Compensation/ Stock Option Grants      |   |                                | -         |       |   | -                      |   |                                      | 7,000     |                                                 |   | -                                                  |   |   | - |   |   | - |   |   | 7,000 |   |
| Dividends                    Paid                                     |   |                                | -         |       |   | -                      |   |                                      | (159,741  | )                                                    |   | -                                                  |   |   | - |   |   | - |   |   | (159,741 | ) |
| **Comprehensive                    Income:**                          |   |                                |      |       |   |                   |   |                                      |      |                                                 |   |                                               |   |   |   |   |   |   |   |   |   |   |
| Net                    income for the period ended September 30, 2006 |   |                                | -         |       |   | -                      |   |                                      | -         |                                                 |   | 205,455                                            |   |   | - |   |   | - |   |   | 205,455 |   |
| Change                    in Fair Value of investments                |   |                                | -         |       |   | -                      |   |                                      | -         |                                                 |   | -                                                  |   |   | - |   |   | 51,117 |   |   | 51,117 |   |
| Total                    Comprehensive Income for the period          |   |                                | -         |       |   | -                      |   |                                      | -         |                                                 |   | -                                                  |   |   | - |   |   | - |   |   | 263,572 |   |
|                                                                  |   |                                |           |       |   |                        |   |                                      |           |                                                 |   |                                                    |   |   |  |   |   |  |   |   |  |   |
| ** ****Balances                    at September 30, 2006**       |   |                                | 2,729,951 |       | $      | 27,299                 |   | $                                         | 1,932,552 |                                                 | $      | (224,233                                           | )      | $ | (185,450 | ) | $ | (48,346 | ) | $ | 1,501,822 |   |

----

**KH      FUNDING COMPANY **

**STATEMENTS      OF CASH FLOWS (UNAUDITED) **

|                                                                                                            |   | **For                The Nine Months Ended****September                30,**** ** |         |
|-----------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------------|
|                                                                                                            |   |  **2006**                                                                         |         |  **2005** |   |
| **Reconciliation                of Net Income (Loss) to Net Cash Provided by Operating Activities**             |   |                                                                                   |         |   |   |
| Net                Income (Loss)                                                                                |   | $                                                                                      | 205,455      |   | $ | (20,298 | ) |
| Adjustments                to Reconcile Net Income (Loss) to Net Cash from Operating                Activities: |   |                                                                                   |         |   |   |  |   |
| Depreciation                                                                                                    |   |                                                                                   | 43,745       |   |   | 36,296 |   |
| Amortization                of Loan Fees                                                                        |   |                                                                                   | (126,000     | ) |   | (33,273 | ) |
| Provision                for Loan Losses                                                                        |   |                                                                                   | 175,103      |   |   | 104,000 |   |
| Stock-Based                Compensation                                                                         |   |                                                                                   | 36,700       |   |   | - |   |
| (Increase)                Decrease in Accrued Late Charges                                                      |   |                                                                                   | (14,989      | ) |   | 10,227 |   |
| Loss                on Sale of Real Estate Owned                                                                |   |                                                                                   | 156,482      |   |   | 21,694 |   |
| Increase                in Prepaid Expenses                                                                     |   |                                                                                   | (203,079     | ) |   | (49,712 | ) |
| Recovery                of Prior Write-Off                                                                      |   |                                                                                   | -            |   |   | 6,500 |   |
| Increase                in Interest Receivable                                                                  |   |                                                                                   | (529,893     | ) |   | (281,642 | ) |
| Increase                in Interest Payable (Included in Notes Payable)                                         |   |                                                                                   | 1,573,154    |   |   | 934,876 |   |
| (Decrease)                Increase in Accounts Payable and Accrued Payroll                Liabilities           |   |                                                                                   | (1,805       | ) |   | 644 |   |
| Decrease                (Increase) in Prepaid Offering Costs                                                    |   |                                                                                   | 227,636      |   |   | (140,392 | ) |
| Increase                in Deferred Loan Origination Costs                                                      |   |                                                                                   | (14,708      | ) |   | - |   |
| Decrease                in Unamortized Brokerage Fees                                                           |   |                                                                                   | (50,743      | ) |   | - |   |
| Increase                in Accrued Long Term Lease Obligation                                                   |   |                                                                                   | 17,301       |   |   | - |   |
| Increase                in Prepaid Loan Expenses                                                                |   |                                                                                   | (203,060     | ) |   | - |   |
| Increase                in Other Assets                                                                         |   |                                                                                   | -            |   |   | (6187 | ) |
|                                                                                                            |   |                                                                                   |    |   |   |                               |   |
| **Net                Cash Provided by Operating Activities**                                                    |   |                                                                                   | 1,291,299    |   |   | 582,733 |   |
|                                                                                                            |   |                                                                                   |         |   |   |  |   |
| **Cash                Flows from Investing Activities**                                                         |   |                                                                                   |         |   |   |  |   |
| Principal                Repayments from Borrowers                                                              |   |                                                                                   | 21,286,337   |   |   | 12,311,654 |   |
| Loans                Directly Made to Borrowers                                                                 |   |                                                                                   | (27,433,890  | ) |   | (25,595,435 | ) |
| Loans                Purchased                                                                                  |   |                                                                                   | (7,364,900   | ) |   | (2,630,300 | ) |
| (Advances)                Collections of Other Receivables                                                      |   |                                                                                   | (291,420     | ) |   | 384,498 |   |
| Sale                of Marketable Securities and Other Investments, net of                purchases             |   |                                                                                   | 71,761       |   |   | - |   |
| Purchase/Payments                on Other Real Estate Owned                                                     |   |                                                                                   | (488,449     | ) |   | (30,925 | ) |
| Proceeds                from Sale of Real Estate Owned                                                          |   |                                                                                   | 163,177      |   |   | 49,899 |   |
| Purchase                of Property and Equipment                                                               |   |                                                                                   | (15,370      | ) |   | (42,473 | ) |
|                                                                                                            |   |                                                                                   |    |   |   |   |   |
| **Net                Cash Used in Investing Activities**                                                        |   |                                                                                   | (14,072,754  | ) |   | (15,553,082 | ) |
|                                                                                                            |   |                                                                                   |         |   |   |  |   |
| **Cash                Flows from Financing Activities**                                                         |   |                                                                                   |         |   |   |  |   |
| Proceeds                from Investor Notes                                                                     |   |                                                                                   | 87,950,172   |   |   | 85,327,830 |   |
| Principal                Payments on Investor Notes                                                             |   |                                                                                   | (77,044,124  | ) |   | (66,785,127 | ) |
| Proceeds                from Common Stock                                                                       |   |                                                                                   | 483,184      |   |   | - |   |
| Proceeds                from Borrowings, net                                                                    |   |                                                                                   | 309,982      |   |   | - |   |
| Collections                on Participation Loans                                                               |   |                                                                                   | -            |   |   | 3,120 |   |
| Payment                of Dividends                                                                             |   |                                                                                   | (159,741     | ) |   | (195,980 | ) |
| Increase                (Decrease) in Escrows and Deposits                                                      |   |                                                                                   | (72,628      | ) |   | 71,850 |   |
|                                                                                                            |   |                                                                                   |    |   |   |   |   |
| **Net                Cash Provided by Financing Activities**                                                    |   |                                                                                   | 11,466,845   |   |   | 18,421,693 |   |
|                                                                                                            |   |                                                                                   |         |   |   |  |   |
| **Net                (Decrease**)                /**Increase                in Cash**                           |   |                                                                                   | (1,314,610   | ) |   | 3,451,344 |   |
| **Cash                Balance, Beginning of Period**                                                            |   |                                                                                   | 6,579,242    |   |   | 2,669,845 |   |
| **Cash                Balance, End of Period**                                                                  |   | $                                                                                      | 5,264,632    |   | $ | 6,121,189 |   |
|                                                                                                            |   |                                                                                   |         |   |   |  |   |
| **Supplemental                Cash Flow Information**                                                           |   |                                                                                   |         |   |   |  |   |
| Interest                Paid                                                                                    |   | $                                                                                      | 1,337,110    |   | $ | 685,315 |   |
| Transfer                of Loans to Other Real Estate Owned                                                     |   | $                                                                                      | 332,137      |   | $ | 106,399 |   |

*The      accompanying notes are an integral part of these statements. *

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**KH        FUNDING COMPANY **

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED) **

**FOR        THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND        2005**

**NOTE        A—ACCOUNTING POLICIES AND OTHER DATA **

**Earnings        Per Share **

|                                                                  |   | **For                    The Three****Months                    Ended****September                    30,** |      | **For                    The Nine****Months                    Ended****September                    30,** |   |
|-----------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------|-----------|------------------------------------------------------------------------------------------------------------|--------|
|                                                                  |   | **2006**                                                                                                    |      | **2005**                                                                                                   |   | **2006** |   | **2005** |   |
| Basic:                                                                |   |                                                                                                        |      |                                                                                                       |   |   |   |   |   |
| Net                    Income (Loss)                                  |   | $                                                                                                           | 35,225    |                                                                                                       | $      | (22,335 | ) | $ | 205,455 |   | $ | (20,298 | ) |
| Weighted                    Average Common Shares Outstanding         |   |                                                                                                        | 2,729,951 |                                                                                                       |   | 2,505,556 |   |   | 2,669,276 |   |   | 2,505,556 |   |
| Basic                    Earnings Per Share                           |   | $                                                                                                           | 0.01      |                                                                                                       | $      | (0.01 | ) | $ | 0.08 |   | $ | (0.01 | ) |
| Diluted:                                                              |   |                                                                                                        |      |                                                                                                       |   |   |   |   |   |   |   |   |   |
| Net                    Income (Loss)                                  |   | $                                                                                                           | 35,225    |                                                                                                       | $      | (22,335 | ) | $ | 205,455 |   | $ | (20,298 | ) |
| Weighted                    Average Common Shares Outstanding         |   |                                                                                                        | 2,729,951 |                                                                                                       |   | 2,505,556 |   |   | 2,669,276 |   |   | 2,505,556 |   |
| Dilutive                    Effect of Stock Options                   |   |                                                                                                        | 98,750    |                                                                                                       |   | - |   |   | 91,865 |   |   | - |   |
| Weighted                    Average Common Shares Outstanding-Diluted |   |                                                                                                        | 2,828,701 |                                                                                                       |   | 2,505,556 |   |   | 2,761,141 |   |   | 2,505,556 |   |
|                                                                  |   |                                                                                                        |      |                                                                                                       |   |   |   |   |   |   |   |   |   |
| Diluted                    Earnings Per Share                         |   | $                                                                                                           | 0.01      |                                                                                                       | $      | (0.01 | ) | $ | 0.07 |   | $ | (0.01 | ) |

**Use          of Estimates in Preparing Financial Statements **

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**Income        Taxes**

**Nature        of Operation **

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**KH        FUNDING COMPANY**

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED) **

**New        Accounting Pronouncements**

In        May        2005, the Financial Accounting Standards Board (the “FASB”) issued Statement of        Financial Accounting Standard (“SFAS”) No. 154, “Accounting Changes and Error        Corrections — a replacement of APB Opinion No. 20 and FASB Statement No.        3.”  This statement requires retrospective application to prior periods’financial statements of changes in an accounting principle, unless it is        impracticable to determine either the period-specific effects or the cumulative        effect of the change.  In the case of impracticability in retrospective        application, the statement gives guidance as to the appropriate treatment        of the        change or correction.  The statement is effective for accounting changes        made in fiscal years beginning after December 15, 2005.  The adoption of        this standard did not have a material impact on the Company’s financial        condition, results of operations or liquidity.

*“Accounting        for Certain Hybrid Financial Instruments”*

*“Accounting        for Servicing of Financial Assets”.*
*“Accounting        for Transfers and Servicing of Financial Assets and Extinguishments of        Liabilities”*

*Considering        the Effects of Prior Year Misstatements when Quantifying Misstatements in        Current Year Financial Statements *

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*Fair        Value Measurements *

**NOTE        B— LOANS RECEIVABLE, IMPAIRED LOANS AND ALLOWANCE FOR LOAN LOSSES**

**Loans        Receivable**

**Impaired        Loans**

*Accounting        by Creditors for Impairment of a Loan,*

**Allowance        for Loan Losses**

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**KH        FUNDING COMPANY **

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED) **

**Information        with respect to impaired loans and the related allowance for loan losses        is        shown below: **

|                                                                                                                                                                       |   | **September                    30,****2006**        |    | **December 31,****2005**                      |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------|---------|---------------------------------------------------------|--------|
|                                                                                                                                                                       |   |                                                     |    |                                                    |   |
| Impaired                    loans with specific allowance                                                                                                                  |   | $                                                        | 683,318 |                                                    | $      | 836,390 |   |
| Impaired                    loans without specific allowance                                                                                                               |   |                                                     | 20,606  |                                                    |   | - |   |
| Total                    impaired loans                                                                                                                                    |   | $                                                        | 703,924 |                                                    | $      | 836,930 |   |
|                                                                                                                                                                       |   |                                                     |         |                                                    |   |  |   |
| Allowance                    for loan losses applicable to impaired loans                                                                                                  |   | $                                                        | 275,154 |                                                    | $      | 228,493 |   |
| Allowance                    for loan losses applicable to other than impaired loans                                                                                       |   |                                                     | 148,213 |                                                    |   | 144,298 |   |
|                                                                                                                                                                       |   |                                                     |    |                                                    |   |   |   |
| Total                    allowance for loan losses                                                                                                                         |   | $                                                        | 423,367 |                                                    | $      | 369,791 |   |
|                                                                                                                                                                       |   |                                                     |    |                                                    |   |   |   |
|                                                                                                                                                                       |   |  **September                    30,****2006**  |    |  **December                    31,****2005**  |   |
| Amount                    of interest income recognized within nine month period when the                    loans were                    impaired                        |   | $                                                        | -       |                                                    | $      | - |   |
| Amount                    of interest income recognized using a cash basis during the nine                    month                    period when the loans were impaired |   | $                                                        | -       |                                                    | $      | - |   |

|                                                      |   | **Nine                  Months Ended****September                  30,**  |     |
|-----------------------------------------------------------|--------|--------------------------------------------------------------------------------|----------|
|                                                      |   | **2006**                                                                  |     | **2005**  |   |
|                                                      |   |                                                                           |     |   |   |
| Beginning                  balance                        |   | $                                                                              | 369,791  |   | $ | 233,311 |   |
| Provision                  for loan losses                |   |                                                                           | 175,104  |   |   | 104,000 |   |
| Charge-off                  of loans                      |   |                                                                           | (121,528 | ) |   | (71,361 | ) |
| Recovery                  of loans previously charged off |   |                                                                           | -        |   |   | 6,500 |   |
| Balance                  at end of period                 |   | $                                                                              | 423,367  |   | $ | 272,450 |   |

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**KH      FUNDING COMPANY **

**NOTES      TO INTERIM FINANCIAL STATEMENTS (UNAUDITED) **

**NOTE      C—INVESTMENTS **

|                                           |   | **December                31, 2005** |    | **September                30, 2006**      |   |
|------------------------------------------------|--------|--------------------------------------|---------|--------------------------------------------|--------|
|                                           |   | **Amortized****Cost**                |    | **Estimated****Fair                Value** |   | **Net****Unrealized****Loss** |   | **Amortized****Cost** |   | **Estimated****Fair                Value** |   | **Net****Unrealized****Loss** |   |
| Corporate                Bonds                 |   | $                                    | 623,351 |                                       | $      | 523,888 |   | $ | (99,463 | ) | $ | 617,311 |   | $ | 568,965 |   | $ | (48,346 | ) |
| Money                Market Fund (Margin Loan) |   |                                 | 74,721  |                                       |   | 74,721 |   |   | - |   |   | (309,982 | ) |   | (309,982 | ) |   | - |   |
| Totals                                         |   | $                                    | 698,072 |                                       | $      | 598,609 |   | $ | (99,463 | ) | $ | 307,329 |   | $ | 258,983 |   | $ | (48,346 | ) |

|                             |   | **Less                  than 12 Months**  |   | **More                  than 12 Month** |   | **Total**                                 |   |
|----------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|-------------------------------------------|--------|
|                             |   | **Estimated                  Fair Value** |   | **Unrealized                  Losses**  |   | **Estimated                  Fair Value** |   | **Unrealized                  Losses** |   | **Estimated                  Fair Value** |   | **Unrealized                  Losses** |   |
|                             |   |                                      |   |                                    |   |                                      |   |   |   |   |   |   |   |
| Corporate                  Bonds |   | $                                         | -      |                                    | $      | -                                         |   | $ | 568,965 |   | $ | 48,346 |   | $ | 568,965 |   | $ | 48,346 |   |
| Other                            |   |                                      | -      |                                    |   | -                                         |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Totals                           |   | $                                         | -      |                                    | $      | -                                         |   | $ | 568,965 |   | $ | 48,346 |   | $ | 568,965 |   | $ | 48,346 |   |

**NOTE      D—RELATED PARTY TRANSACTIONS **

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**NOTE      E - STOCK BASED COMPENSATION**

*Share-Based      Payment,*

*Accounting      for Stock Issued to Employees*
*Accounting      for Stock-Based Compensation*

|                                                                                                                                               |   | **Three                Months****Ended****September                30,****2005** |    | **Nine                Months****Ended****September                30,****2005** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|---------|---------------------------------------------------------------------------------|--------|
| Net                Loss, as reported                                                                                                               |   | $                                                                                | (22,335 | )                                                                               | $      | (20,298 | ) |
| Deduct: Total                stock-based employee compensation expense determined under fair value                based method for all awards |   |                                                                             | -       |                                                                            |   | 59,249 |   |
| Pro                forma net loss                                                                                                                  |   | $                                                                                | (22,335 | )                                                                               | $      | (79,547 | ) |
|                                                                                                                                               |   |                                                                             |    |                                                                            |   |   |   |
| Loss                per common share:                                                                                                              |   |                                                                             |    |                                                                            |   |   |   |
| Basic                - as reported                                                                                                                 |   | $                                                                                | (0.01   | )                                                                               | $      | (0.01 | ) |
| Basic                - pro forma                                                                                                                   |   | $                                                                                | (0.01   | )                                                                               | $      | (0.03 | ) |
| Diluted                - as reported                                                                                                               |   | $                                                                                | (0.01   | )                                                                               | $      | (0.01 | ) |
| Diluted                - pro forma                                                                                                                 |   | $                                                                                | (0.01   | )                                                                               | $      | (0.03 | ) |

----

|                                                       |   | **Options** |                      |  **Weighted-Average                Exercise Price** |   |  **Aggregate****Intrinsic                Value** |   |
|------------------------------------------------------------|--------|-------------|---------------------------|----------------------------------------------------------|--------|-------------------------------------------------------|--------|
| Outstanding                at January 1, 2006              |   |        | 361,250                   |                                                     | $      | 2.07                                                  |   |   |   |   |
| Granted                                                    |   |        | 150,000                   |                                                     |   | 3.00                                                  |   |   |   |   |
| Exercised                                                  |   |        | (40,000                   | )                                                        |   | 2.00                                                  |   |   |   |   |
| Forfeited                                                  |   |        | -                         |                                                     |   | -                                                     |   |   |   |   |
|                                                       |   |        |                      |                                                     |   |                                                  |   |   |   |   |
| Outstanding                at September 30, 2006           |   |        | 471,250                   |                                                     | $      | 2.37                                                  |   | $ | 202,388 |   |
|                                                       |   |        |                      |                                                     |   |                                                  |   |   |   |   |
| Exercisable                at September 30, 2006           |   |        | 321,250                   |                                                     | $      | 2.08                                                  |   | $ | 295,550 |   |
|                                                       |   |        |                      |                                                     |   |                                                  |   |   |   |   |
| Weighted                Average Remaining Contractual Life |   |        | 3.36                Years |                                                     |   |                                                  |   |   |   |   |

| Dividend                  yield                           | 2.67%                    |
|-----------------------------------------------------------|--------------------------|
| Weighted                  average volatility              | 22.4%                    |
| Weighted                  average risk-free interest rate | 5.03%                    |
| Weighted                  average expected life in years  | 5                  years |

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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 of this Report      contain “forward-looking statements,” as that term is defined in the Private      Securities Litigation Reform Act of 1995, that are based on management’s      expectations, estimates, projections and assumptions. These statements may      be      identified by the use of forward-looking words or phrases such as “should”,“expects”, “anticipates”, “plans”, “believes”, “estimates”, “might result”,“projects” and variations of such words and similar expressions. 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. Such risks and uncertainties include liquidity risks      associated with our investor notes payable on demand by the holders,      delinquencies in our loan portfolio, changes in market interest rates, inability      to generate new loans, and competitive factors in our marketplace. Readers      are      cautioned not to place undue reliance on such forward looking statements, which      speak only as of the date of this Report. The Company assumes no obligation      to      update any forward looking statements even if experience or future changes      make      it clear that projected results expressed or implied in such statements will      not      be realized. **

**Overview      **

----

**Critical      Accounting Policies **

**Comparison      of Financial Condition at September 30, 2006 and December 31,      2005**

*Assets.*

*Liabilities.*

*Equity.*

*Past      Due Loans. *

*Non-accrual      Loans.*

**Comparison      of Operating Results for Three Months Ended September 30, 2006 and      2005**

*Net      Income.*

*Interest      Income.*

*Interest      Expense.*

----

*Provision      for Loan Losses.*

*Non-Interest      Income (Loss).*

*Non-Interest      Expense.*

*Income      Taxes.*

**Comparison      of Operating Results for Nine Months Ended September 30, 2006 and      2005**

*Net      Income.*

*Interest      Income.*

*Interest      Expense.*

*Provision      for Loan Losses.*

*Non-Interest      Income (Loss).*

*Non-Interest      Expense.*

*Income      Taxes.*

----

**Liquidity      and Capital Resources **

| **Year**                                            |   | **Notes                Sold** |        | **Notes****Redeemed** |   | **Percentage** |   |
|-----------------------------------------------------|--------|-------------------------------|-------------|-----------------------|--------|----------------|--------|
| 2001                                                |   | $                             | 14,418,456  |                  | $      | 11,280,177     |   |   | 78.23 | % |
| 2002                                                |   | $                             | 22,926,619  |                  | $      | 18,681,654     |   |   | 81.47 | % |
| 2003                                                |   | $                             | 26,630,166  |                  | $      | 24,697,770     |   |   | 92.74 | % |
| 2004                                                |   | $                             | 49,008,102  |                  | $      | 44,786,895     |   |   | 91.39 | % |
| 2005                                                |   | $                             | 120,238,252 |                  | $      | 96,630,099     |   |   | 80.36 | % |
| Nine                Months Ended September 30, 2006 |   | $                             | 87,950,172  |                  | $      | 77,044,124     |   |   | 87.60 | % |

*Redemption      of Notes Payable.*

*Plan      to Raise Additional Funds. *

----

**Known      Trends, Events of Uncertainties **

*Impact      of Inflation and Interest Rates*

*Stockholders’      Equity.*

**ITEM      3. CONTROLS AND PROCEDURES **

**PART      II - OTHER INFORMATION **

----

|  | (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 |
|--|-----|------------------------------------|

----

**SIGNATURE      **

|                                      |                                          |                             |
|-------------------------------------------|-----------------------------------------------|----------------------------------|
|                                      | KH                FUNDING COMPANY(Registrant) |
|                                 |                                     |                        |
| Date: November              17, 2006 |                                          | /s/              James E. Parker |
|                                      | James                E. Parker                |
|                                      | Chief                Financial Officer        |

----