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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 June 30, 2005



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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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 June 30, 2005
|Common Stock, $0.01 par value per share |  | 2,505,556                      



Transitional Small Business Disclosure
Format (Check One);    YES ̈NO  x



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##### Table of Contents



|                                                                                                                            |  |          
|--------------------------------------------------------------------------------------------------------------------------- |  | ---------
|                                                                                                                            |  | PAGE NOS.
|PART I  FINANCIAL INFORMATION                                                                                              |  |          
|                                                                                                                            | 
|ITEM 1. FINANCIAL STATEMENTS                                                                                                |  |          
|                                                                                                                            | 
|BALANCE SHEETS  June 30, 2005 (UNAUDITED) and December 31, 2004                                                            |  | 3        
|                                                                                                                            | 
|STATEMENTS OF OPERATIONS (UNAUDITED), six months ended June 30, 2005 and 2004 and three months ended June 30, 2005 and 2004 |  | 4        
|                                                                                                                            | 
|STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED), six months ended June 30, 2005 and 2004                          |  | 5        
|                                                                                                                            | 
|STATEMENTS OF CASH FLOWS (UNAUDITED), six months ended June 30, 2005 and 2004                                               |  | 6        
|                                                                                                                            | 
|NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)                                                                           |  | 7        



2



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##### Table of Contents

KH FUNDING COMPANY

BALANCE SHEETS



|                                                                                                                                         |  |               |            |   |                  |   |            |  
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | ---------------- | - | ---------- | -
|                                                                                                                                         |  | June 30, 2005 |            |   | December 31,2004 |  
|                                                                                                                                         |  | (unaudited)   |            |   |                  |  
|Assets                                                                                                                                   |  |               |            |   |                  |   |            |  
|Cash                                                                                                                                     |  | $             | 4,075,272  |   |                  | $ | 2,669,845  |  
|Investments Available for Sale:                                                                                                          |  |               |            |   |                  |   |            |  
|Marketable Securities  at fair value                                                                                                    |  |               | 623,736    |   |                  |   | 658,248    |  
|Other                                                                                                                                    |  |               | 158,872    |   |                  |   | 158,872    |  
|Loans, Less Allowance for Loan Losses (2005) $233,450 (2004) $233,311                                                                    |  |               | 29,209,961 |   |                  |   | 20,144,798 |  
|Accrued Interest Receivable                                                                                                              |  |               | 887,003    |   |                  |   | 853,448    |  
|Other Receivables                                                                                                                        |  |               | 205,045    |   |                  |   | 537,737    |  
|Prepaid Expenses                                                                                                                         |  |               | 600,558    |   |                  |   | 445,470    |  
|Property and EquipmentNet                                                                                                               |  |               | 57,469     |   |                  |   | 33,755     |  
|Real Estate Owned: Rental Property                                                                                                       |  |               | 817,594    |   |                  |   | 709,973    |  
|Other Assets                                                                                                                             |  |               | 9,803      |   |                  |   | 9,803      |  
|                                                                                                                                         |  |               |            |   |                  |   |            |  
|Total Assets                                                                                                                             |  | $             | 36,645,313 |   |                  | $ | 26,221,949 |  
|                                                                                                                                         |  |               |            |   |                  |   |            |  
|Liabilities and Stockholders Equity                                                                                                     |  |               |            |   |                  |   |            |  
|                                                                                                                                         |  |              
|Liabilities                                                                                                                              |  |               |            |   |                  |   |            |  
|Notes and Accrued Interest Payable                                                                                                       |  | $             | 35,436,561 |   |                  | $ | 24,817,403 |  
|Other Loans Payable                                                                                                                      |  |               | 200        |   |                  |   | 66,200     |  
|Participation Loans                                                                                                                      |  |               | 106,697    |   |                  |   | 107,248    |  
|Accounts Payable and Accrued Payroll Liabilities                                                                                         |  |               | 3,114      |   |                  |   | 1,900      |  
|Escrows and Deposits                                                                                                                     |  |               | 96,430     |   |                  |   | 33,346     |  
|                                                                                                                                         |  |               |            |   |                  |   |            |  
|Total Liabilities                                                                                                                        |  |               | 35,643,002 |   |                  |   | 25,026,097 |  
|                                                                                                                                         |  |               |            |   |                  |   |            |  
|Stockholders Equity                                                                                                                     |  |               |            |   |                  |   |            |  
|Common Stock (5,000,000 shares authorized; 2,505,556 (2005) shares and 2,505,556 (2004) shares, issued and outstanding; $0.01 par
value) |  |               | 25,056     |   |                  |   | 25,056     |  
|Additional Paid-in-Capital                                                                                                               |  |               | 1,604,374  |   |                  |   | 1,750,443  |  
|Accumulated Deficit                                                                                                                      |  |               | (383,336   | ) |                  |   | (385,373   | )
|Less Subscription Note Receivable                                                                                                        |  |               | (185,450   | ) |                  |   | (185,450   | )
|Accumulated other Comprehensive Loss                                                                                                     |  |               | (58,333    | ) |                  |   | (8,824     | )
|                                                                                                                                         |  |               |            |   |                  |   |            |  
|Total Stockholders Equity                                                                                                               |  |               | 1,002,311  |   |                  |   | 1,195,852  |  
|                                                                                                                                         |  |               |            |   |                  |   |            |  
|Total Liabilities and Stockholders Equity                                                                                               |  | $             | 36,645,313 |   |                  | $ | 26,221,949 |  
|                                                                                                                                         |  |               |            |   |                  |   |            |  



The accompanying notes
are an integral part of these statements.



3



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##### Table of Contents

KH FUNDING COMPANY

STATEMENTS OF OPERATIONS (UNAUDITED)



|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|--------------------------------------------------- |  | ----------------------------------- | ------- | ---- | --------------------------------- | ------- | ---- |  | ---- | --------- |  | - | --------- | -
|                                                    |  | For the Three Months Ended June 30, |         |      | For the Six Months Ended June 30, |        
|                                                    |  | 2005                                |         | 2004 |                                   |         | 2005 |  | 2004 |          
|                                                    |  | (Unaudited)                         |         |      | (Unaudited)                       |        
|Interest Income                                     |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Interest and Fees on Loans                          |  | $                                   | 738,294 |      | $                                 | 457,738 |      |  | $    | 1,373,215 |  | $ | 916,066   |  
|Interest on Bank Accounts                           |  |                                     | 24,624  |      |                                   | 1,142   |      |  |      | 42,639    |  |   | 1,712     |  
|Interest on Investments Marketable Securities      |  |                                     | 7,699   |      |                                   | 30,693  |      |  |      | 14,714    |  |   | 60,975    |  
|Other Interest                                      |  |                                     | 21,218  |      |                                   | 23,553  |      |  |      | 49,074    |  |   | 29,638    |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Total Interest Income                               |  |                                     | 791,835 |      |                                   | 513,126 |      |  |      | 1,479,642 |  |   | 1,008,391 |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Interest Expense                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Interest and Fees on Notes Payable                  |  |                                     | 519,805 |      |                                   | 292,509 |      |  |      | 964,357   |  |   | 581,918   |  
|Interest on Participations                          |  |                                     | 3,629   |      |                                   | 3,632   |      |  |      | 7,230     |  |   | 7,284     |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Total Interest Expense                              |  |                                     | 523,434 |      |                                   | 296,141 |      |  |      | 971,587   |  |   | 589,202   |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Net Interest Income                                 |  |                                     | 268,401 |      |                                   | 216,985 |      |  |      | 508,055   |  |   | 419,189   |  
|Provision for Loan Losses                           |  |                                     | 29,000  |      |                                   | 24,000  |      |  |      | 65,000    |  |   | 44,000    |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Net Interest Income after Provision for Loan Losses |  |                                     | 239,401 |      |                                   | 192,985 |      |  |      | 443,055   |  |   | 375,189   |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Non-interest Income                                 |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Rental Income                                       |  |                                     | 16,010  |      |                                   | 16,870  |      |  |      | 32,606    |  |   | 36,924    |  
|Loss on Investments                                 |  |                                     |        |      |                                   |        |      |  |      |          |  |   | (33,000   | )
|Other                                               |  |                                     | 3,976   |      |                                   | 2,250   |      |  |      | 10,341    |  |   | 5,193     |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Total Non-Interest Income                           |  |                                     | 19,986  |      |                                   | 19,120  |      |  |      | 42,947    |  |   | 9,117     |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Non-interest Expense                                |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Salaries and Wages                                  |  |                                     | 86,834  |      |                                   | 69,028  |      |  |      | 174,672   |  |   | 136,855   |  
|Professional Fees                                   |  |                                     | 37,084  |      |                                   | 37,266  |      |  |      | 56,142    |  |   | 67,363    |  
|Offering Costs                                      |  |                                     | 45,375  |      |                                   | 26,133  |      |  |      | 88,080    |  |   | 53,627    |  
|Administration                                      |  |                                     | 23,396  |      |                                   | 24,886  |      |  |      | 44,394    |  |   | 35,697    |  
|Real Estate Maintenance                             |  |                                     | 9,627   |      |                                   | 12,143  |      |  |      | 17,083    |  |   | 20,428    |  
|Insurance                                           |  |                                     | 18,141  |      |                                   | 17,359  |      |  |      | 33,994    |  |   | 37,293    |  
|Depreciation                                        |  |                                     | 12,430  |      |                                   | 11,757  |      |  |      | 23,580    |  |   | 26,341    |  
|Rent                                                |  |                                     | 11,208  |      |                                   | 10,659  |      |  |      | 22,416    |  |   | 21,318    |  
|Bank Charges                                        |  |                                     | 7,147   |      |                                   | 7,012   |      |  |      | 13,043    |  |   | 12,355    |  
|Other                                               |  |                                     | 5,263   |      |                                   | 9,922   |      |  |      | 10,561    |  |   | 17,935    |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Total Non-Interest Expense                          |  |                                     | 256,505 |      |                                   | 226,165 |      |  |      | 483,965   |  |   | 429,212   |  
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Net Income (Loss)                                   |  | $                                   | 2,882   |      | $                                 | (14,060 | )    |  | $    | 2,037     |  | $ | (44,906   | )
|                                                    |  |                                     |         |      |                                   |         |      |  |      |           |  |   |           |  
|Basic and diluted loss per share                    |  | $                                   |        |      | $                                 | (0.01   | )    |  | $    |          |  | $ | (0.02     | )
|Cash dividends paid per common share                |  | $                                   | 0.02    |      | $                                 | 0.04    |      |  | $    | 0.06      |  | $ | 0.08      |  



The accompanying notes
are an integral part of these statements.



4



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##### Table of Contents

KH FUNDING COMPANY

STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30,
2005 AND 2004



|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|--------------------------------------- |  | ------------ | - |  | -------------- | ------ | - | ------------------ | - | --------- | ------------------------------- |  | - | ------------------------------------------ | - |  | ------------------------ | -------- | - |  | - | ------- | - |  | - | --------- | -
|                                        |  | Common Stock |   |  | Paid-inCapital |        |   | AccumulatedDeficit |   |           | Subscriptionsand NoteReceivable |  |   | AccumulatedOtherComprehensiveIncome (Loss) |   |  | TotalStockholdersEquity |         
|                                        |  | Shares       |   |  | Amount         |        |   |                    |   |           |                                
|Balances at January 1, 2004             |  | 2,485,066    |   |  | $              | 24,851 |   |                    | $ | 2,102,765 |                                 |  | $ | (287,900                                   | ) |  | $                        | (185,450 | ) |  | $ | 27,647  |   |  | $ | 1,681,913 |  
|                                        |  |              |   |  |                |        |  
|Additional Stock                        |  | 22,788       |   |  |                | 228    |   |                    |   | 25,833    |                                 |  |   |                                           |   |  |                          |         |   |  |   |        |   |  |   | 26,061    |  
|                                        |  |              |   |  |                |        |  
|Stock Redeemed                          |  | (2,298       | ) |  |                | (23    | ) |                    |   | (5,058    | )                               |  |   |                                           |   |  |                          |         |   |  |   |        |   |  |   | (5,081    | )
|                                        |  |              |   |  |                |        |  
|Dividend Declared                       |  |             |   |  |                |       |   |                    |   | (185,780  | )                               |  |   |                                           |   |  |                          |         |   |  |   |        |   |  |   | (185,780  | )
|Comprehensive Income:                   |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Net (Loss) for the Period               |  |             |   |  |                |       |   |                    |   |          |                                 |  |   | (44,906                                    | ) |  |                          |         |   |  |   |        |   |  |   | (44,906   | )
|Change in Market Value of Investments   |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   | (16,449 | ) |  |   | (16,449   | )
|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Total Comprehensive Loss for the Period |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   | (61,355   | )
|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Balances at June 30, 2004               |  | 2,505,556    |   |  | $              | 25,056 |   |                    | $ | 1,937,760 |                                 |  | $ | (332,806                                   | ) |  | $                        | (185,450 | ) |  | $ | 11,198  |   |  | $ | 1,455,758 |  
|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Balances at January 1, 2005             |  | 2,505,556    |   |  | $              | 25,056 |   |                    | $ | 1,750,443 |                                 |  | $ | (385,373                                   | ) |  | $                        | (185,450 | ) |  | $ | (8,824  | ) |  | $ | 1,195,852 |  
|Dividend Declared                       |  |             |   |  |                |       |   |                    |   | (146,069  | )                               |  |   |                                           |   |  |                          |         |   |  |   |        |   |  |   | (146,069  | )
|Comprehensive Income:                   |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Net Income for the Period               |  |             |   |  |                |       |   |                    |   |          |                                 |  |   | 2,037                                      |   |  |                          |         |   |  |   |        |   |  |   | 2,037     |  
|Change in Market Value of Investments   |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   | (49,509 | ) |  |   | (49,509   | )
|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Total Comprehensive Loss for the Period |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   | (47,472   | )
|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  
|Balances at June 30, 2005               |  | 2,505,556    |   |  | $              | 25,056 |   |                    | $ | 1,604,374 |                                 |  | $ | (383,336                                   | ) |  | $                        | (185,450 | ) |  | $ | (58,333 | ) |  | $ | 1,002,311 |  
|                                        |  |              |   |  |                |        |   |                    |   |           |                                 |  |   |                                            |   |  |                          |          |   |  |   |         |   |  |   |           |  



The accompanying notes
are an integral part of these statements.



5



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##### Table of Contents

KH FUNDING COMPANY

STATEMENTS OF CASH FLOWS (UNAUDITED)



|                                                                        |  |                                   |             |   |             |   |             |  
|----------------------------------------------------------------------- |  | --------------------------------- | ----------- | - | ----------- | - | ----------- | -
|                                                                        |  | For The Six Months Ended June 30, |            
|                                                                        |  | 2005                              |             |   | 2004        |  
|                                                                        |  | (Unaudited)                       |             |   | (Unaudited) |  
|Reconciliation of Net Loss to Net Cash from Operating Activities        |  |                                   |             |   |             |   |             |  
|Net Income (Loss)                                                       |  | $                                 | 2,037       |   |             | $ | (44,906     | )
|Adjustments to Reconcile Net Loss to Net Cash from Operating Activities |  |                                   |             |   |             |   |             |  
|Depreciation                                                            |  |                                   | 23,580      |   |             |   | 26,341      |  
|(Increase) in Prepaid Expenses                                          |  |                                   | (67,008     | ) |             |   | (15,421     | )
|Provision for Loan Losses                                               |  |                                   | 65,000      |   |             |   | 44,000      |  
|Recovery of Prior Write-off                                             |  |                                   | 6,500       |   |             |   |            |  
|Increase in Accrued Interest Receivable                                 |  |                                   | (48,552     | ) |             |   | (45,302     | )
|Increase in Accrued Interest Payable (Included in notes payable)        |  |                                   | 620,452     |   |             |   | 339,603     |  
|Loss on Write-down of Investment                                        |  |                                   |            |   |             |   | 33,000      |  
|Increase in Accounts Payable and Accrued interest                       |  |                                   | 1,214       |   |             |   | 2,664       |  
|(Loss) on Sale of Assets                                                |  |                                   |            |   |             |   | (2,785      | )
|Amortization of Loan Fee Income                                         |  |                                   | (31,873     | ) |             |   | (30,300     | )
|Decrease in Accrued Late Charges                                        |  |                                   | 12,508      |   |             |   | 6,941       |  
|Offering Costs                                                          |  |                                   | (88,080     | ) |             |   | (53,627     | )
|                                                                        |  |                                   |             |   |             |   |             |  
|Net Cash Provided by (Used in) Operating Activities                     |  |                                   | 495,778     |   |             |   | (260,208    | )
|                                                                        |  |                                   |             |   |             |   |             |  
|Cash Flows from Investing Activities                                    |  |                                   |             |   |             |   |             |  
|Proceeds from Sale of Real Estate Held for Resale                       |  |                                   |            |   |             |   | 90,795      |  
|Collections of Other Receivables                                        |  |                                   |            |   |             |   | 1,000,000   |  
|Purchase of Marketable Securities and Other Investments                 |  |                                   |            |   |             |   | (75,338     | )
|Net Increase in Loans Receivable                                        |  |                                   | (9,223,698  | ) |             |   | (1,164,130  | )
|Payments for Other Receivables                                          |  |                                   | 332,692     |   |             |   | (43,997     | )
|Purchase of Real Estate Owned                                           |  |                                   | (13,409     | ) |             |   | (1,398      | )
|Purchase of Fixed Assets                                                |  |                                   | (35,107     | ) |             |   | (9,795      | )
|Other Assets                                                            |  |                                   |            |   |             |   | (1,000      | )
|                                                                        |  |                                   |             |   |             |   |             |  
|Net Cash Used in Investing Activities                                   |  |                                   | (8,939,522  | ) |             |   | (204,863    | )
|                                                                        |  |                                   |             |   |             |   |             |  
|Cash Flows from Financing Activities                                    |  |                                   |             |   |             |   |             |  
|Proceeds from Investor Notes                                            |  |                                   | 45,593,198  |   |             |   | 17,204,971  |  
|Principal Payments on Investor Notes                                    |  |                                   | (35,594,492 | ) |             |   | (16,914,571 | )
|Proceeds from Common Stock                                              |  |                                   |            |   |             |   | 26,061      |  
|(Payments) Collections in Participation Loans                           |  |                                   | (550        | ) |             |   | 805         |  
|Payments on Borrowings                                                  |  |                                   | (66,000     | ) |             |   | (1,300,200  | )
|Payment of Dividends                                                    |  |                                   | (146,069    | ) |             |   | (185,780    | )
|Redemption of Common Stock                                              |  |                                   |            |   |             |   | (5,081      | )
|Increase (Decrease) in Escrows and Deposits                             |  |                                   | 63,084      |   |             |   | (13,693     | )
|                                                                        |  |                                   |             |   |             |   |             |  
|Net Cash Provided by (Used in) Financing Activities                     |  |                                   | 9,849,171   |   |             |   | (1,187,488  | )
|                                                                        |  |                                   |             |   |             |   |             |  
|Net Increase/(Decrease) in Cash                                         |  |                                   | 1,405,427   |   |             |   | (1,132,143  | )
|Cash Balance, Beginning of Period                                       |  |                                   | 2,669,845   |   |             |   | 1,684,962   |  
|                                                                        |  |                                   |             |   |             |   |             |  
|Cash Balance, End of Period                                             |  | $                                 | 4,075,272   |   |             | $ | 552,819     |  
|                                                                        |  |                                   |             |   |             |   |             |  
|Supplemental Cash Flow Information                                      |  |                                   |             |   |             |   |             |  
|Interest Paid                                                           |  | $                                 | 374,050     |   |             | $ | 249,599     |  
|Transfer of Loans to Other Real Estate Owned                            |  | $                                 | 106,399     |   |             | $ |            |  



The accompanying notes
are an integral part of these statements.



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##### Table of Contents

KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004



NOTE AACCOUNTING POLICIES AND OTHER DATA



The financial statements for the six month periods ended June 30, 2005 and
2004 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.



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. These financial statements should be read in conjunction
with the financial statements contained in Form SB-2 of KH Funding Company (the Company) which was filed with the Securities and Exchange Commission and became effective on July 15, 2005 and Form 10-KSB for the year ended December 31,
2004 filed on April 15, 2005.



Earnings Per Share



Basic earnings per share is derived by dividing net income available to
common stockholders by the weighted-average number of common shares outstanding and does not include the effect of any potentially dilutive common stock equivalents. Diluted earnings per share is derived by dividing net income by the
weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding stock options (all outstanding options are anti-dilutive).



|                                                     |  |                                    |           |      |                                   |           |      |  |      |           |  |   |           |  
|---------------------------------------------------- |  | ---------------------------------- | --------- | ---- | --------------------------------- | --------- | ---- |  | ---- | --------- |  | - | --------- | -
|                                                     |  | For The ThreeMonths Ended June 30, |           |      | For The Six Months Ended June 30, |          
|                                                     |  | 2005                               |           | 2004 |                                   |           | 2005 |  | 2004 |          
|                                                     |  | (unaudited)                        |           |      | (unaudited)                       |          
|Basic:                                               |  |                                    |           |      |                                   |           |      |  |      |           |  |   |           |  
|Net Income (Loss) (Attributable to Common Stock)     |  | $                                  | 2,882     |      | $                                 | (14,060   | )    |  | $    | 2,037     |  | $ | (44,906   | )
|Weighted Average Common Shares Outstanding           |  |                                    | 2,505,556 |      |                                   | 2,486,232 |      |  |      | 2,505,556 |  |   | 2,485,649 |  
|Basic Earnings Per Share                             |  | $                                  |          |      | $                                 | (0.01     | )    |  | $    |          |  | $ | (0.02     | )
|                                                     |  |                                    |           |     
|Diluted:                                             |  |                                    |           |      |                                   |           |      |  |      |           |  |   |           |  
|Net Income (Loss) (Attributable to Common Stock)     |  | $                                  | 2,882     |      | $                                 | (14,060   | )    |  | $    | 2,037     |  | $ | (44,906   | )
|Weighted Average Common Shares Outstanding           |  |                                    | 2,505,556 |      |                                   | 2,486,232 |      |  |      | 2,505,556 |  |   | 2,485,649 |  
|Dilutive Effect of Stock Options                     |  |                                    |          |      |                                   |          |      |  |      |          |  |   |          |  
|Weighted Average Common Shares Outstanding  Diluted |  |                                    | 2,505,556 |      |                                   | 2,486,232 |      |  |      | 2,505,556 |  |   | 2,485,649 |  
|Diluted Earnings Per Share                           |  | $                                  |          |      | $                                 | (0.01     | )    |  | $    |          |  | $ | (0.02     | )



Use of Estimates in Preparing
Financial Statements



In preparing financial statements in
conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates.



Nature of Operation



The 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. The Company emphasizes the direct origination of small commercial real estate mortgage loans and investment property
residential mortgage loans. The Company also purchases first and second trust residential loans nationwide from other lenders and banks.



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##### Table of Contents

KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004



Stock Based Compensation



The Company has adopted the disclosure-only provisions of Statements of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-based
Compensation and related interpretations in accounting for its stock compensation plan. No compensation expense related to stock options was recorded during the six or three month periods ended June 30, 2005 and 2004. If the Company had elected
to recognize compensation cost based on fair value at the vesting dates for awards under the plan consistent with the method prescribed by SFAS No. 123, net income and earnings per share would not have changed because no stock options were granted
or were earned in the six month periods ending June 30, 2005 and 2004.



NOTE
B IMPAIRED LOANS AND ALLOWANCE FOR LOAN LOSSES



Under the provisions of SFAS Nos. 114 and 118, Accounting by Creditors for Impairment of a Loan, a loan is considered impaired (or Nonaccrual) if it is probable that the company will not collect all principal and interest payments
according to the loans contracted terms. The impairment of the loan is measured at the present value of the expected cash flows using the loans effective interest rate, or the loans observable market price. Interest income
generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loans principal balance. Interest income on the other nonaccrual loans
is recognized only to the extent of interest payments received.



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##### Table of Contents

KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004



Information with respect to impaired loans and the related valuation allowance is shown below:



|                                                                                                                 |  |               |         |                   |   |        
|---------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | ----------------- | - | -------
|                                                                                                                 |  | June 30,2005  |         | December 31, 2004
|Impaired loans with valuation allowance                                                                          |  | $             | 800,276 |                   | $ | 516,126
|Impaired loans with no valuation allowance                                                                       |  |               |        |                   |   | 67,225 
|                                                                                                                 |  |               |         |                   |   |        
|Total impaired loans                                                                                             |  |               | 800,276 |                   | $ | 583,351
|                                                                                                                 |  |               |         |                   |   |        
|Allowance for credit losses applicable to impaired loans                                                         |  | $             | 197,288 |                   | $ | 175,117
|Allowance for credit losses applicable to other than impaired loans                                              |  |               | 36,162  |                   |   | 58,194 
|                                                                                                                 |  |               |         |                   |   |        
|Total allowance for loan losses                                                                                  |  | $             | 233,450 |                   | $ | 233,311
|                                                                                                                 |  |               |         |                   |   |        
|                                                                                                                 |  |              
|                                                                                                                 |  | June 30, 2004 |         | June 30, 2005    
|Amount of interest income recognized within six month period when the loans were impaired                        |  | $             |        |                   | $ |       
|Amount of interest income recognized using a cash basis during the six month period when the loans were impaired |  | $             |        |                   | $ |       



Analysis of the
allowance for loan losses is as follows:



|                                         |  |                           |         |   |             |   |         |  
|---------------------------------------- |  | ------------------------- | ------- | - | ----------- | - | ------- | -
|                                         |  | Six Months Ended June 30, |        
|                                         |  | 2005                      |         |   | 2004        |  
|                                         |  | (unaudited)               |         |   | (unaudited) |  
|Beginning balance                        |  | $                         | 233,311 |   |             | $ | 211,000 |  
|Additions charged to expenses            |  |                           | 65,000  |   |             |   | 44,000  |  
|Write-off of loans                       |  |                           | (71,361 | ) |             |   | (61,372 | )
|Recovery of loans previously charged off |  |                           | 6,500   |   |             |   |        |  
|                                         |  |                           |         |   |             |   |         |  
|Balance at end of period                 |  | $                         | 233,450 |   |             | $ | 193,628 |  
|                                         |  |                           |         |   |             |   |         |  



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KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004



NOTE CINVESTMENTS



Marketable securities consists of the following at the periods indicated:



|                                 |  |                   |         |            |   |                |  |   |         |  
|-------------------------------- |  | ----------------- | ------- | ---------- | - | -------------- |  | - | ------- | -
|                                 |  | June 30, 2005     |        
|                                 |  | CarryingValue     |         | Fair Value |   | UnrealizedLoss | 
|Corporate Bonds (Net of Premium) |  | $                 | 627,424 |            | $ | 569,091        |  | $ | (58,333 | )
|Money Market Fund                |  |                   | 54,645  |            |   | 54,645         |  |   |        |  
|                                 |  |                   |         |            |   |                |  |   |         |  
|                                 |  | $                 | 682,069 |            | $ | 623,736        |  | $ | (58,333 | )
|                                 |  |                   |         |            |   |                |  |   |         |  
|                                 | 
|                                 |  | December 31, 2004 |        
|                                 |  | CarryingValue     |         | Fair Value |   | UnrealizedLoss | 
|Corporate Bonds (Net of Premium) |  | $                 | 632,211 |            | $ | 623,387        |  | $ | (8,824  | )
|Money Market Fund                |  |                   | 34,861  |            |   | 34,861         |  |   |        |  
|                                 |  |                   |         |            |   |                |  |   |         |  
|                                 |  | $                 | 667,072 |            | $ | 658,248        |  | $ | (8,824  | )
|                                 |  |                   |         |            |   |                |  |   |         |  



Other investments
available for sale of $158,872 at June 30, 2005 and December 31, 2004 consists of equity investment in private companies. The costs of these non-marketable securities approximates their fair market value.



NOTE DRELATED PARTY TRANSACTIONS



The Company engaged in the following related party transactions:



Included in notes receivable at December 31, 2004, are 6 notes totaling
$1,833,611 and as of June 30, 2005 are 11 notes totaling $2,280,364 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, 2004, are 58 notes totaling $5,443,947, and as of June 30, 2005 are 61 notes totaling $5,682,531 which are held by officers and stockholders. These notes were all issued at the rate in
effect for the applicable term selected as of the date the note was issued.



There is a note receivable included in other receivables of $185,450, shown on the balance sheet at June 30, 2005 and December 31, 2004 as a contra-equity, made to the Companys CEO for the purchase of 100,000
shares of stock in the Company. The interest rate on this loan is seven percent. Accrued interest receivable on this loan totals $73,025 and $69,800 at June 30, 2005 and December 31, 2004, respectively.



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##### Table of Contents

KH FUNDING COMPANY



NOTES TO INTERIM UNAUDITED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004



NOTE ESUBSEQUENT MATERIAL EVENTS



On April 19, 2005 we filed a registration statement on Form SB-2 with the U.S. Securities and Exchange Commission. We applied to register $120,000,000 of Series 3 Senior Secured Investment Debt Securities and
$30,000,000 of Series 4 Subordinated Unsecured Investment Debt Securities. The Registration became effective on July 15, 2005.



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
Investment Debt Securities 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



KH Funding Company (the 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 also 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



On July 15, 2005, our registration statement on Form SB-2 (333-124155) was declared effective by the U.S. Securities and Exchange Commission. We
registered $120,000,000 of Series 3 Senior Secured Investment Debt Securities and $30,000,000 of Series 4 Subordinated Unsecured Investment Debt Securities. The offering is not underwritten and the Notes are being sold on a best efforts basis by Mr.
Robert L. Harris, who is not compensated for such services, and by Capital Financial Services and Spencer Edwards Inc., NASD member broker-dealers, who are compensated for their services.



Critical Accounting Policies



Our significant accounting policies are disclosed in the footnotes to the financial statements included in Form 10-KSB for the year ended December 31, 2004. Management
believes the following significant accounting policies also are considered critical accounting policies:



Loan Impairment  A loan is considered impaired when, based on available information or current events, it is probable that we will be unable to
collect scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not considered impaired. We measure impairment on a loan by loan basis using the present value of expected
future cash flows discounted at the loans effective interest rate, the loans obtainable market value, or the fair value of the collateral if the loan is collateral-dependent. However, impairment is based on the fair value of the
collateral if it is determined that the foreclosure is probable.





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Allowance for loan losses  We periodically evaluate the adequacy of the allowance for loan losses
based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that might affect the borrowers ability to repay, the estimated value of any underlying collateral, and current economic conditions. While we use
information available in establishing the allowance for loan losses, evaluation assessments are inherently subjective and future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in
making the evaluation. The allowance for loan losses is a material estimate that is particularly susceptible to significant change in the near term.



Comparison of Financial Condition at June 30, 2005 and December 31, 2004



Assets. Total assets increased $10.42 million, from $26.22 million at December 31, 2004 to $36.64 million at June 30, 2005. The size of our loan
portfolio increased $9.0 million ending at $29.21 million. Cash increased $1.41 million, from $2.67 million at December 31, 2004 to $4.08 million at June 30, 2005. The increase in total assets is primarily a result of the receipt of funds from our
continuing offering of investor notes. See Liquidity and Capital Resources



Liabilities. Total liabilities increased $10.61 million, from $25.03 million at December 31, 2004 to $35.64 million at June 30, 2005. The increase was due to an increase of $10.62 million in notes payable to
investors.



Equity. Total stockholders equity
decreased from $1.2 million at December 31, 2004 to $1.00 million at June 30, 2005. The decrease was due to the payment of dividends and a decrease in the value of marketable investment securities.



Past Due Loans.We generally make hard collateral loans,
loans based largely on collateral value or, where the value of the loan is below 70% of the collateral value. As of June 30, 2005 we had 16 loans on our books that were more than 90 days late but are still accruing interest. The total amount due on
these loans was $1,331,667. Eight of the loans, totaling $935,386, are first trust real estate loans on which we do not expect to suffer any loss due to collateral value, and the other eight loans are paying currently or we anticipate that they will
be doing so shortly. We continue to accrue interest on these loans based on the underlying collateral value and payment history. We monitor these loans on a consistent basis.



Non-accrual Loans. As of June 30, 2005, there were 21 loans in non-accrual status with a value of $800,276. The
majority 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 any significant loss. We have a specific reserve of $197,288 and a general reserve of $36,162 as
part of our total reserve of $233,450 for anticipated and unanticipated loan losses.



Comparison of Operating Results for Six Months Ended June 30, 2005 and 2004



The average yield earned on loans receivable was 10.72% for the six months ended June 30, 2005 and 10.63% for the six months ended June 30, 2004. The average rate paid on investor accounts increased to 5.94% for the
six months ended June 30, 2005 from 5.59% for the six months ended June 30, 2004, due primarily to an increase in the rate we are paying on investor notes. Overall, the net margin on interest decreased to 4.78% for the six months ended June 30,
2005, from 5.04% for the six months ended June 30, 2004. This net margin is calculated using note rates and excludes fee income and expense.



Net Income. Net Income for the six months ended June 30, 2005 was $2,037, compared to a loss of $44,906 for the six months ended June 30, 2004. The
modest improvement in net income is a result of our increase in scale as we have overcome an increase in expenses due to our public offerings that we began in 2003.



Interest Income. Total interest income was $1.5 million for the six months ended June 30, 2005, compared to $1.0
million for the same period in 2004. The additional income resulted primarily from growth in the average amount of interest-earning assets between the two periods, mostly from an increase in loans receivable. The interest income includes point and
fee income and interest earned on bank investments and marketable securities.



Interest Expense. Interest expense was $971,587 for the six months ended June 30, 2005, and $589,202 for the same period in 2004. The additional expense resulted from an increase in investor accounts. The
interest expense includes the amortization of fees paid to Brokers-Dealers for the sale of investor notes.



Provision for Loan Losses. We added $65,000 to our provision for loan losses for the six months ended June 30, 2005, compared to $44,000 for the
six months ended June 30, 2004. This increased the loan loss reserve after write-offs 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.



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Non-Interest Income. We had non-interest income of $42,947 during the six months ended June 30,
2005 compared to $9,117 for the same period in 2004. The majority of the income is rental income from real estate owned. For the earlier period the company recognized a loss on the impairment of nonmarketable investments of $33,000.



Non-Interest Expense. We experienced an increase in non-interest
expense to $483,965 for the six months ended June 30, 2005 from $429,212 for the six months ended June 30, 2004. The majority of the increase was for salaries and wages, offering costs and administration costs.



Income Taxes. KH Funding Company has elected to be treated as a
Subchapter S corporation under the Internal Revenue code and accordingly no income tax items appear in the financial statements.



Liquidity and Capital Resources



KH Funding Companys primary sources of funding are the proceeds from the sale of notes payable to investors, principal and interest payments on
loans, sale of 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 can cause volatility in our cash balances.



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



|                               |  |            |            |               |   |            |  |        |  
|------------------------------ |  | ---------- | ---------- | ------------- | - | ---------- |  | ------ | -
|Year                           |  | Notes Sold |            | NotesRedeemed |   | Percentage | 
|2000                           |  | $          | 10,367,351 |               | $ | 10,661,308 |  | 102.84 | %
|2001                           |  | $          | 14,418,456 |               | $ | 11,280,177 |  | 78.23  | %
|2002                           |  | $          | 22,926,619 |               | $ | 18,681,654 |  | 81.47  | %
|2003                           |  | $          | 26,630,166 |               | $ | 24,697,776 |  | 92.74  | %
|2004                           |  | $          | 49,008,102 |               | $ | 44,786,895 |  | 91.39  | %
|Six Months Ended June 30, 2005 |  | $          | 45,593,198 |               | $ | 35,594,492 |  | 78.07  | %



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. 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 payable, the funds for redemption are immediately available. Of course, part of our investment strategy is to place funds that are invested with us for a longer period into higher yielding, less liquid
investments, such as mortgages; 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. Only
holders of thirty-day demand notes can ask for funds sooner than 90 days, and if the funds will not be available within thirty days, we will sell some of our mortgage loans (notes receivables) to have the funds available to meet requests for funds
from these note holders. All other types of notes, that is the term notes of one, three and five years, are redeemable upon maturity, or prior to maturity on 90 days advance notice, subject to a penalty. If necessary, we will sell loans (notes
receivables) in bulk to fund redemption requests from note holders.



The Company strives to maintain sufficient liquidity to meet all redemption requests. We normally hold 10% to 20% of our assets in cash and cash equivalents to fund redemptions of one-day accounts. This amount has historically been
sufficient for us to meet our obligations. Also, if required, we are able to sell loans within 30 days to raise cash to meet redemption requests from 30-day account holders or within 90 days to meet early redemption requests from term account note
holders.



Plan to Raise Additional Capital. We continue
to expand our operations through our public offerings of investor notes. We may raise equity funds from private placement of our capital stock. However, there is no assurance that such transactions will occur or be successful.



We have been able to attract more investors who are interested in our
longer-term fixed rate notes. Since February 2003, we have been offering trust services for IRA accounts through our Trust Services Department. We intend to expand these services and believe that IRA investors generally look for investments of a
long-term nature, which complements our preferred mode of investing.



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Known Trends, Events of Uncertainties



Impact of Inflation and Interest Rates. The financial statements of the Company 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 the Company to its borrowers. Unlike typical
industrial companies, nearly all the assets and liabilities of the Company 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 10.6% at December 31, 1999 to 2.7% at June 30, 2005. 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 compared to what it has been in the past, management believes that the present ratio remains adequate. In future periods the Company expects
dividend distributions to be equal to or less than the net income in order to inhibit further decreases in stockholder equity.



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 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.



PART II  OTHER INFORMATION



Item 1. Legal Proceedings



On June 8, 2005 we were notified that a lawsuit had been filed against us (In Circuit Court of Montgomery County, Maryland) by a company known as SBM
Financial, LLC (SBM). SBM claims to operate a business similar to the Company. SBM claims that we have intentionally interfered with the ability of SBM to retain their existing investors. We believe that their claim is groundless. At present, we
expect no material impact to KH Funding as a result of this litigation.



Item
2. Unregistered Sales of 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



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##### Table of Contents

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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##### Table of Contents

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: August 15, 2005 |  |                                                 
|                      |  | /s/ Louis B. Sehman                             
|                      |  | 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.)



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