##### Table of Contents

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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 March 31, 2005



Commission File Number 333-106501



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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 March 31, 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

PART I  FINANCIAL INFORMATION



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



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##### Table of Contents

KH FUNDING COMPANY

BALANCE SHEETS



|                                                                                                                                         |  |               |            |   |                  |   |            |   
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | ---------------- | - | ---------- | --
|                                                                                                                                         |  | March 31,2005 |            |   | December 31,2004 |  
|                                                                                                                                         |  | (unaudited)   |            |   |                  |  
|Assets                                                                                                                                   |  |               |            |   |                  |   |            |   
|Cash                                                                                                                                     |  | $             | 4,910,439  |   |                  | $ | 2,669,845  |   
|Investments Available for Sale:                                                                                                          |  |               |            |   |                  |   |            |   
|Marketable Securities  at fair value                                                                                                    |  |               | 622,798    |   |                  |   | 658,248    |   
|Other                                                                                                                                    |  |               | 158,872    |   |                  |   | 158,872    |   
|Loans, Less Allowance for Loan Losses ($244,878, $233,311, Respectively)                                                                 |  |               | 24,138,978 |   |                  |   | 20,144,798 |   
|Accrued Interest Receivable                                                                                                              |  |               | 992,441    |   |                  |   | 853,448    |   
|Other Receivables                                                                                                                        |  |               | 265,190    |   |                  |   | 537,737    |   
|Prepaid Expenses                                                                                                                         |  |               | 473,861    |   |                  |   | 445,470    |   
|Property and EquipmentNet                                                                                                               |  |               | 52,735     |   |                  |   | 33,755     |   
|Real Estate Owned: Rental Property                                                                                                       |  |               | 818,985    |   |                  |   | 709,973    |   
|Other Assets                                                                                                                             |  |               | 9,803      |   |                  |   | 9,803      |   
|                                                                                                                                         |  |               |            |   |                  |   |            |   
|Total Assets                                                                                                                             |  | $             | 32,444,102 |   |                  | $ | 26,221,949 |   
|                                                                                                                                         |  |               |            |   |                  |   |            |   
|Liabilities and Stockholders Equity                                                                                                     |  |               |            |   |                  |   |            |   
|                                                                                                                                         |  |              
|Liabilities                                                                                                                              |  |               |            |   |                  |   |            |   
|Notes and Accrued Interest Payable                                                                                                       |  | $             | 31,237,706 |   |                  | $ | 24,817,403 |   
|Other Loans Payable                                                                                                                      |  |               | 200        |   |                  |   | 66,200     |   
|Participation Loans                                                                                                                      |  |               | 108,255    |   |                  |   | 107,248    |   
|Accounts Payable and Accrued Payroll Liabilities                                                                                         |  |               | 7,514      |   |                  |   | 1,900      |   
|Escrows and Deposits                                                                                                                     |  |               | 39,799     |   |                  |   | 33,346     |   
|                                                                                                                                         |  |               |            |   |                  |   |            |   
|Total Liabilities                                                                                                                        |  |               | 31,393,474 |   |                  |   | 25,026,097 |   
|                                                                                                                                         |  |               |            |   |                  |   |            |   
|Stockholders Equity                                                                                                                     |  |               |            |   |                  |   |            |   
|Common Stock (5,000,000 shares authorized; 2,505,556 shares and 2,505,556 shares, respectively, issued and outstanding; $0.01 par
value) |  |               | 25,056     |   |                  |   | 25,056     |   
|Additional Paid-in-Capital                                                                                                               |  |               | 1,654,685  |   |                  |   | 1,750,443  |   
|Accumulated Deficit                                                                                                                      |  |               | (386,218   | ) |                  |   | (385,373   | ) 
|Less Subscription Note Receivable                                                                                                        |  |               | (185,450   | ) |                  |   | (185,450   | ) 
|Accumulated other Comprehensive Loss                                                                                                     |  |               | (57,445    | ) |                  |   | (8,824     | ))
|                                                                                                                                         |  |               |            |   |                  |   |            |   
|Total Stockholders Equity                                                                                                               |  |               | 1,050,628  |   |                  |   | 1,195,852  |   
|                                                                                                                                         |  |               |            |   |                  |   |            |   
|Total Liabilities and Stockholders Equity                                                                                               |  | $             | 32,444,102 |   |                  | $ | 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 March 31, |        
|                                                    |  | 2005                                 |         |   | 2004 |  
|                                                    |  | (Unaudited)                          |        
|Interest Income                                     |  |                                      |         |   |      |   |         |  
|Interest and Fees on Loans                          |  | $                                    | 634,921 |   |      | $ | 458,327 |  
|Interest on Bank Accounts                           |  |                                      | 18,015  |   |      |   | 571     |  
|Interest on Investments Marketable Securities      |  |                                      | 7,015   |   |      |   | 30,283  |  
|Other Interest                                      |  |                                      | 27,856  |   |      |   | 6,084   |  
|                                                    |  |                                      |         |   |      |   |         |  
|Total Interest Income                               |  |                                      | 687,807 |   |      |   | 495,265 |  
|                                                    |  |                                      |         |   |      |   |         |  
|Interest Expense                                    |  |                                      |         |   |      |   |         |  
|Interest and Fees on Borrowing                      |  |                                      | 444,552 |   |      |   | 289,409 |  
|Interest on Participations                          |  |                                      | 3,601   |   |      |   | 3,651   |  
|                                                    |  |                                      |         |   |      |   |         |  
|Total Interest Expense                              |  |                                      | 448,153 |   |      |   | 293,060 |  
|                                                    |  |                                      |         |   |      |   |         |  
|Net Interest Income                                 |  |                                      | 239,654 |   |      |   | 202,205 |  
|Provision for Loan Losses                           |  |                                      | 36,000  |   |      |   | 20,000  |  
|                                                    |  |                                      |         |   |      |   |         |  
|Net Interest Income after Provision for Loan Losses |  |                                      | 203,654 |   |      |   | 182,205 |  
|                                                    |  |                                      |         |   |      |   |         |  
|Non-interest Income                                 |  |                                      |         |   |      |   |         |  
|Rental Income                                       |  |                                      | 16,596  |   |      |   | 20,054  |  
|Recognized Loss on Impairment of Securities         |  |                                      |        |   |      |   | (33,000 | )
|Other                                               |  |                                      | 6,365   |   |      |   | 2,942   |  
|                                                    |  |                                      |         |   |      |   |         |  
|Total Non-Interest Income (expense)                 |  |                                      | 22,961  |   |      |   | (10,004 | )
|                                                    |  |                                      |         |   |      |   |         |  
|Non-interest Expense                                |  |                                      |         |   |      |   |         |  
|Salaries and Wages                                  |  |                                      | 87,838  |   |      |   | 64,933  |  
|Professional Fees                                   |  |                                      | 19,058  |   |      |   | 30,097  |  
|Offering Costs                                      |  |                                      | 42,705  |   |      |   | 27,494  |  
|Administration                                      |  |                                      | 20,998  |   |      |   | 10,811  |  
|Real Estate Maintenance                             |  |                                      | 7,456   |   |      |   | 9,373   |  
|Insurance                                           |  |                                      | 15,853  |   |      |   | 19,933  |  
|Depreciation                                        |  |                                      | 11,150  |   |      |   | 13,497  |  
|Rent                                                |  |                                      | 11,208  |   |      |   | 10,659  |  
|Bank Charges                                        |  |                                      | 5,896   |   |      |   | 5,343   |  
|Other                                               |  |                                      | 5,298   |   |      |   | 8,012   |  
|                                                    |  |                                      |         |   |      |   |         |  
|Total Non-Interest Expense                          |  |                                      | 227,460 |   |      |   | 200,152 |  
|                                                    |  |                                      |         |   |      |   |         |  
|Net Loss                                            |  | $                                    | (845    | ) |      | $ | (27,951 | )
|                                                    |  |                                      |         |   |      |   |         |  
|Basic and diluted loss per share                    |  | $                                    |        |   |      | $ | (0.01   | )
|Cash dividends paid per common share                |  | $                                    | 0.04    |   |      | $ | 0.04    |  



The accompanying notes
are an integral part of these statements.



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##### Table of Contents

KH FUNDING COMPANY

STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 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 |  
|Dividend Declared                            |  |             |  |                |       |  |                    | (92,891   | ) |                                 |   |         |                                            |  |   |                         |   |  |   |        |   |  |   | (92,891   | )
|                                             |  |              |  |                |        |  |                   
|Comprehensive Income:                        |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Net Loss for the Period Ended March 31, 2004 |  |              |  |                |        |  |                    |           |   |                                 |   | (27,951  | )                                          |  |   |                         |   |  |   |        |   |  |   | (27,951   | )
|Change in Market Value of Investments        |  |              |  |                |        |  |                    |           |   |                                 |   |         |                                            |  |   |                         |   |  |   | 55,901  |   |  |   | 55,901    |  
|                                             |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Total Comprehensive Income for the Period    |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   | 27,950    |  
|                                             |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Balances at March 31, 2004                   |  | 2,485,066    |  | $              | 24,851 |  | $                  | 2,009,874 |   |                                 | $ | (315,851 | )                                          |  | $ | (185,450                 | ) |  | $ | 83,548  |   |  | $ | 1,616,972 |  
|                                             |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Balances at January 1, 2005                  |  | 2,505,556    |  | $              | 25,056 |  | $                  | 1,750,443 |   |                                 | $ | (385,373 | )                                          |  | $ | (185,450                 | ) |  | $ | (8,824  | ) |  | $ | 1,195,852 |  
|Dividend Declared                            |  |             |  |                |       |  |                    | (95,758   | ) |                                 |   |         |                                            |  |   |                         |   |  |   |        |   |  |   | (95,758   | )
|                                             |  |              |  |                |        |  |                   
|Comprehensive Income:                        |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Net Loss for the Period Ended March 31, 2005 |  |              |  |                |        |  |                    |           |   |                                 |   | (845     | )                                          |  |   |                         |   |  |   |        |   |  |   | (845      | )
|Change in Fair Value of Investments          |  |              |  |                |        |  |                    |           |   |                                 |   |         |                                            |  |   |                         |   |  |   | (48,621 | ) |  |   | (48,621   | )
|                                             |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Total Comprehensive Loss                     |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   | (49,466   | )
|                                             |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  
|Balances at March 31, 2005                   |  | 2,505,556    |  | $              | 25,056 |  | $                  | 1,654,685 |   |                                 | $ | (386,218 | )                                          |  | $ | (185,450                 | ) |  | $ | (57,445 | ) |  | $ | 1,050,628 |  
|                                             |  |              |  |                |        |  |                    |           |   |                                 |   |          |                                            |  |   |                          |   |  |   |         |   |  |   |           |  



The accompanying notes
are an integral part of these statements.



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##### Table of Contents

KH FUNDING COMPANY

STATEMENTS OF CASH FLOWS (UNAUDITED)



|                                                                        |  |                                      |             |   |      |   |            |  
|----------------------------------------------------------------------- |  | ------------------------------------ | ----------- | - | ---- | - | ---------- | -
|                                                                        |  | For the Three Months Ended March 31, |            
|                                                                        |  | 2005                                 |             |   | 2004 |  
|                                                                        |  | (unaudited)                          |            
|Reconciliation of Net Loss to Net Cash from Operating Activities        |  |                                      |             |   |      |   |            |  
|Net Loss                                                                |  | $                                    | (845        | ) |      | $ | (27,951    | )
|Adjustments to Reconcile Net Loss to Net Cash from Operating Activities |  |                                      |             |   |      |   |            |  
|Depreciation                                                            |  |                                      | 11,150      |   |      |   | 13,497     |  
|Decrease (Increase) in Prepaid Expenses                                 |  |                                      | 14,314      |   |      |   | (12,834    | )
|Amortization of Loan Fees                                               |  |                                      | (15,468     | ) |      |   | (15,300    | )
|Provision for Loan Losses                                               |  |                                      | 36,000      |   |      |   | 20,000     |  
|Increase in Interest Receivable                                         |  |                                      | (152,164    | ) |      |   | (26,881    | )
|Decrease in Accrued Late Charges                                        |  |                                      | 3,112       |   |      |   | 6,441      |  
|Principal Repayments from Borrowers                                     |  |                                      | 4,883,913   |   |      |   | 1,878,995  |  
|Loans Made to Borrowers                                                 |  |                                      | (9,008,136  | ) |      |   | (1,519,085 | )
|Amortization of Prepaid Offering Costs                                  |  |                                      | (42,705     | ) |      |   | (27,000    | )
|Recognized Loss on Impairment of Investments                            |  |                                      |            |   |      |   | 33,000     |  
|Increase in Interest Payable (Included in notes payable)                |  |                                      | 290,217     |   |      |   | 201,565    |  
|Increase in Accounts Payable and Accrued Payroll Liabilities            |  |                                      | 5,614       |   |      |   | 2,978      |  
|                                                                        |  |                                      |             |   |      |   |            |  
|Net Cash (Used in) Provided by Operating Activities                     |  |                                      | (3,974,998  | ) |      |   | 527,425    |  
|                                                                        |  |                                      |             |   |      |   |            |  
|Cash Flows from Investing Activities                                    |  |                                      |             |   |      |   |            |  
|Purchase of Marketable Securities and Other Investments                 |  |                                      |            |   |      |   | (27,243    | )
|Decrease in Other Receivables                                           |  |                                      | 272,547     |   |      |   | 1,014,855  |  
|Purchase of Fixed Assets                                                |  |                                      | (24,397     | ) |      |   | (6,097     | )
|Proceeds from Sale of Real Estate Held for Resale                       |  |                                      |            |   |      |   | 90,795     |  
|Payments on Real Estate Owned                                           |  |                                      | (8,346      | ) |      |   | (1,699     | )
|Other Assets                                                            |  |                                      |            |   |      |   | 100        |  
|                                                                        |  |                                      |             |   |      |   |            |  
|Net Cash Provided by Investing Activities                               |  |                                      | 239,804     |   |      |   | 1,070,711  |  
|                                                                        |  |                                      |             |   |      |   |            |  
|Cash Flows from Financing Activities                                    |  |                                      |             |   |      |   |            |  
|Proceeds from Investor Notes                                            |  |                                      | 22,189,236  |   |      |   | 7,669,795  |  
|Principal Payments on Investor Notes                                    |  |                                      | (16,059,150 | ) |      |   | (8,289,414 | )
|Increase (Decrease) in Participation Loans                              |  |                                      | 1,007       |   |      |   | (163       | )
|Payments on Borrowings                                                  |  |                                      | (66,000     | ) |      |   | (1,300,000 | )
|Payment of Dividends                                                    |  |                                      | (95,758     | ) |      |   | (92,891    | )
|Increase (Decrease) in Escrow and Security Deposits                     |  |                                      | 6,453       |   |      |   | (25,547    | )
|                                                                        |  |                                      |             |   |      |   |            |  
|Net Cash Provided by (Used in) Financing Activities                     |  |                                      | 5,975,788   |   |      |   | (2,038,220 | )
|                                                                        |  |                                      |             |   |      |   |            |  
|Net Increase/(Decrease) in Cash                                         |  |                                      | 2,240,594   |   |      |   | (440,084   | )
|Cash Balance, Beginning of Period                                       |  |                                      | 2,669,845   |   |      |   | 1,684,962  |  
|                                                                        |  |                                      |             |   |      |   |            |  
|Cash Balance, End of Period                                             |  | $                                    | 4,910,439   |   |      | $ | 1,244,878  |  
|                                                                        |  |                                      |             |   |      |   |            |  
|Supplemental Cash Flow Information                                      |  |                                      |             |   |      |   |            |  
|Interest Paid                                                           |  | $                                    | 141,657     |   |      | $ | 91,495     |  
|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 MONTHS ENDED MARCH 31, 2005 AND 2004



NOTE AACCOUNTING POLICIES AND OTHER DATA



The financial statements for the three month periods ended March 31, 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 August 2, 2004 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. For this calculation the effect of 311,250 and 331,250 options have been excluded as their effect is antidilutive due to the losses for the
three months ended March 31, 2005 and 2004, respectively.



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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KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004



|                                                 |  |                                      |           |   |      |   |           |  
|------------------------------------------------ |  | ------------------------------------ | --------- | - | ---- | - | --------- | -
|                                                 |  | For The Three Months Ended March 31, |          
|                                                 |  | 2005                                 |           |   | 2004 |  
|                                                 |  | (unaudited)                          |          
|Basic:                                           |  |                                      |           |   |      |   |           |  
|Net (Loss) Income (Attributable to Common Stock) |  | $                                    | (845      | ) |      | $ | (27,951   | )
|Average Common Shares Outstanding                |  |                                      | 2,505,556 |   |      |   | 2,485,066 |  
|Basic Earnings Per Share                         |  | $                                    |          |   |      | $ | (0.01     | )
|                                                 |  |                                     
|Diluted:                                         |  |                                      |           |   |      |   |           |  
|Net (Loss) Income (Attributable to Common Stock) |  | $                                    | (845      | ) |      | $ | (27,951   | )
|Average Common Shares Outstanding                |  |                                      | 2,505,556 |   |      |   | 2,485,066 |  
|Dilutive Effect of Stock Options                 |  |                                      |          |   |      |   |          |  
|Average Common Shares Outstanding  Diluted      |  |                                      | 2,505,556 |   |      |   | 2,485,066 |  
|Diluted Earnings Per Share                       |  | $                                    |          |   |      | $ | (0.01     | )



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 three-month periods ended March 31, 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 being earned in the three month periods ending March 31, 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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KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004



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



|                                                                                                                   |  |                |         |                  |   |        
|------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------- | ---------------- | - | -------
|                                                                                                                   |  | March 31,2005  |         | December 31,2004
|Impaired loans with valuation allowance                                                                            |  | $              | 733,518 |                  | $ | 516,126
|Impaired loans with no valuation allowance                                                                         |  |                | 183,301 |                  |   | 67,225 
|                                                                                                                   |  |                |         |                  |   |        
|Total impaired loans                                                                                               |  | $              | 916,819 |                  | $ | 583,351
|                                                                                                                   |  |                |         |                  |   |        
|Allowance for credit losses applicable to impaired loans                                                           |  | $              | 221,615 |                  | $ | 175,117
|Allowance for credit losses applicable to other than impaired loans                                                |  |                | 23,263  |                  |   | 58,194 
|                                                                                                                   |  |                |         |                  |   |        
|Total allowance for loan losses                                                                                    |  | $              | 244,878 |                  | $ | 233,311
|                                                                                                                   |  |                |         |                  |   |        
|                                                                                                                   |  |               
|                                                                                                                   |  | March 31, 2004 |         | March 31, 2005  
|                                                                                                                   | 
|Amount of interest income recognized within three month period when the loans were impaired                        |  | $              | -0-     |                  | $ | -0-    
|Amount of interest income recognized using a cash basis during the three month period when the loans were impaired |  | $              | -0-     |                  | $ | -0-    



Analysis of the
allowance for loan losses is as follows:



|                                         |  |                             |         |   |             |   |         |  
|---------------------------------------- |  | --------------------------- | ------- | - | ----------- | - | ------- | -
|                                         |  | Three Months EndedMarch 31, |        
|                                         |  | 2005                        |         |   | 2004        |  
|                                         |  | (unaudited)                 |         |   | (unaudited) |  
|Beginning balance                        |  | $                           | 233,311 |   |             | $ | 211,000 |  
|Additions charged to expenses            |  |                             | 36,000  |   |             |   | 20,000  |  
|Write-off of loans                       |  |                             | (24,433 | ) |             |   | (2,214  | )
|Recovery of loans previously charged off |  |                             |        |   |             |   |        |  
|                                         |  |                             |         |   |             |   |         |  
|Balance at end of period                 |  | $                           | 244,878 |   |             | $ | 228,786 |  
|                                         |  |                             |         |   |             |   |         |  



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KH FUNDING COMPANY



NOTES TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004



NOTE CINVESTMENTS



Marketable securities consists of the following at the periods indicated:



|                                 |  |                   |         |            |   |                |  |   |         |  
|-------------------------------- |  | ----------------- | ------- | ---------- | - | -------------- |  | - | ------- | -
|                                 |  | March 31, 2005    |        
|                                 |  | CarryingValue     |         | Fair Value |   | UnrealizedLoss | 
|Corporate Bonds (Net of Premium) |  | $                 | 629,475 |            | $ | 572,030        |  | $ | (57,445 | )
|Money Market Fund                |  |                   | 34,941  |            |   | 34,941         |  |   |        |  
|Accrued Interest-Corporate Bonds |  |                   | 15,827  |            |   | 15,827         |  |   |        |  
|                                 |  |                   |         |            |   |                |  |   |         |  
|                                 |  | $                 | 680,243 |            | $ | 622,798        |  | $ | (57,445 | )
|                                 |  |                   |         |            |   |                |  |   |         |  
|                                 | 
|                                 |  | December 31, 2004 |        
|                                 |  | CarryingValue     |         | Fair Value |   | UnrealizedLoss | 
|Corporate Bonds (Net of Premium) |  | $                 | 632,211 |            | $ | 623,287        |  | $ | (8,824  | )
|Money Market Fund                |  |                   | 34,862  |            |   | 34,861         |  |   |        |  
|                                 |  |                   |         |            |   |                |  |   |         |  
|                                 |  | $                 | 667,073 |            | $ | 658,248        |  | $ | (8,824  | )
|                                 |  |                   |         |            |   |                |  |   |         |  



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 March 31, 2005 are 11 notes totaling $1,443,541 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 March 31, 2005 are 59 notes totaling $5,585,836
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 March 31, 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
March 31, 2005 and December 31, 2004, respectively.



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KH FUNDING COMPANY



NOTES TO INTERIM UNAUDITED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 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. As of the date of this filing of this 10-QSB the registration is not effective.



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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 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



Broker-Dealers. The Company has been expanding the wholesale distribution
for its investment products by engaging in strategic alliances with several major financial services firms throughout the country. We currently have signed selling agreements with two NASD Broker-Dealers with a network of over 170 registered
representatives in the Midwest and West. These alliances give us the ability to sell our Investment Debt Securities through a network of financial consultants in defined geographic locations. To date, our wholesale distribution plan has been very
successful, establishing close to 300 new investment accounts providing over $8,000,000 in funds to the Company. We plan to further increase our wholesale network, and are currently in negotiations with several NASD member Broker Dealers interested
in distributing our notes in parts of the United States where we are not currently represented.



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Critical Accounting Policies



Our significant accounting policies are disclosed in the footnotes to the financial statements included in Form 10-KSB. 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.



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 March 31, 2005 and
December 31, 2004



Assets. Total assets increased
$6.22 million, from $26.22 million at December 31, 2004 to $32.44 million at March 31, 2005. The size of our loan portfolio increased $4 million ending at $24.14 million. Cash increased $2.24 million, from $2.67 million at December 31, 2004 to $4.91
million at March 31, 2005.



Liabilities. Total
liabilities increased $6.36 million, from $25.03 million at December 31, 2004 to $31.39 million at March 31, 2005. The increase was due to an increase of $6.42 million in notes payable to investors.



Equity. Total stockholders equity decreased from $1.2 million at
December 31, 2004 to $1.05 million at March 31, 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 collateral is below 70% of the loan amount. As of March 31, 2005 we had fourteen loans on our books that were more than 90 days late but are still



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accruing interest. The total amount due on these loans was $1,719,211. Eight of the loans, totaling $1,580,080, are first
trust real estate loans on which we do not expect to suffer any loss due to collateral value, and the other six 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. We monitor these loans on a consistent basis.



Non-accrual Loans. As of March 31, 2005, there were 26 loans in non-accrual status with a value of $916,819. 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 $221,615 and a general reserve of $23,263 as part of our total reserve of $244,878 for these loans.



Comparison of Operating Results for Three Months Ended March 31, 2005 and 2004



The average yield earned on loans receivable was 10.65%
for the three months ended March 31, 2005 and 10.80% for the three months ended March 31, 2004. The average rate paid on investor accounts increased to 5.90% for the three months ended March 31, 2005 from 5.63% for the three months ended March 31,
2004, due primarily to an increase in the rate we are paying on investor notes. Overall, the net margin on interest decreased to 4.75% for the three months ended March 31, 2005, from 5.17% for the three months ended March 31, 2004. this net margin
is calculated using note rates and excludes fee income and expense.



Net Income. Net loss for the three months ended March 31, 2005 was $845, compared to a loss of $27,951 for the three months ended March 31, 2004



Interest Income. Total interest income was $687,807 for the three months ended March 31, 2005, compared to $495,265 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. The interest income includes point and fee income and interest earned on bank investments and marketable securities.



Interest Expense. Interest expense was $448,153 for the
three months ended March 31, 2005, and $293,060 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. Our
provision for loan losses was $36,000 for the three months ended March 31, 2005, compared to $20,000 for the three months ended March 31, 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.



Non-Interest Income. We had non-interest income of $22,961 during the three months ended March 31, 2005 compared to expense of ($10,004) 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, causing a overall negative result.



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Non-Interest Expense. We experienced an increase in non-interest expense to $227,460 for the three
months ended March 31, 2005 from $200,152 for the three months ended March 31, 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, sales of participation interests in loans and rental income. While maturities and scheduled
amortization of loans and investments are predictable sources of funds, the sale and redemption of investor notes and mortgage loan prepayments are greatly influenced by interest rate trends, economic conditions and competition. Our one-day demand
notes 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  | %



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



Redemption of Notes Payable. Management believes that the risk of not being able to fund redemption requests only exists if the requests for redemption exceed the amount of readily available cash, i.e., if our
liquidity is insufficient to fund redemptions. Upon the sale of a note 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,



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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 intend to continue to expand our
operations through future public offerings of investor notes, and we may raise funds from private placement of our capital stock. See Note E to the Accompanying Interim Unaudited Financial Statements. However, there is no assurance that such
transactions will occur or be successful.



We also expect that
we will be 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.



Known Trends, Events of Uncertainties



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



Stockholders Equity. Total stockholders equity has decreased as a percentage of total assets over the
last five years, from 10.6% at December 31, 1999 to 3.2% at March 31, 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.



Recent Accounting Pronouncements



In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No.
153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No.29, Accounting for Nonmonetary Transactions.



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This statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of
the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. This Statement is effective for nonmonetary asset changes occurring in fiscal periods beginning after June
15, 2005. The adoption of this standard is not expected to have a material impact on financial condition, results of operations, or liquidity.



In November 2003 the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) issued EITF Abstract 03-1,
The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1) effective for fiscal year ending after December 15, 2003. The abstract provides guidelines on the meaning of other
than-temporary impairment and its application to investments in addition to requiring quantitative and qualitative disclosures in the financial statements. The Company has implemented the guidelines of this Consensus. The adoption of this Consensus
did not have any impact on the Companys financial condition, results of operations, or liquidity.



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.



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##### Table of Contents

PART II  OTHER INFORMATION



Item 1. Legal Proceedings



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



Item 2. Changes in Securities and Use of Proceeds



Not applicable



Item 3. Defaults Upon Senior Securities



Not applicable



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



Not applicable



Item 5. Other Information



Not applicable



Item 6. Exhibits and Report on Form 8-K



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



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



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



None



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SIGNATURE



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



|                   |  |                                                 
|------------------ |  | ------------------------------------------------
|                   |  | KH FUNDING COMPANY                              
|                   |  | (Registrant)                                    
|                   | 
|Date: May 20, 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.)



19