**FORM        10-QSB**

|   |   |   |
|--------|--------|--------|

**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, 2006**

**Commission        File Number 333-124155**

|   |   |   |
|--------|--------|--------|

**KH        FUNDING COMPANY**

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

| **Maryland**                                                                                            | **6162**                                                                                          | **52-1886133**                                                                |
|---------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------|
| **(State                  or other jurisdiction of****incorporation                  or organization)** | **(Primary                  Standard Industrial****Classification                  Code Number)** | **(I.R.S.                  Employer****Identification                  No.)** |

**10801        Lockwood Drive, Suite 370**

**Silver        Spring, Maryland 20901**

**(301)        592-8100**

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

| **Class**                                                |   | **Outstanding                  as of March 31, 2006** |
|----------------------------------------------------------|--------|-------------------------------------------------------|
| Common                  Stock, $0.01 par value per share |   | 2,699,951                                             |

|   |
|--------|

**PART        I**
**        - FINANCIAL INFORMATION**

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

----

**KH        FUNDING COMPANY**

**BALANCE        SHEETS**

|                                                                                                                                                                                                                                               |   |   | **March                  31, 2006** |   |   |   | **December                  31, 2005** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|-------------------------------------|--------|--------|--------|----------------------------------------|--------|
|                                                                                                                                                                                                                                               |   |   | **(unaudited)**                     |   |   |   |                                   |   |
| **Assets**                                                                                                                                                                                                                                         |   |   |                                |   |   |   |                                   |   |
| Cash                                                                                                                                                                                                                                               |   | $      | 8,294,938                           |   |   | $      | 6,579,242                              |   |
| Investments                  Available for Sale:                                                                                                                                                                                                   |   |   |                                |   |   |   |                                   |   |
| Marketable                  Securities - At Fair Value                                                                                                                                                                                             |   |   | 625,263                             |   |   |   | 598,609                                |   |
| Other                                                                                                                                                                                                                                              |   |   | 50,872                              |   |   |   | 50,872                                 |   |
| Loans,                  Less Allowance for Loan Losses                                                                                                                                                                                             |   |   |                                |   |   |   |                                   |   |
| (March                  31, 2006) $427,143 and (December 31, 2005) $369,791                                                                                                                                                                        |   |   | 46,688,124                          |   |   |   | 40,678,941                             |   |
| Accrued                  Interest Receivable                                                                                                                                                                                                       |   |   | 1,443,496                           |   |   |   | 1,405,424                              |   |
| Other                  Receivables                                                                                                                                                                                                                 |   |   | 26,721                              |   |   |   | 126,269                                |   |
| Prepaid                  Expenses                                                                                                                                                                                                                  |   |   | 326,319                             |   |   |   | 374,762                                |   |
| Property                  and Equipment - Net                                                                                                                                                                                                      |   |   | 133,771                             |   |   |   | 137,623                                |   |
| Real                  Estate Owned                                                                                                                                                                                                                 |   |   |                                |   |   |   |                                   |   |
| Rental                  Property                                                                                                                                                                                                                   |   |   | 624,478                             |   |   |   | 622,513                                |   |
| Held                  for Resale                                                                                                                                                                                                                   |   |   | 180,302                             |   |   |   | 180,302                                |   |
| Other                  Assets                                                                                                                                                                                                                      |   |   | 15,988                              |   |   |   | 15,988                                 |   |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Total                  Assets**                                                                                                                                                                                                                  |   | $      | 58,410,272                          |   |   | $      | 50,770,545                             |   |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Liabilities                  and Stockholders' Equity**                                                                                                                                                                                          |   |   |                                |   |   |   |                                   |   |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Liabilities**                                                                                                                                                                                                                                    |   |   |                                |   |   |   |                                   |   |
| Notes                  and Accrued Interest Payable                                                                                                                                                                                                |   | $      | 56,820,138                          |   |   | $      | 49,681,335                             |   |
| Other                  Loans Payable                                                                                                                                                                                                               |   |   | 31,500                              |   |   |   | -                                      |   |
| Long                  Term Accrued Lease Obligation                                                                                                                                                                                                |   |   | 7,863                               |   |   |   | -                                      |   |
| Accounts                  Payable and Accrued Payroll Liabilities                                                                                                                                                                                  |   |   | 2,315                               |   |   |   | 2,730                                  |   |
| Escrows                  and Deposits                                                                                                                                                                                                              |   |   | 168,192                             |   |   |   | 171,673                                |   |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Total                  Liabilities**                                                                                                                                                                                                             |   |   | 57,030,008                          |   |   |   | 49,855,738                             |   |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Stockholders'                  Equity**                                                                                                                                                                                                          |   |   |                                |   |   |   |                                   |   |
| Common                  Stock (5,000,000 shares authorized; 2,699,951 shares (March 31,                  2006) and                  2,555,556 shares (December 31, 2005) issued and outstanding; $0.01                  par                  value |   |   | 27,000                              |   |   |   | 25,556                                 |   |
| Paid-in-Capital                                                                                                                                                                                                                                    |   |   | 1,944,483                           |   |   |   | 1,603,852                              |   |
| Accumulated                  Deficit                                                                                                                                                                                                               |   |   | (334,554                            | )      |   |   | (429,688                               | )      |
| Less                  Subscription Note Receivable                                                                                                                                                                                                 |   |   | (185,450                            | )      |   |   | (185,450                               | )      |
| Accumulated                  Other Comprehensive (Loss)                                                                                                                                                                                            |   |   | (71,215                             | )      |   |   | (99,463                                | )      |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Total                  Stockholders' Equity**                                                                                                                                                                                                    |   |   | 1,380,264                           |   |   |   | 914,807                                |   |
|                                                                                                                                                                                                                                               |   |   |                                |   |   |   |                                   |   |
| **Total                  Liabilities and Stockholders' Equity**                                                                                                                                                                                    |   | $      | 58,410,272                          |   |   | $      | 50,770,545                             |   |

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

----

**KH        FUNDING COMPANY**

**STATEMENTS        OF OPERATIONS (UNAUDITED)**

|                                                                     |   | **For                  The Three Months Ended March 31,** |
|--------------------------------------------------------------------------|--------|-----------------------------------------------------------|
|                                                                     |   |                                                      | **2006** |   |   |   | **2005** |   |
| **Interest                  Income**                                     |   |                                                      |   |   |   |   |   |   |
| Interest                  and Fees on Loans                              |   | $                                                         | 1,260,203 |   |   | $ | 662,777 |   |
| Interest                  on Bank Accounts                               |   |                                                      | 43,065 |   |   |   | 18,015 |   |
| Interest                  on Investments - Marketable Securities         |   |                                                      | 7,727 |   |   |   | 7,015 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| Total                  Interest Income                                   |   |                                                      | 1,310,995 |   |   |   | 687,807 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| **Interest                  Expense**                                    |   |                                                      |   |   |   |   |   |   |
| Interest                  and Fees on Borrowing                          |   |                                                      | 851,979 |   |   |   | 444,552 |   |
| Interest                  on Participations                              |   |                                                      | - |   |   |   | 3,601 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| Total                  Interest Expense                                  |   |                                                      | 851,979 |   |   |   | 448,153 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| Net                  Interest Income                                     |   |                                                      | 459,016 |   |   |   | 239,654 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| **Provision                  for Loan Losses**                           |   |                                                      | 57,352 |   |   |   | 36,000 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| **Net                  Interest Income after Provision for Loan Losses** |   |                                                      | 401,664 |   |   |   | 203,654 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| **Non-Interest                  Income**                                 |   |                                                      |   |   |   |   |   |   |
| Rental                  Income                                           |   |                                                      | 10,516 |   |   |   | 16,596 |   |
| Other                                                                    |   |                                                      | 5,144 |   |   |   | 6,365 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| Total                  Non-Interest Income                               |   |                                                      | 15,660 |   |   |   | 22,961 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| **Non-Interest                  Expense**                                |   |                                                      |   |   |   |   |   |   |
| Salaries                  and Wages                                      |   |                                                      | 95,608 |   |   |   | 87,838 |   |
| Professional                  Fees                                       |   |                                                      | 29,448 |   |   |   | 19,058 |   |
| Offering                  Costs                                          |   |                                                      | 56,208 |   |   |   | 42,705 |   |
| Administration                                                           |   |                                                      | 37,617 |   |   |   | 20,998 |   |
| Real                  Estate Maintenance                                 |   |                                                      | 20,400 |   |   |   | 7,456 |   |
| Insurance                                                                |   |                                                      | 19,385 |   |   |   | 15,853 |   |
| Depreciation                                                             |   |                                                      | 14,863 |   |   |   | 11,150 |   |
| Rent                                                                     |   |                                                      | 31,815 |   |   |   | 11,208 |   |
| Bank                  Charges                                            |   |                                                      | 6,444 |   |   |   | 5,896 |   |
| Other                                                                    |   |                                                      | 10,402 |   |   |   | 5,298 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| Total                  Non-Interest Expense                              |   |                                                      | 322,190 |   |   |   | 227,460 |   |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| **Net                  Income (Loss)**                                   |   | $                                                         | 95,134 |   |   | $ | (845 | ) |
|                                                                     |   |                                                      |   |   |   |   |   |   |
| Basic                  Earnings Per Share                                |   | $                                                         | 0.04 |   |   | $ | - |   |
| Diluted                  Earnings Per Share                              |   | $                                                         | 0.04 |   |   | $ | - |   |
| Cash                  Dividends Paid Per Common Share                    |   | $                                                         | 0.02 |   |   | $ | 0.04 |   |

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

----

**KH        FUNDING COMPANY**

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

**FOR        THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005**

|                                                           |   |   | **Common                  Stock** |   |   |   | **Paid-In** |   |   |   | **Accumulated** |   |   |   | **Subscription                  Note** |   |   |   | **Accumulated                  Other Comprehensive** |   |   |   | **Total                  Stockholders'** |   |
|----------------------------------------------------------------|--------|--------|-----------------------------------|--------|--------|--------|-------------|--------|--------|--------|-----------------|--------|--------|--------|----------------------------------------|--------|--------|--------|------------------------------------------------------|--------|--------|--------|------------------------------------------|--------|
|                                                           |   |   | **Shares**                        |   |   |   | **Amount**  |   |   |   | **Capital**     |   |   |   | **Deficit**                            |   |   |   | **Receivable**                                       |   |   |   | **(Loss)                  Income**       |   |   |   | **Equity** |   |
|                                                           |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| **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 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 |   |
|                                                           |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| **Balances                  at January 1, 2006**               |   |   | 2,555,556                         |   |   | $      | 25,556      |   |   | $      | 1,603,852       |   |   | $      | (429,688                               | )      |   | $      | (185,450                                             | )      |   | $      | (99,463                                  | )      |   | $ | 914,807 |   |
|                                                           |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| **Additional                  Stock Issued**                   |   |   | 144,395                           |   |   |   | 1,444       |   |   |   | 391,741         |   |   |   | -                                      |   |   |   | -                                                    |   |   |   | -                                        |   |   |   | 393,185 |   |
| **Dividend                  Declared**                         |   |   | -                                 |   |   |   | -           |   |   |   | (51,110         | )      |   |   | -                                      |   |   |   | -                                                    |   |   |   | -                                        |   |   |   | (51,110 | ) |
|                                                           |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| **Comprehensive                  Income**                      |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| Net                  Income for Period Ended March 31, 2006    |   |   | -                                 |   |   |   | -           |   |   |   | -               |   |   |   | 95,134                                 |   |   |   | -                                                    |   |   |   | -                                        |   |   |   | 95,134 |   |
| Change                  in Fair Value of Investments           |   |   | -                                 |   |   |   | -           |   |   |   | -               |   |   |   | -                                      |   |   |   | -                                                    |   |   |   | 28,248                                   |   |   |   | 28,248 |   |
|                                                           |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| **Total                  Comprehensive Income for the Period** |   |   | -                                 |   |   |   | -           |   |   |   | -               |   |   |   | -                                      |   |   |   | -                                                    |   |   |   | -                                        |   |   |   | 123,382 |   |
|                                                           |   |   |                              |   |   |   |        |   |   |   |            |   |   |   |                                   |   |   |   |                                                 |   |   |   |                                     |   |   |   |   |   |
| **Balances                  at March 31, 2006**                |   |   | 2,699,951                         |   |   | $      | 27,000      |   |   | $      | 1,944,483       |   |   | $      | (334,554                               | )      |   | $      | (185,450                                             | )      |   | $      | (71,215                                  | )      |   | $ | 1,380,264 |   |

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

----

**KH        FUNDING COMPANY**

**STATEMENTS        OF CASH FLOWS (UNAUDITED)**

|                                                                                                               |   | **For                  The Three Months Ended March 31,** |
|--------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|
|                                                                                                               |   |                                                      | **2006** |   |   |   | **2005** |   |
| **Reconciliation                  of Net Income to Net Cash from Operating                  Activities**           |   |                                                      |   |   |   |   |   |   |
| Net                  Income (Loss)                                                                                 |   | $                                                         | 95,134 |   |   | $ | (845 | ) |
| Adjustments                  to Reconcile Net Income (Loss) to Net Cash from Operating                  Activities |   |                                                      |   |   |   |   |   |   |
| Depreciation                                                                                                       |   |                                                      | 14,863 |   |   |   | 11,150 |   |
| Amortization                  of Loan Fees                                                                         |   |                                                      | (30,000 | ) |   |   | (15,468 | ) |
| Provision                  for Loan Losses                                                                         |   |                                                      | 57,352 |   |   |   | 36,000 |   |
| Common                  Stock Issued for Past Services                                                             |   |                                                      | 9,975 |   |   |   | - |   |
| (Increase)                  Decrease in Accrued Late Charges                                                       |   |                                                      | (5,175 | ) |   |   | 3,112 |   |
| (Increase)                  Decrease in Prepaid Expenses                                                           |   |                                                      | 20,960 |   |   |   | 14,314 |   |
| Increase                  in Interest Receivable                                                                   |   |                                                      | (28,322 | ) |   |   | (152,164 | ) |
| Increase                  in Interest Payable (Included in Notes Payable)                                          |   |                                                      | 546,561 |   |   |   | 290,217 |   |
| (Decrease)                  Increase in Accounts Payable and Accrued Payroll                  Liabilities          |   |                                                      | (415 | ) |   |   | 5,614 |   |
| Accrued                  Interest on Investments                                                                   |   |                                                      | (7,728 | ) |   |   | - |   |
| Decrease                  (Increase) in Prepaid Offering Costs                                                     |   |                                                      | 56,208 |   |   |   | (42,705 | ) |
| Deferred                  Loan Origination Costs                                                                   |   |                                                      | (7,491 | ) |   |   | - |   |
| Unamortized                  Brokerage Fees                                                                        |   |                                                      | (80,922 | ) |   |   | - |   |
| Long                  Term Lease Liability                                                                         |   |                                                      | 7,863 |   |   |   | - |   |
| Prepaid                  Loan Expenses                                                                             |   |                                                      | (48,917 | ) |   |   | - |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Net                  Cash Provided by Operating Activities**                                                     |   |                                                      | 599,946 |   |   |   | 149,225 |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Cash                  Flows from Investing Activities**                                                          |   |                                                      |   |   |   |   |   |   |
| Principal                  Repayments from Borrowers                                                               |   |                                                      | 8,377,164 |   |   |   | 4,883,913 |   |
| Loans                  made to Borrowers                                                                           |   |                                                      | (14,352,116 | ) |   |   | (9,008,136 | ) |
| Purchase                  of Marketable Securities and Other Investments                                           |   |                                                      | (428 | ) |   |   | - |   |
| Payments                  for Other Receivables                                                                    |   |                                                      | 99,548 |   |   |   | 272,547 |   |
| Purchase                  of Property and Equipment                                                                |   |                                                      | (5,828 | ) |   |   | (24,397 | ) |
| Payments                  on Other Real Estate Owned                                                               |   |                                                      | (7,148 | ) |   |   | (8,346 | ) |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Net                  Cash Used in Investing Activities**                                                         |   |                                                      | (5,888,808 | ) |   |   | (3,884,419 | ) |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Cash                  Flows from Financing Activities**                                                          |   |                                                      |   |   |   |   |   |   |
| Proceeds                  from Investor Notes                                                                      |   |                                                      | 37,002,763 |   |   |   | 22,189,236 |   |
| Principal                  Payments on Investor Notes                                                              |   |                                                      | (30,329,599 | ) |   |   | (16,059,150 | ) |
| Proceeds                  from Common Stock                                                                        |   |                                                      | 354,485 |   |   |   | - |   |
| Increase                  in Participation Loans                                                                   |   |                                                      | - |   |   |   | 1,007 |   |
| Payment                  on Borrowings                                                                             |   |                                                      | 31,500 |   |   |   | (66,000 | ) |
| Payment                  of Dividends                                                                              |   |                                                      | (51,110 | ) |   |   | (95,758 | ) |
| (Decrease)                  Increase in Escrow and Security Deposits                                               |   |                                                      | (3,481 | ) |   |   | 6,453 |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Net                  Cash Provided by Financing Activities**                                                     |   |                                                      | 7,004,558 |   |   |   | 5,975,788 |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Net                  Increase in Cash**                                                                          |   |                                                      | 1,715,696 |   |   |   | 2,240,594 |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Cash                  Balance, Beginning of Period**                                                             |   |                                                      | 6,579,242 |   |   |   | 2,669,845 |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Cash                  Balance, End of Period**                                                                   |   | $                                                         | 8,294,938 |   |   | $ | 4,910,439 |   |
|                                                                                                               |   |                                                      |   |   |   |   |   |   |
| **Supplemental                  Cash Flow Information**                                                            |   |                                                      |   |   |   |   |   |   |
| Cash                  Paid for Interest                                                                            |   | $                                                         | 305,885 |   |   | $ | 141,657 |   |
| Transfer                  of Loans to Real Estate Owned                                                            |   | $                                                         | - |   |   | $ | 106,399 |   |

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

----

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

**Earnings        Per Share**

|                                                                  |   | **For                  The Three Months Ended March 31,** |
|-----------------------------------------------------------------------|--------|-----------------------------------------------------------|
|                                                                  |   |                                                      | **2006** |   |   |   | **2005** |   |
|                                                                  |   |                                                      | **(unaudited)** |   |   |   | **(unaudited)** |   |
| Basic:                                                                |   |                                                      |   |   |   |   |   |   |
| Net                  (Loss) Income (Attributable to Common Stock)     |   | $                                                         | 95,134 |   |   | $ | (845 | ) |
| Weighted                  Average Common Shares Outstanding           |   |                                                      | 2,574,236 |   |   |   | 2,505,556 |   |
| Basic                  Earnings Per Share                             |   | $                                                         | 0.04 |   |   | $ | - |   |
|                                                                  |   |                                                      |   |   |   |   |   |   |
| Diluted:                                                              |   |                                                      |   |   |   |   |   |   |
| Net                  (Loss) Income (Attributable to Common Stock)     |   | $                                                         | 95,134 |   |   | $ | (845 | ) |
| Weighted                  Average Common Shares Outstanding           |   |                                                      | 2,574,236 |   |   |   | 2,505,556 |   |
| Dilutive                  Effect of Stock Options                     |   |                                                      | 111,490 |   |   |   | - |   |
| Weighted                  Average Common Shares Outstanding - Diluted |   |                                                      | 2,685,726 |   |   |   | 2,505,556 |   |
| Diluted                  Earnings Per Share                           |   | $                                                         | 0.04 |   |   | $ | - |   |

**Use        of Estimates in Preparing Financial Statements**

**Nature        of Operation**

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

*Accounting        by Creditors for Impairment of a Loan*

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

|                                                                                                                                          |   |   | **March                  31,****2006** |   |   |   | **December                  31,****2005** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|----------------------------------------|--------|--------|--------|-------------------------------------------|--------|
|                                                                                                                                          |   |   | **(unaudited)**                        |   |   |   | **(unaudited)**                           |   |
| Total                  Recorded Investment in Impaired Loans at End of Period                                                                 |   | $      | 993,742                                |   |   | $      | 836,390                                   |   |
| Amount                  of that Recorded Investment for which there is a Related Allowance                  for                  Loan Losses  |   | $      | 984,571                                |   |   | $      | 836,390                                   |   |
| Amount                  of Related Allowance for Loan Losses Associated with such                  Investment                                 |   | $      | 260,001                                |   |   | $      | 228,493                                   |   |
| Amount                  of that Recorded Investment for which there is no Related Allowance                  for                  Loan Losses |   | $      | 9,171                                  |   |   | $      | -                                         |   |

|                                                                                                                                             |   |   | **March                  31,****2006** |   |   |   | **December                  31,****2005** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|----------------------------------------|--------|--------|--------|-------------------------------------------|--------|
|                                                                                                                                             |   |   | **(unaudited)**                        |   |   |   | **(unaudited)**                           |   |
| Average                  Recorded Investment in Impaired Loans during Period                                                                     |   | $      | 851,807                                |   |   | $      | 709,871                                   |   |
| Related                  Amount of Interest Income Recognized within Period when Loans were                  Impaired                            |   | $      | -                                      |   |   | $      | -                                         |   |
| Amount                  of Income Recognized Using Cash Basis during Time Within Period                  that Loan                  was Impaired |   | $      | -                                      |   |   | $      | -                                         |   |

**Analysis        of the allowance for loan losses is as follows:**

|                                                      |   |   | **March                  31,****2006** |   |   |   | **December                  31,****2005** |   |
|-----------------------------------------------------------|--------|--------|----------------------------------------|--------|--------|--------|-------------------------------------------|--------|
|                                                      |   |   | **(unaudited)**                        |   |   |   | **(unaudited)**                           |   |
| Beginning                  Balance                        |   | $      | 369,791                                |   |   | $      | 233,311                                   |   |
| Provision                  for Loan Losses                |   |   | 57,352                                 |   |   |   | 251,048                                   |   |
| Loans                  Charged Off                        |   |   | -                                      |   |   |   | (121,068                                  | )      |
| Recovery                  of Loans Previously Charged Off |   |   | -                                      |   |   |   | 6,500                                     |   |
| Ending                  Balance                           |   | $      | 427,143                                |   |   | $      | 369,791                                   |   |

**NOTE        C—**
**INVESTMENTS**

|                                              |   | **March                  31, 2006** |
|---------------------------------------------------|--------|-------------------------------------|
|                                              |   |                                | **Amortized                  Cost** |   |   |   | **Gross                  Unrealized Gains** |   |   |   | **Gross                  Unrealized Losses** |   |   |   | **Estimated                  Fair****Value** |   |
| Corporate                  Bonds (Net of Premium) |   | $                                   | 621,328 |   |   | $ | - |   |   | $ | (71,215) |   |   | $ | 550,113 |   |
| Money                  Market Fund                |   |                                | 75,150 |   |   |   | - |   |   |   | - |   |   |   | 75,150 |   |
| Totals                                            |   | $                                   | 696,478 |   |   | $ | - |   |   | $ | (71,215) |   |   | $ | 625,263 |   |

|                                              |   | **December                  31, 2005** |
|---------------------------------------------------|--------|----------------------------------------|
|                                              |   |                                   | **Amortized                  Cost** |   |   |   | **Gross                  Unrealized Gains** |   |   |   | **Gross                  Unrealized Losses** |   |   |   | **Estimated                  Fair****Value** |   |
| Corporate                  Bonds (Net of Premium) |   | $                                      | 623,351 |   |   | $ | - |   |   | $ | (99,463 | ) |   | $ | 523,888 |   |
| Money                  Market Fund                |   |                                   | 74,721 |   |   |   | - |   |   |   | - |   |   |   | 74,721 |   |
| Totals                                            |   | $                                      | 698,072 |   |   | $ | - |   |   | $ | (99,463 | ) |   | $ | 598,609 |   |

**NOTE        D—**
**RELATED        PARTY TRANSACTIONS**

**NOTE        E—**
**STOCK        BASED COMPENSATION**

*Share-Based        Payment*

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

|                                                                                                                                                                       |   | **Three                  Months Ended March 31, 2005** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|
| Net                  loss, as reported                                                                                                                                     | $      | (845                                                   | )      |
| Deduct: total                  stock-based employee compensation expense determined under fair                  value based method for all awards, net of tax effects |   | 59,249                                                 |   |
| Pro                  forma net loss                                                                                                                                        | $      | (60,094                                                | )      |
|                                                                                                                                                                       |   |                                                   |   |
| Earnings                  (loss) per common share:                                                                                                                         |   |                                                   |   |
| Basic                  - as reported                                                                                                                                       | $      | -                                                      |   |
| Basic                  - pro forma                                                                                                                                         | $      | (0.02                                                  | )      |
| Basic                  - as reported                                                                                                                                       | $      | -                                                      |   |
| Basic                  - pro forma                                                                                                                                         | $      | (0.02                                                  | )      |

|                                                         |   | **Options**                |   |   |   | **Weighted-Average                  Exercise Price** |   |   |   | **Aggregate****Intrinsic                  Value** |   |
|--------------------------------------------------------------|--------|----------------------------|--------|--------|--------|------------------------------------------------------|--------|--------|--------|---------------------------------------------------|--------|
| Outstanding                  at January 1, 2006              |   | 361,250                    |   |   | $      | 2.07                                                 |   |   |   |                                              |   |
| Granted                                                      |   | -                          |   |   |   |                                                 |   |   |   |                                              |   |
| Exercised                                                    |   | (40,000                    | )      |   |   | 2.00                                                 |   |   |   |                                              |   |
| Forfeited                                                    |   | -                          |   |   |   |                                                 |   |   |   |                                              |   |
|                                                         |   |                       |   |   |   |                                                 |   |   |   |                                              |   |
| Outstanding                  at March 31, 2006               |   | 321,250                    |   |   | $      | 2.08                                                 |   |   | $      | 295,550                                           |   |
|                                                         |   |                       |   |   |   |                                                 |   |   |   |                                              |   |
| Exercisable                  at March 31, 2006               |   | 321,250                    |   |   | $      | 2.08                                                 |   |   | $      | 295,550                                           |   |
|                                                         |   |                       |   |   |   |                                                 |   |   |   |                                              |   |
| Weighted                  Average Remaining Contractual Life |   | 3.2                  Years |   |   |   |                                                 |   |   |   |                                              |   |

----

**KH              FUNDING COMPANY**

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

**FOR              THE THREE MONTHS ENDED MARCH 31, 2006 AND 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**

**Recent        Developments**

**Critical        Accounting Policies**

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

*Assets*

*Liabilities*

*Equity*

*Past        Due Loans*

*Non-Accrual        Loans*

**Comparison        of Operating Results for Three Months Ended March 31, 2006 and        2005**

*Net        Income*

*Interest        Income*

*Interest        Expense*

*Provision        for Loan Losses*

*Non-Interest        Income*

*Non-Interest        Expense*

*Income        Taxes*

**Liquidity        and Capital Resources**

| **Year**                                           |   |   | **Notes                  Sold** |   |   |   | **Notes                  Redeemed** |   |   | **Percentage** |
|----------------------------------------------------|--------|--------|---------------------------------|--------|--------|--------|-------------------------------------|--------|--------|----------------|
| 2001                                               |   | $      | 10,367,351                      |   |   | $      | 10,661,318                          |   |   | 102.84         | % |
| 2002                                               |   | $      | 14,418,456                      |   |   | $      | 11,280,177                          |   |   | 78.23          | % |
| 2003                                               |   | $      | 22,926,619                      |   |   | $      | 18,681,654                          |   |   | 81.47          | % |
| 2004                                               |   | $      | 26,631,166                      |   |   | $      | 24,697,776                          |   |   | 92.74          | % |
| 2005                                               |   | $      | 49,008,102                      |   |   | $      | 44,786,895                          |   |   | 91.39          | % |
| Three                  Months Ended March 31, 2006 |   | $      | 37,002,763                      |   |   | $      | 30,329,599                          |   |   | 81.97          | % |

*Redemption        of Notes Payable*

*Plan        to Raise Additional Capital. *

**Known        Trends, Events of Uncertainties**

*Impact        of Inflation and Interest Rates*

*Stockholders'        Equity*

**ITEM        3.**
**CONTROLS        AND PROCEDURES**

**PART        II **
**-        OTHER INFORMATION**

----

**SIGNATURE**

|                                 | KH                  FUNDING COMPANY                    |
|--------------------------------------|--------------------------------------------------------|
|                                 | (Registrant)                                           |
|                                 |                                                   |
|                                 |                                                   |
| Dated:                  May 15, 2006 | /s/                  James E. Parker                   |
|                                 | James                  E. Parker                       |
|                                 | Chief                  Financial Officer and Treasurer |