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Here's a quick render of a Kobold Tatzlwyrm Rider. Its desktop sized for download.

Kobold Tatzlwyrm Rider

I was looking through the Ultimate Campaign guide for troop ideas. The biggest concern that I can see is that these blighters are more powerful than the average Kobold. I don't see the regular rules as being very effective at working this out.

I think that the breath weapon\grab would be effectively 'Bleed 1D6'. Since Tatzlwyrm's are carnivorous, I'd increase their base consumption by one size category.

In the new rules, troops that die do permanent damage to your kingdom's Economy, Stability, etc. The fact is that these guy's would effectively have a bit of a glass jaw in battle and are a liability compared to a large group of human troops. I'd use them largely defensively, since they are fast, and can dish out some effective one shot stings with Dirty fighting, at Night, with Tatzlwyrms.

Anyways that's my two coppers.

Bounce the idea of Kobolds off your players. Kobold's are pretty good in the Advanced Race guide. And if you want to keep to the original(ish) script, they can be the minions of a surviving adventurer. i.e. the Kobolds rescue a Dwarf from the Mites? The Dwarf is friendless, but grateful, and he does have a charter...

I was thinking of having the Kobolds as a vassal Kingdom to the Humans. I was thinking that they'd be more of a city state, and far from the more optimally run human Kingdom.

I think you might allow it for cool factor. Perhaps only Kobold leaders ride them for the first 6 years, after that, small cavalry troops would be possible. I agree that maintenance should be expensive.

Depending on your campaign however, a side quest may be for the players to obtain more appropriate mounts for the Kobolds.

i.e. everyone knows that the northern Kobolds are more prosperous due to lack of competition with the 'civilized' races, and they have domesticated and trained Dire WWeasels. The players can go and negotiate with those Kobolds, to bring a trainer and a few Dire Weasels.

This brings in a more extra territoriality into the campaign, which I think is good.

I was thinking of adapting the Kingdom rules for the Kobolds. Should they survive first contact with the players, I'd like to incorporate the Kobolds as a vassal city state.

I was thinking of restricting them to two hexes, and largely subterranean. I was thinking that the cost of developing hexes should be 5 times greater, although city development costs should be the same as for the humans. Subterranean cities should have a default high defense.

Of course the players would have to be convinced to lend the seed cash to the Kobolds... Perhaps by the King's son who's joined the group. Kobold fighting forces later on would also be interesting. (Darkvision, and Traps sounds like some great night raids....)