Comfort Letters: Just Say No

comfort letterPhoenix, AZ (AZ CPA) July/Aug 2013 – Many lenders and loan brokers offering no-documentation and low-documentation loans have developed a bad habit of asking CPAs to issue comfort letters for self-employed borrowers.  These requests come in many forms.  A lender may ask for a simple written confirmation of a client’s self-employed status or verification of self-employment income.  More aggressive requests ask the CPA to confirm the sustainability of a client’s profitability or to indicate that withdrawing money from a business to fund a down payment will not adversely impact the borrower’s business.

Guidance related to such requests is provided in Interpretation No. 2, “Responding to Requests for Reports on Matters Relating to Solvency,” of AT section 101, Attest Engagements (AICPA, Professional Standards, AT sec. 9101 par. .23-.33).  Paragraph .25 of Interpretation No. 2 defines matters related to solvency as whether an entity (a) is not insolvent at the time the debt is incurred or would not be rendered insolvent thereby, (b) does not have unreasonably small capital, or (c) has the ability to pay its debts as they mature.  Paragraph .27 of Interpretation 2 indicates that because of the varying legal interpretation of solvency the practitioner does not have suitable criteria to evaluate the assertion.  CPAs are therefore precluded from giving any form of assurance on matters related to solvency or any financial presentation relating to solvency.

In obtaining a comfort letter, lenders and brokers effectively shift the burden of assessing a borrower’s creditworthiness to an unwitting CPA.  If the borrower later defaults on the loan, the lender may sue the CPA alleging that it relied on negligent misrepresentations contained in the letter.  The definitive guidance provided by Interpretation No. 2 would not afford the CPA with much of a defense.  Essentially the CPA has co-signed the client’s loan via their professional liability insurance policy, assuming their policy does not specifically forbid it, which many now do.

Despite efforts by the AICPA to reach out to the lending community to explain what services CPAs can and cannot provide, lenders continue to press the CPA community for comfort letters.  When these requests are submitted, it creates an uncomfortable tension between the practitioner and the client.  The client, who does not understand the implication of issuing such a statement, feels the CPA is being unreasonable and uncooperative at one of their most vulnerable moments.  The client is fearful to return to their lender absent the requested documentation and has concerns about how they will explain why their CPA would not provide the letter.

There are several ways a CPA can respond to these requests.  It is important to help the client understand the applicable professional standards, but simply quoting scripture and sending the client to face the lender alone will probably not solidify the relationship.  The CPA should also engage directly with the lender to (1) help them understand why the request cannot be fulfilled, and (2) to find out if there is alternative documentation that may satisfy the need.  In many cases, the lender may accept a client’s articles of incorporation, a current state / business license, a letter from a professional organization verifying their current self-employment, a letter from a business that employs their services verifying the type of service and the dates that they were used, or a bond or workers’ compensation insurance policy verifying that they own the business.

The CPA should further advise the client and the lender of the professional services that are available and may be useful for purposes of making a financing decision.  The CPA may audit, review or compile financial statements.  A CPA can examine, review or compile pro forma financial information.  CPAs are permitted to examine or compile prospective financial information.  CPAs can also perform agreed-upon procedures, provided the resulting report does not provide any assurance on matters related to solvency.

In the many cases where mortgages will be resold to Freddie Mac, lenders may assert that a self-employed borrower will not qualify for a mortgage unless the CPA provides the comfort letter.  The CPA may challenge the lender by referencing the fact neither Fannie Mae nor Freddie Mac contain such guidance in their seller guides for residential mortgages.

Historically, Freddie Mac’s Single Family Seller / Servicer Guide (the Guide) provided that in order to assess whether the withdrawal of funds would adversely affect the ability of the business to continue operations the secondary market sellers could obtain a comfort letter from the accountant stating that, “The Borrower has access to the funds and the withdrawal of the funds for the down payment and closing costs will not have a detrimental effect on the business.”  Such guidance regarding comfort letters has never been found in Fannie Mae’s guide.

In 2012, Freddie Mac revised the Guide by deleting the practice of obtaining a comfort letter.  Instead the Guide now indicates that the lender should verify the borrower’s business and personal assets and perform a cash flow analysis, both of which must now be contained in their mortgage file.  The revision to the Guide places the burden of evaluating the borrower’s solvency solely on the lender or broker.

In an effort to avoid alienating their client, the CPA may provide a letter confirming that the CPA prepared the applicable income tax return(s).  Disclaimers indicating that the tax return was not audited or verified are appropriate.  The CPA should also make specific reference to the fact that in preparing the tax return, the CPA does not perform any assessment of creditworthiness and that the lender is solely responsible for such determination.

If after offering these practical solutions the lender continues to press the client for the comfort letter, the CPA should consider that the client’s underlying desire is to have flexibility in obtaining credit in the marketplace.  As an important center of influence in their client’s lives, the CPA is well-positioned to help the client find a different lender.

Benjamin Podraza, CPA, is the principal at Podraza CPA, PLLC in Scottsdale.  He provides tax and accounting services for individuals and small businesses.  He can be reached at or (480) 998-3945.

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