* IL&FS audit by Grant Thornton shows lapses by rating agencies
* Rating agencies knew of problems, gave good ratings-report
* "Certain favors/gifts" possible reason for good ratings-report
* Favours, gifts included tickets to Real Madrid game and gadgets
* Report raises queries about reliability of other company ratings (Adds ICRA comment)
By Abhirup Roy and Aditya Kalra
MUMBAI/NEW DELHI, July 20 (Reuters) - Credit rating agencies for years assigned high ratings to India's Infrastructure Leasing & Financial Services (IL&FS) and its group companies despite its deteriorating finances, according to a special audit.
Audit firm Grant Thornton was appointed by IL&FS' new board to conduct the review following the government's decision to take charge of the group after its defaults on debt obligations sparked fears of financial contagion.
Grant Thornton reviewed the role of five credit rating agencies -- Fitch group's India Ratings and Research, the Indian affiliate of Moody's, ICRA, Standard & Poor's local unit Crisil, CARE Ratings and Brickwork Ratings India -- which assigned 429 ratings to various IL&FS financial instruments in recent years.
In a 105-page report, reviewed by Reuters on Saturday, Grant Thornton said the agencies raised multiple concerns on IL&FS group's financial stress and liquidity position between June 2012 and June 2018, but continued to assign "consistently high" ratings which were only downgraded or reversed last year.
"Various strategies deployed by the then key officials of IL&FS group and certain favours/gifts provided to rating agency officials suggest the possible reasons for consistent good ratings provided to IL&FS group," said Grant Thornton in its report that detailed gifts or favours such as smartwatches and tickets to overseas sporting events.
IL&FS declined to comment. India Ratings said the Grant Thornton report is based on "partial and selective source material", adding "our ratings were based on robust and transparent analysis of relevant information".
Brickwork said it did not assign the highest ratings to IL&FS "because it follows robust, transparent and consistent rating methodology" and its actions were not influenced by any commercial pressures or rating withdrawal requests.
ICRA said it will determine an appropriate course of action and was examining the report, which it said ignores the "alleged fraud perpetrated by former IL&FS management".
Crisil and CARE did not immediately respond to a request for comment.
The IL&FS crisis that started last year has sparked a series of federal probes into the firm's operations, but Grant Thornton's report raises questions on whether rating agencies misled investors about the stress levels at other companies in India's shadow banking sector, where new fractures are emerging.
Dewan Housing Finance Corp, another top firm in the sector, last week warned its financial situation was dire, raising more worries about the sector's health and signalling the crisis was far from over.
"These instances show a glimpse into the incestuous financial services industry where quid pro quo has become the norm. The rot ... is deep and needs more cleansing," said Shriram Subramanian, a corporate governance expert at proxy advisory firm InGovern.
Grant Thornton's review of communication between former IL&FS employees and ratings agencies found the company at times "used to potentially pressurize" rating firms to withdraw their assessment if the company did not receive a favourable rating.
It also found instances where credit rating agencies would meet with IL&FS employees and then decide not to downgrade the ratings they had initially decided on, the report said.
"It appears that various potential strategies noted above were applied to ensure favorable ratings or to avoid the rating downgrade," Grant Thornton said.
Highlighting "potential favours/gifts", Grant Thornton said various key officials at rating agencies received gifts such as smartwatches, shirts and coasters.
E-mail communication showed a former IL&FS employee had facilitated the purchase of a villa at a steep discount for the wife of a senior Fitch executive, while another had arranged football tickets for a Brickwork Ratings executive to a Real Madrid game, the report added.
Brickwork said it had shared "a detailed response" on this specific allegation with IL&FS' new management. Fitch in a statement said the employee involved had violated the agency's code of conduct and was no longer employed.
India's market regulator has toughened regulations for credit rating agencies over the past three years to boost monitoring and bring clarity for investors. Following the IL&FS crisis, the regulator last month ordered enhanced disclosure norms for such agencies. (Reporting by Abhirup Roy and Aditya Kalra; Editing by Euan Rocha, Stephen Powell and Kirsten Donovan)