Moody's Investors Service reduced Chicago's debt rating by three steps late Wednesday to an A3 rating.
The credit ratings firm, part of Moody's Corporation (NYSE:MCO), said the third-largest city in the U.S. has a $36 billion retirement-fund deficit and "unrelenting public safety demands" on its budget, when it cut its rating of Chicago's general-obligation debt. Chicago's $7.7 billion in general-obligation bonds is now under a negative outlook, and Moody's indicated that another cut could be made.
The New York firm had rated Chicago's general-obligation bonds at Aa3, or fourth highest. The company also cut its grades on the city's securities tied to sales-tax revenue and water and sewer debt, to A3 from Aa3 and to A1 from Aa2, respectively, affecting almost $3.9 billion in related debt.
"Absent significant growth in the city's operating revenues, escalating pension funding requirements will increasingly strain the city's operating budget, as pension outlays compete with other spending priorities, including debt service and public safety," Moody's analysts wrote in the report, referring specifically to Chicago's high costs of controlling crime. The city of about 2.7 million managed to reduce its homicide rate by 29 percent in the first half of 2013, yet it had to pay overtime to 400 officers.
Chicago Mayor Rahm Emanuel said the downgrade confirmed his long-held belief that large municipalities will continue to receive negative reviews from rating agencies without comprehensive pension relief from the state. However, state lawmakers could not agree to provide relief during two special sessions called by Illinois Gov. Pat Quinn in the past five weeks.
"I urge our leaders to come together, find common ground and pass pension relief that will give taxpayers, retirees, residents and rating agencies confidence in our city's finances and our city's future," Emanuel's office said in a statement.
The 53-year-old Chicago resident and former investment banker, former congressman and former White House chief of staff to President Barack Obama previously warned that retirement contributions would cost about $1.2 billion within four years if the state legislature didn't restructure the system. His 2012 estimate was just $476 million.
The two Moody's analysts, Rachel Cortez and Thomas Aaron, said the city's four pensions reported a $19 billion collective deficit -- about half of what the analysts figured it would be. Chicago's downgrade is now just four steps above noninvestment grade, considered junk.
Moody's began reviewing the credit effects of Chicago's municipal retirement obligations in April amid political obstacles to meaningful retirement system reform that reach all the way up to the state level.
Fitch dropped Illinois to its fourth-lowest investment grade of A- after the Springfield legislature adjourned May 31 without passing a pension fix. Three days later, Moody's announced its equivalent cut to A3, while Standard & Poor's rates Illinois at the same level.