Moody’s Investors Service lowered Middletown’s bond rating Monday, and city officials are saying pension obligations and new standards set by the credit-rating agency are largely to blame.

Moody’s reported that the city’s credit rating was being downgraded from Aa2, the third-highest rating on the agency’s 21-level scale, to Aa3. The agency cited concerns about Middletown’s “deteriorating” tax base and demographic profile, reliance on economically-sensitive income tax receipts for the majority of its general fund revenues and the nearly $1 million loan from the general fund to finance Weatherwax Golf Course.

The rating downgrade means it will cost the city more to borrow money for future capital projects. Finance Director Michelle Greis said the ratings drop would have a “minimal” cost impact to the city of an extra nickle for every $1,000 borrowed moving forward.

“So when we issue debt, we’ll have to pay a little more in interest,” Greis said, noting the city still has the fourth-highest rating available.

General obligation bonds are a financing tool similar to a home mortgage that cities use to finance large capital projects over a multiple year period. Such projects include new roads, neighborhood improvements like sidewalks and curbs, and certain economic development projects.

Bonds are used when a city’s capital needs exceed the ability to fund these projects on a “pay as you go basis.” They allow the city to pay for projects over a longer period of time.

Cities typically pay the holders of these bonds back through a number of funding sources such as property taxes, sales taxes and city fees.

A good credit rating lowers the investment risk for lenders and provides the city with a low interest rate.

The statewide pension system, known as the Ohio Public Employees Retirement System, was a key reason for the city’s downgrade and could result in further deterioration of the city’s credit rating, Greis said.

“One of the new (Governmental Accounting Standards Board) requirements is due to pensions and unfunded pensions,” Greis said. “In two years, GASB is requiring that all local governments take on their piece of what their liability will be.”

What that means for Middletown is it will look like they have more debt than they actually do, she said.

While the downgrade is a negative reflection upon the city, Moody’s did cite some strengths in its assessment of Middletown, including the “expected stability of financial operations despite recent series of fund balance declines” and “strong management team that is expected to maintain sound financial reserves going forward.”

City Manager Judy Gilleland said Moody’s report gave an honest assessment of the city’s financial picture, but it’s a picture many other local governments are seeing. The city of Cincinnati also saw its bond rating lowered from Aa1 to Aa2, because of concerns about its pension systems and continued reliance on one-time solutions for a structurally unbalanced budget.

“They emphasized many positive aspects of the Middletown community and our city organization and also identified those areas in which we know we have financial challenges,” she said. “Unfortunately many cities across the nation are seeing a decline in their revenues and resulting change in their bond rating, Middletown being among them.”

There are about a dozen factors Moody’s reviews in determining its credit ratings, including a municipality’s budget management, demographics, and level of wealth. The agency said there are ways to increase credit ratings, which include diversifying operating revenues, improving residents’ standard of living and sustaining growth in the city’s tax base.

But if Middletown’s 15 percent reserve fund balance declines, or there is “ongoing deterioration” of the city’s tax base or demographic profile, that could result in more downgrades, according to Moody’s report.

Middletown’s income and property tax receipts have been on the decline over the past three years. The city collected $3.4 million in property taxes in 2010, $3 million in 2011 and $2.7 million in 2012. Likewise, income taxes dropped from $10.97 million in 2010 to $10.76 million in 2011 and $10.6 million in 2012.

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Income taxes are projected to rebound in 2013, increasing to $11.6 million, while property taxes will remain flat at $2.7 million, according to the city budget.

Meanwhile, the city is on pace to subsidize its 36-hole golf course by $357,000 this year. But Gilleland said “the golf season is still young,” and the city may yet lower that projected cost if Weatherwax’s receipts are good.