Fitch called Thursday's ruling "among the worst of the possible outcomes for the city's credit quality," while warning the rating could be downgraded further in the absence of "a realistic plan that puts the pension funds on an affordable path toward solvency."

"Not only did (the Illinois Supreme Court) strike down the pension reform legislation in its entirety, but it made clear that the city bears responsibility to fund the promised pension benefits, even if the pension funds become insolvent," Fitch said in a statement.

The two-notch rating downgrade to BBB-minus, which is one step above "junk," affects $9.8 billion of the city's general obligation bonds and $486 million of sales tax revenue bonds. Chicago's credit rating with Moody's Investor Service is already in the "junk" level.

Standard & Poor's lowered its rating to BBB-plus from A-minus in July.

Chicago, the country's third-biggest city, has been mired in a financial crisis largely fueled by a $20 billion unfunded liability in its four retirement systems.

The Illinois high court rejected Chicago's assertion that the 2014 state law affecting the city's municipal and laborers' retirement systems actually benefited workers and retirees by taking steps to avoid insolvency for the funds.

The law, which was challenged by unions and retirees, required the city and affected workers to increase their pension contributions and replaced automatic 3 percent annual cost-of-living increase for retirees with an adjustment tied to inflation. The adjustment would be skipped in some years.

Without reforms, Chicago warned that the two funds would run out of money within 10 to 13 years.

The ruling made it clear that Chicago bears the ultimate responsibility to pay pensions in full.

Fitch said any plan to address pensions "must rely on meaningful use of revenue and expenditure controls to meet much higher annual payments."

Chicago Chief Financial Officer Carole Brown said in a statement that Mayor Rahm Emanuel has taken steps to address the city's financial challenges, including the implementation of debt reforms.

The city, which is already paying a premium to borrow in the U.S. municipal bond market, could sell as much as $1.25 billion of GO bonds this year.