Fitch: REIT Status Will Not Change Potlatch Ratings.

CHICAGO -- Fitch Ratings has affirmed Potlatch Corporation's (Potlatch) senior unsecured ratings and issuer default rating at 'BB+' and the company's senior subordinated rating at 'BB'. The Potlatch Rating Outlook remains Stable.

Potlatch has asked its shareholders to approve a downstream merger as an initial step in the company's conversion to a real estate investment trust (REIT). Post conversion, Potlatch will own a qualified REIT subsidiary (QRS) which will have all of the company's existing 1.5 million acres of timberlands in Idaho, Arkansas and Minnesota, its hybrid poplar tree farm in Oregon, and all of the common stock of a taxable REIT subsidiary (TRS). The TRS will own the company's tissue, pulp and paperboard, and wood products (primarily lumber) operations and will be the obligor of Potlatch's outstanding publicly traded debt and industrial revenue bonds, all of which will be guaranteed by QRS. Both QRS and TRS are expected to become parties, jointly and severally, to a revolving bank facility which will be unsecured and provide sufficient liquidity as necessary to either subsidiary.

The incentive behind the conversion is to permit Potlatch to distribute earnings from QRS to Potlatch shareholders without paying federal corporate income taxes on the QRS earnings paid to shareholders. This will put Potlatch's potential cash returns to shareholders from timberland operations on a level playing field with other timberland investment vehicles. Potlatch's business mix will remain unchanged. However, the company anticipates increasing its annual dividend to $2.60 per common share (approximately $76 million) beginning in 2006 which could impact the level of reinvestment in TRS' taxable businesses.

A key issue in this structure is whether TRS' businesses can be self-supporting, with a majority of cash earnings from QRS going to shareholders. It doesn't appear this way in the current year, factoring in a slightly larger appetite for capital expenditures. The profitability of TRS' tissue and pulp and paperboard operations is expected to improve. This likely will not be the case with lumber and plywood operations, prices having peaked last year and not expected to appreciate to those record levels again either this year or next. To take up the slack, TRS will need better realizations in tissue and pulp and paperboard, lower cost structures in all of the taxable businesses, and/or a lower allocated corporate overhead. The likelihood of achieving these targets in current markets is fair, but not assured, and there is an equal likelihood that TRS may have to borrow to support its taxable operations while Potlatch is paying out QRS earnings to shareholders.

In consolidation Potlatch's financial metrics, a 1.8 times (x) debt-to-EBITDA and a 5.1x trailing four quarters net interest coverage, are relatively strong but these could suffer if cost reduction milestones are not realized or if commodity prices do not live up to expectations. Potlatch could potentially become investment grade, but one of the things it will have to prove is the financial independence of its taxable businesses and the ability of those businesses to function without support from the cash earnings of QRS' operations.

Potlatch is a mid-sized, integrated forester and manufacturer of wood and pulp based products. The company's timberlands provide the majority of the raw materials for the manufacture of lumber, plywood and particleboard. Potlatch also makes pulp, paperboard and tissue and is a leading producer of retail private-label tissue products.

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