In the wake of State Street Corp.'s decision to leave the 529 college savings business, executives and experts say they believe other providers could follow the Boston banking company out the door as the market for the product evolves.
"I think that it is not unlike the 401(k) business," said Bruce Harrington, a vice president and the director of product development and marketing at MFS Investment Management in Boston. "A lot of people rushed in with the premise that the assets were going to be huge and there was just an unlimited ability to make some money here. Everyone needs to realize that a lot of work has to go in before money can be made."
Mr. Harrington said other 529 providers would probably leave the business in the next year as companies struggle for scale. At Sept. 30 each of the top 40 college savings plans had at least $86 million of assets, he said, but the 50th-largest had only $16 million.
"You can't make money at this business with only $16 million in assets," he said. "What is happening is, bigger plans are getting bigger, and the bottom 10 or 15 plans are finding it very, very tough."
Rich Gershen, the head of business strategy, risk, and product management at Evergreen Investments, the mutual fund arm of Wachovia Corp., said he would not be surprised if other providers leave the 529 business. Another provider whose company is looking to sell its 529 plan has already contacted him. And Evergreen has joined with OppenheimerFunds Inc. in an agreement announced this month to take over State Street's 529 program in New Mexico.
"It is not uncommon when a business is young for people to leave," he said. "At the beginning everyone wants to take a shot. But over time you will separate the winners from the losers, and the business will naturally consolidate. Scale is important, and some consolidation is healthy."
Charles Toth, the education savings director for Merrill Lynch & Co., agreed that larger companies will see the rapid growth. He foresaw no further defections from the business, however, because he sees the product's future as bright.
Mr. Harrington said the 529 college savings business is just beginning to mature. In the past four years, he said, companies chased after states for authority to open programs and start plans. Currently, eighty-five 529 plans are in operation nationally.
Companies need at least $250 million of 529 plan assets in order to make money, he said.
"Now companies are coming to their senses, and the business is calming down," Mr. Harrington said. "People will leave, and the business will evolve."
State Street announced last week that it had agreed to assign its New Mexico 529 college savings program management business, which was conducted by its Schoolhouse Capital unit, to two of its distribution partners - Evergreen and OppenheimerFunds, which is majority-owned by Massachusetts Mutual Life Insurance Co. - as of Jan. 31. Schoolhouse also manages a plan in Oregon that Mr. Harrington said MFS would take over early next year.
In reporting its third-quarter earnings in October, State Street had announced its plan to quit the 529 college savings business due to insufficient scale, though the $1.05 billion of assets under management in Schoolhouse Capital's plans at Sept. 30 made it the 11th-largest 529 manager, according to data from Financial Research Corp.
State Street said then that it expected to save $50 million a year by restructuring moves that included dropping its 529 plan servicing business.
Mr. Gershen said he believes this is a great opportunity for both Evergreen and OppenheimerFunds.
"State Street, through Schoolhouse, was a 529 processor; they were not advisers," he said. "To turn a processing business into a moneymaker, the scale necessary is dramatically higher than if you are handling money management."
The portion of the processing business that Evergreen is to assume will really only make it a "break-even business" for the asset management unit of Wachovia, Mr. Gershen said, but he believes the 529 business is still profitable.
"The business of college savings will grow over time," he said. "By combining the revenue streams and the growth we expect, we are sure that we can succeed in the 529 business."
Mr. Harrington said State Street's business model was its downfall. Schoolhouse Capital was a 529 provider that outsourced distribution and asset management to other companies, he said. In New Mexico, OppenheimerFunds and Evergreen handled distribution, and in Oregon, MFS handled distribution.
A company needs much bigger scale in order to make money with this kind of model, Mr. Harrington said.
"We have a saying that if you have to choose between killer product or killer distribution, killer distribution is what you want," he said. "Schoolhouse had a killer product but no distribution."
But some analysts are less optimistic about the product. Unlike the early years, 529 plan sales have begun to grow more slowly. Assets in 529 plans increased by 5% in the third quarter, to $45.1 billion at Sept. 30, according to data from Financial Research.
Joe Hurley, the president of Savingforcollege.com, a Web site for 529 plan information, said State Street's decision to leave the 529 business reflects the difficult time companies are having finding profits. "This business is certainly more of a challenge than some firms expected when they got into it," he said. "I could see more firms getting out, and I think you will still see some firms that will dig in."
"The providers who can develop the best product and get it through to strong distribution channels are the ones who will survive here," he added.
Mr. Hurley said only a few companies have 529 business models that mirror State Street's unsuccessful one. In South Dakota, Pacific Investment Management Co. of Newport Beach, Calif., is the program manager for a plan distributed by Legg Mason; and in Nebraska, AIM Investments and State Farm Insurance distribute plans under a mandate from the state held by Union Bank and Trust Co. of Lincoln, Neb.
"This is a competitive market, and firms are competing for market share," Mr. Hurley said. "The best plans will continue to gather assets."
Mr. Toth of Merrill Lynch, who is also the chairman of the College Savings Foundation, an organization for building awareness of the 529 product, said he does not believe others will follow State Street's lead out of the business.
"As an industry, firms are gaining scale," he said. "At the end of the day," Schoolhouse Capital's withdrawal "will all be a nonevent and, perhaps, by eliminating some fees, this can be a benefit to the customers."
Mr. Toth, whose program has $2.7 billion of assets, said large programs are showing rapid growth as the 529 business continues to evolve. "Portions of the industry have underachieved because of the complexities associated with a new product," he said. "But this is a product with a bright future because the cost of college continues to increase."
