An investment’s return is its change in value over the tenure of the investment and is typically expressed as a percentage. It is common knowledge that globally, NAR or Net Annualized Return is used to calculate returns made by lenders on their investments through P2P lending platforms.

Often the question arises that why simple return which refers to loss or profit earned on an investment divided by principal invested is not used to measure returns from P2P Lending. This leads to further queries such as what is NAR and why is it considered a better measure to calculate returns made from P2P lending. Let’s try to answer all these questions below.

Why NAR?

P2P lending is like a fixed income financial instrument, where returns are received on a monthly basis. Monthly repayments consist of part principal and interest. For any other form of investment, once the money is invested it is received along with interest/earnings only at the end of tenure. Hence, returns can be calculated simply by understanding the loss or profit made on the amount invested once the tenure of investment is over. However, in online lending, repayments are being received every month and these can be reinvested to benefit from compounding returns. In such a situation, simple return calculation is not a sufficient measure and NAR steps in.

What is NAR?

Net Annualized Return (NAR) represents annualized net return of a loan portfolio where the monthly income divided by the principal outstanding for the month is calculated and then annualized. Income refers to interest component of the EMI + any penalty and late fee charges received less any expenses such as investment fees and losses.

Annualized returns are returns over a period scaled down to a 12-month period. This scaling process allows investors to objectively compare the returns with any other asset over any period. Since NAR is an annualized figure, it’s a projection.

How does NAR change?

NAR reduces abnormally in case of default and increases abnormally when an income foreclosure fee or late payment fees are received. Since initial EMIs have a larger interest component NAR is initially higher and reduce as the loan progresses and matures. To keep NAR high or same, reinvestment of monthly income/EMIs is a must.

NAR reported by Faircent

Faircent reports a lender’s NAR in three formats - Gross NAR which only considers returns and not losses; Optimistic NAR which considers the principal component of only the EMIs which are 180 days past due as on date as a loss and Pessimistic NAR considers EMI of a loan over-due past 180 days as unrecoverable and the complete unpaid principal of the loan is treated as a loss.

Since with collections and recovery efforts some of the defaulted EMIs can come back along with penalty charges, actual returns would be somewhere in-between the optimistic and pessimistic NAR projections.

Platform NAR is used to understand the average performance of all the lenders investing through a platform. The platform's NAR is calculated as the weighted average (based on the amount invested) of the NAR for all individual lenders who have invested until the previous month end.