* Shares up on better-than-expected results
* Clients' cash holdings back to pre-recession levels
* First-quarter EPS 20 cents vs Wall St. view for 19 cents
* CFO says investor sentiment improving (Adds analyst comment, Advisor Services business, updates share price)
By Philipp Gollner
SAN FRANCISCO, April 15 (Reuters) - Charles Schwab Corp (SCHW.N), the largest U.S. discount brokerage, posted higher-than-expected earnings as rising stock markets fueled trading and fees from clients, sending the stock up nearly 3 percent.
First-quarter profit and revenue both came in above analysts' estimates, driving the stock up 2.9 percent to $18.75 on the New York Stock Exchange.
"The numbers show that Schwab's earnings and its stock price still have potential upside," said Morningstar Inc analyst Michael Wong. "There are many tailwinds out there for Schwab," including the potential for rising interest rates and prospects for an improving economy.
Net income for the three months ended March 31 was $243 million, or 20 cents per share, compared with $6 million, or nil per share, in the year-earlier quarter, when a legal settlement nearly wiped out earnings.
Revenue at San Francisco-based Schwab rose to $1.21 billion from $978 million, helped by higher stock markets that generated more trading and fees on invested assets. The Standard & Poor's 500 index rose 4.2 percent in the first quarter.
Analysts, on average, had forecast earnings of $225.8 million, or 19 cents per share, on revenue of $1.18 billion, according to Thomson Reuters I/B/E/S.
Rising stock markets have attracted more retail customers to Schwab and led to greater inflows into Schwab mutual funds. But competition from online brokers TD Ameritrade Holding Corp (AMTD.O), E*trade Financial Corp (ETFC.O) and independent broker-dealers has led Schwab to lower prices for trades, hampering revenue growth.
Average revenue per trade fell to $12.12 in the first quarter from $12.60 a year ago, Schwab said.
"We've definitely seen improvement in investor sentiment over the last several months," Chief Financial Officer Joe Martinetto said in an interview after the quarterly report was released on Friday. He said the results showed the strength of Schwab's business model, in which relatively stable costs allow for rapid earnings growth when revenue rises.
Shares of Schwab, which is highly sensitive to interest rate movements, have gained 4.1 percent this year before Friday's results, partly on expectations that rising interest rates would widen net interest margins and restore fees waived on low-yielding money market funds.
First-quarter revenue rose even though the company waived $112 million in fees on money market mutual funds, which have been yielding less than the fees Schwab normally charges on them.
Chairman Charles Schwab said in a statement that clients had reduced their cash holdings at Schwab to levels not seen since before the financial crisis of 2008 and are investing more money in stocks.
"At the same time, investors are faced with navigating ongoing challenges - including geopolitical turmoil, vacillating energy prices and the aftermath of major natural disasters," he added.
Daily average trades, a widely watched measure of client activity, rose 14 percent in the first quarter to 472,500. The company recently agreed to buy U.S. online brokerage optionsExpress Holding Inc OXPS.O for $1 billion in stock to target some of the most active retail traders in the booming options market.
Schwab said it had net new assets of $23 billion, and total invested assets reached a record $1.65 trillion at the end of March, up 10 percent from a year ago.
Client assets in the company's Advisor Services business, which provides services to registered investment advisers, rose 10 percent from last year's first quarter to $688.6 billion.
Schwab holds client funds in custody, clears trades and provides technical advice to more than 6,000 fee-based registered investment advisers, or RIAs, and hopes to attract more as a growing number of brokers consider switching from full-service firms to set up shop on their own.
All three major components of Schwab's revenue rose in the first quarter. Asset management and administration fees charged on client funds rose 20 percent to $502 million, while net interest revenue was up 28 percent at $436 million. Trading revenue gained 15 percent to $241 million.
Earnings in the year-earlier quarter were slashed by a $196 million addition to legal reserves to cover a settlement over the Schwab YieldPlus fund, a bond fund that soured when the housing market collapsed. The company did not add to legal reserves in this year's first quarter.
Schwab's overall expenses fell 15 percent because of last year's legal settlement. Compensation and benefits edged up to $437 million from $402 million as Schwab added about 500 employees for a total staff of 13,100. (Reporting by Philipp Gollner, editing by Gerald E. McCormick, Dave Zimmerman)