Mesenchymal stromal cell (MSC) therapy is a promising treatment option for autoimmune and other diseases. One of the major hurdles besetting clinical islet transplantation is early islet graft death caused by inflammatory events immediately post-transplantation. In a procedure mirroring the clinical setting, we assessed the mechanism of how intrahepatic co-infusion of MSCs leads to better survival of human islets after transplantation into streptozotocin-induced diabetic NOD-SCID mice. We further deciphered whether alpha-1 antitrypsin overexpressing MSCs (AAT-MSCs) exert similar or better protection against naive MSCs. Luciferase imaging studies and immunohistochemistry staining of serial liver sections identified significantly more islets in the livers of the MSC or AAT-MSCs groups compared to the mice receiving islets only. Luciferase+ (Luc+) MSCs co-transplanted with islets remained in the liver for at least one week. Compared to controls, MSC or AAT-MSCs mice showed reduced serum levels of inflammatory-related chemokines, including interleukin 6 (IL-6), interferon-gamma (IFN-g), interleukin-9 (IL-9), among others. In vitro mechanistic studies revealed that MSC or AAT-MSCs suppress IFN-g-induced M1-like CD206-iNOS high macrophages while promoting IL-4-induced M2-like CD206+IL-10 high macrophages. These data suggest that AAT-MSCs protect transplanted islets from early graft death via suppression of inflammation, and can be used to improve the efficacy of islet transplantation.