Following the decision of American International Group Inc. ( AIG - Analyst Report ) to buy back shares worth $3 billion in the latest U.S. Treasury stock sale, Moody’s Investor Service of Moody’s Corp. ( MCO - Analyst Report ) asserted the company’s financial strength and senior debt ratings. This elucidates the confidence of this rating agency in AIG.

Accordingly, Moody’s affirmed the senior unsecured debt of AIG at “Baa1,” while the insurance financial strength (IFS) of AIG’s businesses – Chartis and SunAmerica were confirmed at “A1” and “A2,” respectively.

Basking after a good second-quarter performance, late last week AIG announced that the U.S. Treasury will vend company shares worth about $5.0 billion, which were held by the Treasury.

In this fourth round of stock sale since the recapitalization in 2011, the Treasury has offered to buyback about 163.9 million shares for an average price of $30.50, modestly above the Treasury’s break-even of $28.73 per AIG share, thereby aggregating $5.0 billion.

While AIG intends to repurchase 98.4 million shares for $3.0 billion, the remaining $2.0 billion worth of stock will be raised through open market operations. In addition to the $5.0 billion stock offering, the underwriters are granted a 30-day option of buying another 24.6 million shares for $750 million.

The total stock sale will in turn bring down the Treasury’s stake in the company to 55% from the prior 61%, while the former will still own about 1.06 billion shares of AIG. Including the latest repurchase, the company has bought back shares worth $8 thus far in 2012.

The rating agency is also optimistic about this latest sale since AIG is using the funds gained from its recent equity interest repayment of $6 billion in Maiden Lane III and from the sale of other assets in this investment portfolio. Another $1.9 billion of cash inflow is due in August, while the remaining will be gained in the future.

Consequently, as of June 2012, AIG’s Direct Investment book (DIB), a runoff portfolio which also includes the interest of Maiden Lane III had excess liquidity worth $5 billion, while more than 50% of DIB’s debt is scheduled to mature in next 5 years.

Additionally, AIG’s total financial leverage of 33% and pre-tax interest coverage of 3.0x at the end of the second quarter of 2012 is sustainable, according to Moody’s. Further, operating cash flow surged to $1.63 million from cash outflow of $3.54 billion in the prior-year period.

Hence, the company need not use its cash and other fund sources apportioned for operations currently. Conversely, these fund sources enhances the company’s capital flexibility. Going ahead, the simultaneous improvement in the company’s credit curve and earnings potential from Chartis and SunAmerica should provide the required buoyancy for long-term growth.

As a result, Moody’s is quite optimistic about the company’s core earnings and underwriting profitability for the rest of 2012. Through some consistent debt reduction and improvement in core operations in the next 12–18 months, AIG is likely to reduce its financial leverage to below 30% and augment its pre-tax interest coverage to mid-to-high single digits.

Overall, we believe amidst the macro-economic factors and interest rate volatility, AIG has the potential to liberate itself from the clutches of the government, while also being able to maintain a strong and competitive business profile in the future. Currently, AIG carries a Zacks Rank #2, which implies a short-term Buy rating although the long-term recommendation remains Neutral.