(Corrects securities affected to $64 billion in 1st paragraph; error first appeared in update 2)

NEW YORK - State regulators are taking control of some of U.S. bond insurer Ambac Financial Group Inc's worst assets, the company said on Thursday, a move that affects some $64 billion of complex debt securities.

Regulators in Wisconsin, where Ambac's main insurance unit is legally based, ordered the insurer to set up a separate account to house assets that have generated, or are expected to generate, big losses.

I am taking action to protect policyholders, including investors in thousands of state and local municipal bond issues and other public finance securities, Wisconsin Insurance Commissioner Sean Dilweg said in a statement.

Dilweg received court approval to temporarily prevent Ambac's main unit, Ambac Assurance Corp, from paying out claims on the assets. Ambac has been paying out $120 million a month on some of these assets.

These are not surprising actions, given what we have seen over the last couple of years, said Morningstar senior analyst Jim Ryan.

Bond insurers like Ambac charge bond issuers a fee and in exchange guarantee bonds against default. If guaranteed bonds do default, Ambac must step in to make interest payments and ultimately repay principal.

Ambac's capital levels have become severely strained by the mortgage crisis, which forced it to make big payouts on a number of complicated repackaged mortgage bonds and other instruments.

Bond insurers broadly suffered from making big bets on the mortgage market, which took them away from their main business of guaranteeing bonds issued by states and cities.

Like its larger rival MBIA , Ambac in 2008 lost the coveted triple-A credit rating it depended on to insure a wide range of bonds. Both companies have struggled to write new business since then.

REPACKAGED DEBT

The segregated account will include guarantees against default that Ambac sold on mortgage securities, repackaged consumer loans known as collateralized debt obligations of asset-backed securities, and other instruments.

Ambac Assurance Corp will put $2 billion of notes into the segregated account, which will in turn be used to help pay claims.

The Wisconsin Office of the Commissioner of Insurance (OCI) will administer the segregated account. Any losses will still be borne by Ambac.

The OCI has experience administering other insurance companies, although these have been far smaller entities than the Ambac segregated account, according to a statement on a Web site set up to answer Ambac policyholders' questions about the arrangement. But OCI has done its homework and it's prepared, according to the statement.

Ambac does not believe the segregated account rehabilitation constituted an event of default under its bond indenture and said it was highly unlikely that AAC would be able to make dividend payments to Ambac for the foreseeable future.

Management believes that it will have sufficient liquidity to satisfy its needs through the second quarter of 2011, Ambac said.

The company said it is open to renegotiating its debt through a prepackaged bankruptcy.

Shares in Ambac fell 23 percent to 61 cents. Shares in MBIA were down 2 cents, or 0.3 percent, at $6.38.

(Reporting by Dan Wilchins and Elinor Comlay, Additional reporting by Sakthi Prasad in Bangalore; Editing by Dave Zimmerman and Derek Caney)

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