* Files for bankruptcy with $1.68 billion in liabilities
* Company had been in talks with bondholders
* Shares quoted down 65 percent at 20 cents after market (Updates with background paragraphs 8-13)
By Tom Hals
WILMINGTON, Del., Nov 8 Ambac Financial Group Inc ABK.N, which was the second-largest U.S. bond insurer before suffering huge losses on risky mortgages, filed for Chapter 11 bankruptcy on Monday.
The company, which filed in Manhattan bankruptcy court, said it had liabilities of $1.68 billion. The company's shares plummeted in after-hours trading to 20 cents, down from 52 cents at their close on the New York Stock Exchange.
Ambac faltered after it began chasing higher profits by expanding beyond municipal bond insurance and insuring riskier debt. That move backfired when the housing market crashed and credit markets tightened.
Ambac said it was unable to raise needed capital and failed to reach an agreement with senior bondholders that would have allowed it to restructure through a prepackaged bankruptcy.
A prepackaged filing allows for a speedy restructuring.
Ambac said it agreed to a nonbinding term sheet that will serve as the basis for further talks with bondholders.
"That may allow the company to emerge from bankruptcy more expeditiously," Ambac said in a statement.
The company also said it is planning to ask the bankruptcy court to restrict transfers of the company's stock and claims against the company, a move that will allow it to preserve a tax benefit worth about $7 billion.
At its peak, Ambac Financial Group was the second-largest bond insurer in the world, having guaranteed the timely payment of interest and principal on more than $550 billion of debt.
The bond insurer was a favorite of short-sellers for much of the last decade, who insisted that the company had too little capital to cover its exposure. Ambac routinely dismissed these concerns, saying as recently as mid-2008 that "we have got more than sufficient capital against any claim."
In March, Wisconsin Insurance Commissioner Sean Dilweg, who regulates the company's Ambac Assurance Corp unit, seized $64 billion of Ambac's worst assets and placed them in a segregated account.
On Oct. 8, he filed a rehabilitation plan for those insurance policies, which would pay policyholders a combination of cash and notes for their claims.
Hedge funds including Aurelius Capital Management LP and King Street Capital LP that say they own more than $1 billion of residential mortgage debt insured by Ambac Assurance are suing Ambac to stop it from moving assets from that unit.
The case is In re Ambac Financial Group Inc, U.S. Bankruptcy Court, Southern District of New York, No. 10-15973. (Additional reporting by Dan Wilchins and Jonathan Stempel in New York; Editing by Steve Orlofsky)