* Airline reported Kenya's biggest corporate loss in 2016
* Air France KLM stake to shrink to under 8 percent
* Minister cites "business case" for restructuring (Rewrites throughout)
NAIROBI, Nov 13 (Reuters) - Kenya's government converted some loans to Kenya Airways into equity to lift its stake to nearly 50 percent in an effort to return the carrier to profitability, the finance minister said on Monday.
The airline, also part owned by Air France KLM, is restructuring to cut debt and reduce pressure on cash flow.
Kenya Airways posted the country's biggest ever annual corporate loss of 26 billion shillings ($251 million) in the financial year 2016, as it reeled from a slump in travel and high financing costs after purchase of new Boeing planes.
The government, which offered contingent guarantees of $750 million for the airline's debts, would convert $185 million of its loans into equity, while 11 local lenders would also convert part of their loans, Finance Minister Henry Rotich said.
The agreement would increase the government's shares to 48.9 percent from 29.8 percent while banks would get a 38.1 percent stake, through a special vehicle, he said.
Air France KLM's 26.7 percent stake would be diluted to 7.8 percent, the minister told a briefing where he signed documents for the government transaction. Representatives of Air France KLM were not at the briefing to comment on the move.
Rotich said the government expected a return once the carrier was back on its feet and in a position to attract a strategic investor.
"There is a business case for a restructured Kenya Airways," Rotich said, adding that the 10-year life of the debt guarantees offered "sufficient time to bring on board a strategic partner."
The government and banks still have outstanding portions of debt to be converted into equity at a later date, they said.
They have applied to the market regulator for exemption from making a take-over offer, in line with regulations, since the transaction was aimed at rescuing the carrier.
Michael Joseph, a respected telecoms executive, took over as chairman of the board last year, overseeing the hiring of a new chief executive, Sebastian Mikosz, who helped turn around Poland's ailing national flag carrier LOT Polish Airlines.
Mikosz replaced Mbuvi Ngunze in June.
Kenya has been investing in new facilities at its main airport in Nairobi, seeking to increase its appeal as a hub for business and leisure travelers after fire gutted the main arrivals terminal in 2013.
U.S. investment banking firm PJT Partners, was hired last year by Kenya Airways to advise on restructuring the airline's balance sheet and long-term capital raising. It advised on the debt to equity swap completed this week. The government also took guidance from a study by U.S. consultants Seabury.
Kenya Airways shares fell 1.8 percent on Monday to close at 5.55 shillings per share, extending losses since climbing to a five-month peak of nearly 6.40 shillings this month but still well off their 2016 low around 3.30 shillings.
"It is a hefty dilution," said Aly Khan Satchu, an independent trader and analyst.
($1 = 103.5000 Kenyan shillings) (Additional reporting by Maggie Fick; Editing by Edmund Blair)