In their 2012 Annual Report
(see Note 5) iShares says
1. They lend to approved borrowers (brokers, dealers and other financial institutions). They don't say exactly who.
2. The borrower puts up collateral consisting of cash, an irrevocable letter of credit, or securities issued or guaranteed by the U.S. government in an initial amount of 102% of the current value of what they borrow, maintained at a value of at least 100% of the current value of what's borrowed.
3. They may reinvest the collateral in "certain short-term instruments ... in one or more joint accounts or money market funds, including those managed by BFA [Black Rock] or its affiliates. Each Fund could suffer a loss if the value of an investment purchased with cash collateral falls below the value of the cash collateral received."
4. As of Feb 29, 2012 any securities on loan were collateralized by cash, and the cash was invested in money market funds managed by BFA. They don't say exactly which money market funds.
5. Securities lending income (reported elsewhere in the report as $1.5M) is the income earned from the investment of the cash collateral, net of fees and other payments to and from borrowers, and less the fees paid to BTC [Black Rock] as the lending agent.
Elsewhere, they say about $1B of the $4B of TLT's net assets are currently loaned.
Also elsewhere (Note 2), they say the lending agent fees are 35% of the income derived from lending, and were $823K.
The bottom line seems to be that 25% of TLT's assets are actually invested in money market funds, but they collect all of the bond interest plus 65% of the interest the money market fund is paying.
[edit: $1B of $4B, not $1T of $4T]