Your company is not paying you to be a pal. Implicit in Joe Strazzere's comment is that being "both" a pal and a Team Lead is not an option in this case.
You should be honest, since you should generally be honest. But really there are two perspectives that you don't seem to be considering that, for me at least, would by themselves be completely decisive. Particularly the first.
First, how does this look to others? In fact, how would an analogous situation look to you. Let's say your boss has another Team Lead who he's "pals" with but who significantly under-performs. The boss makes up for this under-performance by helping the "pal" out, lightening their load, and generally being more lax. How would you feel about this situation? Maybe you think it's no big deal, but will you still think that way if the boss complains about under-performance on your part or states that you need to work over-time to meet department goals? Maybe such things would still not bother you, but flagrant double standards bother many people. Certainly, it is demoralizing to others.1
Next, is lying about or generally attempting to keep your friend in the same role actually in your friend's interest? If this role is a bad fit, it may be better for them to start redirecting their energy into a more productive route. Even if this is beneficial to them in the short-term, what happens when you (or they!) move on to a different job? Suddenly, they find out what they thought was adequate performance isn't, and now they're out of a job and maybe can't get a comparable one. Perhaps they've already adjusted their standard of living to the level of income the role they are not qualified for brings in. In this case, they may have spent months or years failing to build a stable base for their career.
And an extra third perspective, hearkening back to my first sentence: unless you treat any over-and-above effort you spend on your friend as not "billable" (i.e. you work extra hours to make up for that time), your company is now paying the cost for two developers but getting less than the output of two developers. And you want to actively deceive them about this. This is unethical. If you want to give extra help to your friend, do it outside of work.
To explicitly answer the title question: you should endeavor to treat this developer during work the same as you would if you did not have a better than usual relationship with them. In particular, you should endeavor to treat this developer like you would any of the other developers. This likely will include some degree of mentorship but certainly doesn't include doing their work for them and lying about their performance. Feel free to pour as much time as you want into helping this developer outside of work. Personally, I think you should give this developer as clear and honest of an appraisal of their skills and progress as you can if you are going to mentor them. I, personally, would tell them outright that, if asked by management, this is the appraisal I would give.
You don't have to work together to be friends. (So the implicit message I read into Joe Strazzere's comment is wrong; you can be a pal and a Team Lead if you decouple work and friendship. Of course, if your friend views the friendship as contingent on you providing extra help and behaving unethically then maybe you should reevaluate whether you want this "friendship".)
1 In the US military, it's not only illegal to show favoritism to subordinates, it's illegal to even create the appearance of doing so, even if no actual favoritism occurs.