From MozillaZine Knowledge Base

In Thunderbird and the Mozilla Suite, "Local Folders" is the name given to the set of mail folders at the bottom of the folders pane. Many newcomers to Thunderbird or the Mozilla Suite don't know what these Local Folders are for, or why they're called that in the first place.

Uses for Local Folders

• For people who have an IMAP e-mail account, where mail is stored "remotely" (on the server) rather than being downloaded and stored "locally" (on your own computer), Local Folders provides a convenient place to store messages locally when desired. If you select a remote folder for offline use Thunderbird stores a copy in Local Folders. If you enable auto-save of drafts its less likely to interfere with your typing if you store it in Local Folders.
• If you use Thunderbird's Global Inbox for your POP3 e-mail accounts, your mail for those accounts will be downloaded into Local Folders.
• When you compose a message and save it to be sent later ("File -> Send Later"), it will be saved in the Unsent Messages folder in Local Folders.
• Sent newsgroups messages are saved in Local Folders by default.
• Some people use Local Folders as a place to archive old messages, so that their actively used mail folders are smaller and less cluttered.
• If you reconfigure several profiles to use a common directory for Local Folders outside of the profile its much easier for the users to share mail messages.

Renaming Local Folders

To change the name of Local Folders, just right click on "Local Folders" in the folders pane, choose "Properties", and then in the dialog that pops up, enter the new name in the "Account Name" field. Alternatively, you can go to "Tools -> Account Settings" (in Thunderbird) or "Edit -> Mail & Newsgroup Account Settings" (in Mozilla Suite), then click on "Local Folders" in the left-hand pane, and type in the new name in the "Account Name" field.

Moving the storage location for Local Folders

By default, Local Folders is stored in your profile folder, as a subfolder of the "Mail" folder. To change this storage location, see Moving your mail storage location for instructions.

Getting rid of Local Folders

The easiest and safest way to hide Local folders is to use an option in the Mail Tweak extension. However, hiding Local Folders might cause problems with unsent messages (which normally get stored in Local Folders) or other program behavior. Thunderbird doesn't handle surprises well. It's usually better to ignore Local Folders instead of trying to hide them. You can collapse it to one line in the folder pane.

You could also edit the prefs.js file file in your profile folder per [1] or [2] to get rid of it. That works, but it requires you to understand how account settings are stored in the prefs.js file and any mistakes can seriously mess up your profile. If you try it, be sure to backup your profile first. It also has the disadvantage of being much harder to undo - at least with the Mail Tweak extension you can uncheck the "Hide Local Folders" setting if it causes problems.