The most common case for a local address is to denote a user's mailbox. This mailbox is located in /var/spool/mail and has the name of the user. It is owned by her, with a group of mail, and has mode 660. If it does not exist, it is created by smail.
Note that although /var/spool/mail is currently the standard place to put the mailbox files, some mail software may have different paths compiled in, for example /usr/spool/mail. If delivery to users on your machine fails consistently, you should try if it helps to make this a symbolic link to /var/spool/mail.
There are two addresses smail requires to exist: MAILER-DAEMON and Postmaster. When generating a bounce message for an undeliverable mail, a carbon copy is sent to the postmaster account for examination (in case this might be due to a configuration problem). The MAILER-DAEMON is used as the sender's address on the bounce message.
If these addresses do not name valid accounts on your system, smail implicitly maps MAILER-DAEMON to postmaser, and postmaster to root, respectively. You should usually override this by aliasing the postmaster account to whoever is responsible for maintaining the mail software.