Have you tried debugging this in flex builder or eclipse?
The most likely candidate for your null reference error is the 'item' argument passed to namer(). The tree component does pass a string through to the labelFuntion method but it may not be a string that can be converted to an xml object. I'd definitely check that first.
The other thing that I can see is wrong is that you are accessing localName as if it's a property. It's actually method so you should be calling it by nodeName.localName(). Edit... this is incorrect now as i didn't realise nodeName was of type QName. localName is actually a property of this type. appologies
Edit: also your Tree component has a dataProvider of
dataProvider="{treeData}"
From the example you have given it doesn't look like treeData exists. Should that be fullXML?