app/code/core/Mage/Adminhtml/Model/System/Config/Source/Allregion.php

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<?php
/**
 * Magento
 *
 * NOTICE OF LICENSE
 *
 * This source file is subject to the Open Software License (OSL 3.0)
 * that is bundled with this package in the file LICENSE.txt.
 * It is also available through the world-wide-web at this URL:
 * http://opensource.org/licenses/osl-3.0.php
 * If you did not receive a copy of the license and are unable to
 * obtain it through the world-wide-web, please send an email
 * to license@magentocommerce.com so we can send you a copy immediately.
 *
 * DISCLAIMER
 *
 * Do not edit or add to this file if you wish to upgrade Magento to newer
 * versions in the future. If you wish to customize Magento for your
 * needs please refer to http://www.magentocommerce.com for more information.
 *
 * @category   Mage
 * @package    Mage_Adminhtml
 * @copyright  Copyright (c) 2008 Irubin Consulting Inc. DBA Varien (http://www.varien.com)
 * @license    http://opensource.org/licenses/osl-3.0.php  Open Software License (OSL 3.0)
 */


class Mage_Adminhtml_Model_System_Config_Source_Allregion
{
    protected $_countries;
    protected $_options;

    public function toOptionArray($isMultiselect=false)
    {
        if (!$this->_options) {
            $countriesArray = Mage::getResourceModel('directory/country_collection')->load()
                ->toOptionArray(false);
            $this->_countries = array();
            foreach ($countriesArray as $a) {
                $this->_countries[$a['value']] = $a['label'];
            }

            $countryRegions = array();
            $regionsCollection = Mage::getResourceModel('directory/region_collection')->load();
            foreach ($regionsCollection as $region) {
                $countryRegions[$region->getCountryId()][$region->getId()] = $region->getDefaultName();
            }
            uksort($countryRegions, array($this, 'sortRegionCountries'));

            $this->_options = array();
            foreach ($countryRegions as $countryId=>$regions) {
                $regionOptions = array();
                foreach ($regions as $regionId=>$regionName) {
                    $regionOptions[] = array('label'=>$regionName, 'value'=>$regionId);
                }
                $this->_options[] = array('label'=>$this->_countries[$countryId], 'value'=>$regionOptions);
            }
        }
        $options = $this->_options;
        if(!$isMultiselect){
            array_unshift($options, array('value'=>'', 'label'=>''));
        }

        return $options;
    }

    public function sortRegionCountries($a, $b)
    {
        return strcmp($this->_countries[$a], $this->_countries[$b]);
    }
}

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