Cake: Grease and flour three 9-inch layer pans.
Preheat oven to 350°.
Blend cake mix, pudding mix, water, eggs and oil in large mixing bowl.
Beat at medium speed with electric mixer for 4 minutes.
Stir in coconut and walnuts.
Pour into prepared pans.
Bake 35 minutes.
Cool in pans for 15 minutes, then remove from pans and cool on rack.
Frosting: Melt 2 tablespoons butter in skillet.
Add coconut; stir constantly over low heat until golden brown.
Spread coconut on absorbent paper to cool.
Cream 2 tablespoons butter with cream cheese.
Add milk and sugar alternately, beating well.
Add vanilla; stir in 1 3/4 cups of coconut.
Spread on tops and sides of cake layers.
Sprinkle with remaining coconut.