Troy Matteson, who had the lead after 36 holes, posted a 1-over 73 to fall back into a tie for third place with Chris Couch at 9-under-par 207. Brandt Snedeker, Chris Tidland and Sean Pacetti were one shot further back at 8-under-par 208.
Smith parred his first four holes at the TPC at Virginia Beach before he picked up a birdie at the par-5 fifth. Smith then birdied the par-5 eighth to make the turn at 8 under.
Smith, who could celebrate his 41st birthday with a victory on Sunday, added a birdie at the par-4 11th and made it two in a row with a birdie at the par-5 12th. He continued his fine play with back-to-back birdies starting at the par-4 15th.
He was cruising down the stretch until a bogey at the par-4 18th shrunk his lead to a single stroke. Nevertheless, Smith held on to lead after 54 holes for the first time in his career on the Nationwide Tour.
'I hit it a lot like the day before,' said Smith. 'I hit a lot of greens and putted the ball really well. It's nice to be in the lead obviously and tomorrow will be another tough day and a lot can happen. It's the kind of golf course where there's trouble lurking.'
Watson stumbled out of the gate with a bogey at the first, but he recovered well with two straight birdies from the fourth. Watson then eagled the par-5 eighth and tallied a birdie at the 11th to jump to minus-9.
The 26-year-old found trouble with a bogey at the par-3 13th, but he countered with back-to-back birdies starting at the par-5 16th for a round of 67.
Matteson had four birdies and two bogeys over his first nine holes, but he had a rocky back nine that left him two shots off the pace. The 25-year-old bogeyed the 10th and the 12th before a birdie at the 16th moved him to 10 under. Matteson then bogeyed each of his last two holes to finish in a tie for third.
Boo Weekley, Steve Larick, David Branshaw and Brendon de Jonge share eighth place at 7-under-par 209. First-round lead Dave Christensen followed at 6-under-par 210 along with Jim McGovern and Chris Nallen.