The first thing you need to understand is that shepherds are notoriously territorial, and I’m not surprised at all at his reaction to a loose dog coming in to his territory. Second, prey drive is a real thing, and again, GSD’s are notorious for this as well.
Your dog protected his territory, and his family, from a perceived threat. Not only that, but he listened to you when you gave a release command. That’s awesome. I would be concerned if he wasn’t able to be called off the other dog.
I’ve mentioned in another post recently that my GSD was on a lead in my front yard, while I was doing some gardening. Three small dogs came running into our front yard yapping their little yappers off. A black pug charged my GSD, and my GSD grabbed the pug by the haunches, and began the death shake. I gave her the “drop it” command, followed quickly by the “leave it” command, and that’s exactly what she did. The three dogs then ran off, the pug crying and screaming. I didn’t look for the owner of the dogs, I didn’t care. That may sound harsh and make me seem like a crap person, but I manage my dogs. If my dogs got out and got injured, that’s on me, not the person that owned the other dog.
Your dog wasn’t in the wrong, and the people’s reaction to watching the whole thing and not caring one bit just proves it’s likely to happen again and again. They think it’s no big deal, they have little dog syndrome, and let them run loose because they don’t care!
I wouldn’t look at your GSD in a negative light, he did his job, and did it well. He’s not going to turn into some hungry beast and start going after kids and other pets in the home.
As for the reactivity on walks, that is an issue that I would address, but I wouldn’t worry about him protecting his own yard and family.
I’m sure you’ll get a lot of different advice here, and I may be in the minority on this one, but that is what is so great about this forum, you’ll get a lot of varying advice, and you can learn which fits your style and what’s best for your specific situation.
Lots of luck, and keep working with a trainer on the leash issues.