I'm not sure where my stories come from, but I have a pretty good idea generally how my characters develop. I have always been an observer. I prefer to sit on the sidelines and watch people wherever I go. As I observe the people around me, I try to think of where they might be from and where they are going. I make up stories about how they are related to one another and what their jobs are.
Interesting-looking people catch my eye and I try not to stare while I try to memorize their features for later reference. I must have thousands of "interesting-people" characteristics floating around in my mind. Occasionally some of those interesting-looking things congregate and a new character emerges from my subconscious. Most of the time I start describing the character and jotting down back story for some time before I know the character's name. In my first draft of my current WIP, I didn't know the main character's name until she introduced herself to another character in what started out to be Chapter 3.
Most of my characters end up to be aggregates of a constellation of physical and personality traits that I have collected over the years from watching people. For each principal character, I build in some aspect of my personality for a touch of realism and so I can better identify with the character.
After writing more than a dozen novels, I've found it interesting to notice that there are certain physical traits, I especially like to use. I have always liked red hair -- except for that ugly purplish henna-colored hair. Several of my favorite characters have red hair. I like curly, wild hair. Several of my characters have seriously uncontrollable curly hair. I like tall men who are in good shape, but but I do not like bulging muscles. Virtually all of my characters (male and female) characters are in good shape from running or other "cardio" exercises as opposed to body building. All of my male characters are tall. Most of my female characters are tall, too, with a couple of notable exceptions. I like blue eyes. Most of my characters have blue eyes, except for one who has very striking green eyes. The male protagonist in my current WIP (working title Second Chances) has brown eyes which I keep wanting to change, but the female protagonist really loves his doe eyes, so I have resisted changing the color to avoid upsetting her. (She has enough problems without me screwing around with her man.)
I love watching people do quirky things. I try to give each of my principal characters one unique quirk: getting up early; serious coffee habit; aversion to meat; passion for music or certain kinds of food or dancing.
The exact process of how all these various body parts and personality quirks aggregate themselves into characters who are as real to me as actual people is still a mystery, and I hope it stays that way. I like to think of it as the the Magic of my Muse.